SENSEX NIFTY
Feb 25, 2013, 01.17 PM IST | Source: CNBC-TV18

Biased towards rate sensitives, cyclicals than defensives

The market is unlikely to fall significantly even if the Budget disappoints, says Dhiraj Sachdev, Vice President & Fund Manager, HSBC Global Asset Management.

The market is unlikely to fall significantly even if the Budget disappoints, says Dhiraj Sachdev, Vice President & Fund Manager, HSBC Global Asset Management. That is because the market has not seen a strong enough pre-Budget rally to pose the risk of a sell-off.

In an interview to CNBC-TV18, Sachdev says that corporate earnings could be subdued for one or two more quarters, but sees low inflation as a key positive for the market. He prefers to invest on sectors that are likely to benefit from low interest rates, and sees the market testing new highs by the end of this calendar.

Edited excerpts of the interview:

Q: What is your sense of what the Budget might do for the market?

 A: I think in the run up to the Budget, given the kind of correction we have seen in about 3-5 weeks or so, we are expecting a lot in the Budget itself. It could be the roadmap for the long-pending issues like Goods and Services Tax (GST), Direct Taxes Code (DTC). Lot of hopes will be on the fiscal deficit and twin deficits because this time the government has already built up expectations in the last few months on reforms. We have seen the lowest economic growth in the last decade or so and the third quarter results have been pretty disappointing whether it is on the revenue or the margins or the post-tax earnings.

But the only silver-lining is that we have seen inflation inching down to about 6.5 percent or so in the month of January and we do expect that this could be a gradual decline over the next 12-14 months which means that if there is lower growth and declining inflation, it will only prompt the Reserve Bank of India (RBI) to continue its rate cutting stance.

I think this is the single most important variable for the markets to rally, because it will get rerated due to rotation of money from deposits to equities. So we do believe that post-Budget whatever be the reaction, but eventually the markets will test new highs this year.

Also read: Budget 2013 thrust to be on investments, savings: Citi

Q: What did you make of the banking license guidelines that came out over the weekend and how would you approach some of these Non-Banking Financial Companies (NBFCs)?

A: It is definitely a game changer for NBFCs, because they will have access to low-cost deposits. But it will play out eventually over longer period of time, nothing will happen over the next few quarters or next couple of years.

Q: What is your sense of how deep downside risk could be if the Budget disappoints?

A: One thing clearly is that lot of things have been done outside the Budget, whether it is providing cash subsidy or raising diesel prices. Budget pronouncements may not have a material impact, though there could be knee-jerk reaction over the next couple of days after the Budget is presented. But over a period of time the government actions will have an influencing factor on the market.

As it is, we have not really seen a very concrete pre-Budget rally to warrant any kind of a sharp reaction post-Budget. We have already seen a fairly decent kind of a correction of about 1 or 2 percent in the market on the large caps as well as 8 to 10 percent on the mid and small cap side and retail investors have not really participated. So we do not expect too much of a negative reaction despite not so capital market friendly Budget.

Q: How are you mapping liquidity flows now? Over the last week or 10 days flows have dwindled compared to the very strong gush that we were seeing from the start of the year?

 A: I think we have seen spate of issuances both on the divestment front as well as Qualified Institutional Placement (QIP) and these have been jumbled together in the last few months or so and that absorbs part of the liquidity from the secondary market into the primary market. So that definitely is a negative aspect on the secondary market. We are dependent on Foreign Institutional Investor (FII) flows. So possibly if the Budget continues to be fairly good and the fiscal deficit is managed with concrete growth steps to gradually decline it then FII confidence will be retained and we might see flows eventually coming in, even this year compared to the last calendar year.

Q: Don’t you think that there is a prospect of a deep correction over the next two or three months? By deep I mean 10 percent plus.

A: We do not think so. In the run up to the Budget we have already seen the correction happening. The expectations are already low. Market is light and hollow. Given that we have seen 7 to 11 percent correction in mid and small cap basket it already shows that the market is light in terms of leveraged positions or retail investor participation.

Q: The first few weeks of the calendar year seemed to suggest that it was time to take exposure into high-beta, but those pockets have begun to suffer again. How would you play this sectorally? Would you go back to defensives or is that not such a great tack either?

A: In the first few months itself, contrary to our expectations the defensives have outperformed the cyclicals. The third quarter earnings clearly highlight that FMCG and pharma have sustained some kind of a growth, but the valuations are very rich. So eventually we believe if the interest rate cycle trend continues to behave downwards then the rate sensitives will come back and sectoral rotation will happen in favour of cyclicals, be it autos, banks, selective real estate companies, capital goods eventually. So we are still biased towards rate sensitives and cylicals rather than defensives given their rich valuations.

Q: Do you also expect to see this much disparity in the performance between the mid and small caps, i.e. the broader market versus the narrow universe of the Nifty or Sensex?

A: We have seen a relatively higher beta in mid and small cap compared to large cap and this has been a peculiar basket as far as mid and small caps are concerned. It tends to underperform in a falling market and tends to outperform in a rising market, that is the nature of this beast. This kind of correction that we have seen is not something new. Last calendar year,  we saw somewhere close to 7.5-9 percent correction in the midcap index in February, April as well as July before it saw a peak of about 25-26 percent. So this is virtually the fourth kind of a correction of about 8-10 percent in the last 12-14 months or so and it generally provides a good entry point to our experience.

Q: What is the risk that the kind of disappointing earnings picture that you saw this quarter extends for another two-three quarters which would sap the market of any kind of energy to possibly rerate on the way higher?

A: We may actually see one or two quarters of subdued earnings growth which indicates that the demand environment continues to be sluggish. But the markets do not wait for the earnings to improve; it anticipates that the earnings have bottomed out. So one aspect where the markets will anticipate and precede the earnings phase will be if the interest rate cutting cycle continues. We do expect that 100-125 bps rate cut will happen over the next 12-14 months which means that the markets will anticipate that now there could be gradual recovery in terms of economic growth as well as cost of funds for a lot of capital intensive sectors and businesses will come down. So yes, one or two quarters of pain or sluggishness can continue in the form of earnings, but the markets will anticipate that this is enough and we might actually see gradual improvement.

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