Beware of interest rate sensitive stocks, says Daiwa MF

Excerpts from Markets Midday on CNBC-TV18 Watch the full show »

Inflation for the month of May rose a higher-than-expected 9.06% as against 8.66% on a month on month basis (MoM). Inflation, as measured by the Wholesale Price Index (WPI), stood at 8.66% in April. It stood at 10.48% in May, 2010.

N Sethuram, CIO of Daiwa Mutual Funds, in an interview with CNBC-TV18 gave his reading of the market post inflation numbers and his outlook on how sector-specific stocks would play out ahead of the monetary policy.

Below is a verbatim transcript of his interview with CNBC-TV18's Anuj Singhal and Latha Venkatesh. Also watch the accompanying video.

Q: What have you made of the inflation numbers and would you say that still remains the big risk for the market?

A: Yes. Inflation is very clearly a big risk for the market now. The options seem to have been closed. The option for RBI for a pause or something in interest rates is closed now. RBI would definitely have to take some more rate actions. The bigger worry is that inflation does not seem to have been impacted by any of the measures so far taken by the RBI. So, obviously certain bolder measures have to be taken which can actually impact the growth in the economy. That's a bigger concern now.

Q: What is your stock strategy at this point in time? If you are expecting a more hawkish Reserve Bank, what would you say about growth and do you, therefore, think that depth of 5300 which was protected could be broken into?

A: At this point of time, yes. One would take a slightly negative view on the market because it does appear that RBI is going to continue with rate hike actions. The options for the government to even affect diesel price hike looks a little bit difficult now because that would drive the inflation numbers to double digits which is again a risk.

So, we have a lot of negatives building in into the system. So, for the short term, yes, the market sentiment looks a little negative. The valuations are such that I don't see too much of a downside from these levels. But there is definitely no upside on the market. I don't see anything that can cheer the markets up from these levels immediately.

Q: It is still a 5,500 Nifty level and the Bank-ex has made some ground in the past six months or so. Would you be selling bank stocks now or would you be selling autos and realty if you had them in your portfolio?

A: I think the interest rate sensitive would be more impacted like auto and the realty stocks because very definitely interest rates are heading higher. That is something which they have to factor in. The second factor is that demand is going to get impacted because RBI would take a little more drastic action now. If demand gets impacted, then a lot of sectors are going to face the brunt of it.

Q: In particular what about auto sector because that is one space where we have seen some pressure at least in select stocks?

A: Yes, the pressure would be getting built up. I think it may get a little bit accelerated because of today's news flows. Auto is definitely a slight negative at this point of time. I think a balanced portfolio is what is called for now. I don't see any sector where one can go gung-ho and go completely overweight on. I think the positive sectors at this point of time still would be an IT where none of these factors would significantly impact their performances.

The negatives would be all the interest rate sensitive ones such as auto, real estate and manufacturing. Manufacturing could get under pressure because if growth factors are going to get downsized, then that is one area where one needs to look at. One has to also weigh the fact that government is not really active in terms of either its disinvestments or in terms of reform measures. We need to wait and watch what's happening because this is also the last year of this five year plan.

Q: Do you expect that you could see some outflow of funds this time around now that clearly the inflation trajectory itself has surprised some people who were expecting the May number to be a little better than the April number? It has come 40 basis points higher so do you expect that a little bit of selling could come and would you worry therefore about the resilience you are seeing in the broader markets that has been holding up for some time now?

A: I don't see a major sell off because in terms of valuation, markets have already factored in a fair amount of de-growth in terms of the economy. All these things have been already factored into the market. Markets are trading at fairly cheap levels at this point of time.

So, from these levels I don't see a major sell off, which could crash the markets from today's levels. So there could be some amount of continued selling from FIIs. FIIs have been positive in the last month but there could be a trend where they would still stay aware little bit from Indian markets given their macro numbers.

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