What is ICICI Pru betting on in this consolidating mkt?

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Markets, both globally and locally have been witnessing a continuous up tick since the past few days. But this surge has been caught up in a range. "We are in a consolidation phase," says Nilesh Shah CIO of ICICI Prudential.

Citing reasons for this consolidation, he says the valuations, which are at the higher end coupled with a slowdown in insurance flows will cap the upside for the market and the downside seems limited on account of improving macro fundamentals.

In his interview with CNBC-TV18's Udayan Mukherjee and Sonia Shenoy, Shah talks about his favourite sector and stock picks. He sees values in state-owned power companies, telecom and the cement sectors.

Read the complete transcript of this interview below. Also watch the accompanying video.

Q: Where do you think the market will be after the September-October period?

A: Markets probably are in a consolidation phase rather than going up or down. The insurance flows will get slowed down a little bit because of the changes in the regulation. The supply side is increasing with Coal India 's initial public offering (IPO) and other qualified institutional placements (QIPs) lined up. These are all quality IPOs and will attract investors' money, but there are also large sized IPOs which can whet investors' appetite.

Also in terms of valuation, both on the relative and absolute basis, we are trading above our historical average trading valuation about 17.5 times one year forward earnings. We are also trading at a reasonable premium over the peer group like Brazil, Russia, China Indonesia, Turkey and Mexico. All these things are going to cap the upside of the market.

On the other hand, the downside of the market looks limited because India is growing at a nice pace which is faster than rest of the world. The return on equity for Indian corporates is pretty attractive and all have a domestic consumption driven growth rather than dependency on exports.

The fiscal picture of India is also improving with the 3G auctions. The interest rates are also probably going to remain range bound. Inflation is coming down. The downside seems to be protected based on the improving macro fundamentals and upside probably looks a little bit capped because of the valuation. It creates an ideal scenario for market to remain rangebound for the time being and eventually start moving up.

Q: There has been lot of positive global economic data as well. What does all of these amount to in terms of equity market movement for the globe?

A: Let us keep the global equity flow separately and the global economy separately. Global economy probably for sometime to come, will remain in below potential performance mode. If we see in 1991 when India came under crisis or in 1997 when Asia came under crisis, there was a painful transition. We raised interest rates, we took out liquidity, we depreciated our currency, we cut down government deficits, we cut down wasteful expenditure, we basically inflicted pain on people so that the economy could recover and that was the reason why our economy has recovered after a brief downturn.

When the crisis hit the Western World, the medicine given, is exactly opposite to what we had implemented. They have cut interest rates, they have provided liquidity and they have increased the role of government in every sphere so that the common man doesn't suffer. Because of this their economy has not yet transitioned into a stronger economy, which is why global economists will probably remain below potential performance mode for sometime to come.

If you read the expressions of various central bankers, clearly they are looking at slowing down economy albeit not in a deflation but definitely slowing down economy. Now this scenario creates good position for India, the world is not falling over the cliff but at the same time it is not growing as much as it's potential. In that scenario, India's potential performance in terms of growth will definitely capture investors' attention.

Globally since economies are not doing that well, Central Banks around the world will go the same old fashionable tools of keeping liquidity high and keeping interest rates low. Both these again auger well for Indian equity markets, we will benefit as long as global economies perform below potential but not outright in deflation.

Q: If this is your view of the market now that is fairly rangebound in terms of high beta versus defensives and sectors, how are you positioning yourself?

A: This time we are poised for a bit defensive allocation. We are looking at where the values are left in the stocks and in the sector. Lot of it is a bottom-up analysis rather than top-down. This time the market is a little bit different because the traditional defensives like FMCG probably are priced for perfection and may not prove as defensive in case there is a correction in the market.

We are more focused on bottom-up values today like state owned power companies, values in telecom and cement. It is more bottom-up analysis about companies, their management and their inherent intrinsic values. These are what are available in the market.

Q: You like cement as well. Do you have a positive view on cement stocks, a contrarian call?

A: I think the September end quarterly results for cement companies will be subdued. One, they will be impacted by fairly good monsoon we have witnessed in the last 3 months. It will also be subdued due to price correction. It will also be futile to expect that in December, everything will turn around.

From a price and performance point of view, we think September and December end quarterly results of cement companies will be negative or will be lower than last year. Market is already aware of that. As long as these results are not below what market is expecting, it should not have material adverse impact on stock prices.

We are evaluating cement companies more from a longer term performance point of view where we believe that the economic growth will increase the demand for cement and the oversupply will not result into creation of capacity. Maybe over the next six-18 months, cement cycle will start firming up. From that valuation point of view, today cement stocks provide reasonable opportunity to invest.

Should we invest at one go and become completely overweight cement companies? The answer is no. We have to average ourselves in over probably next three-six months depending on how the prices are.

Q: What is your take on policy related sectors like fertilizers and sugar where the market is getting increasingly hopeful of some affirmative policy action?

A: We definitely welcome regulation of every sector by the government but we detest the control on those sectors which is not market related. For many years we had control on steel prices and it never resulted into development of the steel market in India. The Chinese had an open steel economy and steel market and that's why they are running at a capacity which is multiple of India.

If India has to grow as much as China, we will also have to build steel capacity which is as much as theirs. With steel decontrol that could have never happened. Fortunately for us the Government of India recognized the necessity to decontrol the steel sector and opened up the sectors for private and public enterprises and we have seen the steel sector has grown. It has not grown as fast as China but certainly it has grown much faster than when it was under decontrol.
The benefit of decontrol is clearly manifested in the steel sector. The same experience needs to be replanted in sectors like sugar. Today sugar sector is controlled by government away from market reality. This doesn't augur well for farmers it doesn't augur well for sugar companies; it doesn't even augur well for the consumers like it was not auguring well for the steel sector.

If government decontrols this sector, certainly it will benefit consumers it will benefit sugar companies and its investors and it will also benefit the government. We will be positively looking forward to such deregulation. However, it is difficult to price in whether government will do this or not. We are investing in sugar companies today based on their intrinsic value which is taking a call on sugar cycle and taking a call on the value of their businesses. We are not pricing in for deregulation. If deregulation happens certainly we will benefit from it.