See U-shaped recovery in 2-3 months, buy largecaps: IL&FS

India's large current account deficit (CAD), falling manufacturing growth and impending earnings, speculated to be weak, can force Nifty to land in the 5400-5450 region, says seasoned market expert Vibhav Kapoor, director at IL&FS. 

He says India is passing through the worst economic cycle which will be fully factored in by mid-May when the last of India Inc member would have announced its numbers.
Kapoor, however, is optimistic of a U-shaped recovery from April-June quarter onwards, triggered by improving inflation, lower CAD and better growth. Nifty can go up to 6000 on the upside, he said.
For those investing in the market, Kapoor's advice is in line with other experts, i.e to avoid midcaps and look at largecaps names from IT, Pharma, FMCG and private banking space. Below is the edited transcript of his interview to CNBC-TV18. Q: We saw a bit of a pullback but market generally has been quite weak and underperforming for the last many weeks?
A: Yes, we saw pretty bad economic data over the past several weeks and months now. The recent CAD and PMI data were bad. Going forward the market expects the result season to be poor. In the last quarter, the market came down after the results and I don't think this quarter to be any better. I think the market is trying to factor that all in and it will take a few weeks before that happens. Q: Do you think 5600 is safe as a bottom or could it get violated you think in the next few weeks?
A: The lower end could be in the region of 5400-5450. Q: What could drive that, disappointment in earnings or just the general macro environment?
A: The macro environment is pretty poor and the result season month could be a trigger for the market to come down to the levels that we are talking about. Having said that right now we are probably passing through the worst of the economic data points. Going forward over the next few months we are likely to see better data both in terms of growth as well as may be a lower CAD and inflation dipping a bit.
So, probably we are going through the worst of the economic data cycle right now and the impact of that will fully get factored in by around mid May when all the results would be out. Q: Don't you fear that this is going to be a more prolonged or protracted recovery cycle than one thought earlier and therefore the markets might have bearish kind of groove for two-three more quarters?
A: Well, I don't expect a V-shaped recovery to happen in the economy, I think it will be U shaped. However, the steps taken by the government in terms of bringing down the fiscal deficit and also increasing diesel prices etc, will show some impact in next two-three months in terms of better activity in the economy.
In terms of growth, January-March quarter was very bad so there was cut in government expenditure, much of that should get reversed as we move closer to April-June quarter. However, there is a risk of downsides in terms of high inflation, the Food Subsidy Bill which will come in the later session of Parliament. The market could remain in a protracted range for sometime. But, I don't see at this point of time a risk to 5300-5450 levels. Q: On the upside where could the line be drawn for the range that you mentioning?
A: Over the next two-three months the maximum upside would be 6000. I don't see the market moving beyond that for the time being.
_PAGEBREAK_ Q: What do you expect from the midcap end of the market? Many of these stocks are trading at close to 2008 lows and we are about to enter an earning season which in the last quarter was not very kind to the broader market?
A: Midcap is not the correct segment to be in when the economy is doing bad because these companies are small and are not able to withstand the negative pressures from the economy be it in the form of cost, interest rates, demand etc. In this environment, I would rather stick to the large caps and the midcaps on a very selective basis.     Q: In large caps too, the preferred list is getting narrower with every passing day. It is just IT, handful of FMCG and pharmaceuticals. Would you just stick to that or is there anything outside it that one can buy?
A: I think it is too early to go outside that list. One can add private sector banks to that list, they are doing pretty well and in the last results some three-four sectors came out with decent numbers. Given the fact that the economy is still not showing any great signs of picking up, I would stick to these three-four sectors. Q: What is your view on yesterday's Reliance Communication deal? Would you get excited?
A: It is too early to comment and it is a small deal. Q: Today, power stocks are up quite a bit. Is that a space that you like because some of them seem to have got some relief from the Central Electricity Regulatory Commission (CERC)?
A: Yes, going forward power could be a better sector. We are seeing some reforms happening both in terms of the State Electricity Boards (SEBs) and power tariffs.
However, there are still a large number of problems in terms of the coal pooling, fuel, land etc. So one could be very selective in this space, select stocks are attractive and are good on valuations. Q: What do you see for retail participation for the rest of the year because for a lot of people we speak to they had point out that if we just take out 20-25 stocks in the market the rest of the market seems to be in a bear market so they are staying away?
A: True, no doubt about that. Only select sector like IT, private sector banks and FMCG have done well and that is where the index is where it is because the broader market is in a much worse situation. I don't think there will be much retail participation till elections. Political and economic uncertainty will keep the retail away. It is only after elections next year that one could hope the retail sector to come back.
_PAGEBREAK_ Q: What do you do in terms of asset allocation? What do you do between now and the next elections?
A: I would increase equity allocation if market touches 5400 level or thereabouts, because from that level one can expect a possible decent upside of around 10 percent over the next five-six months. Though the corporate sector is not doing too well, but it is still growing at 10-12 percent in terms of profitability. So as we go forward the valuations will begin to look cheaper. But if bond yields go up a little more, they are already back to 8 percent so at about 8.1-8.15 percent, one would like to increase allocation to the bond funds and the gilt funds. Q: What is your view on gold; it has suffered quite a few losses?
A: Gold is performing very badly, it is probably getting into sort of very long-term correction and it is not unnatural given the fact that the US economy has started to do well and all the fears and the problems that we had in the global economy have started to fade away a little bit and therefore it is no surprise that gold is not doing that well. Q: What about real estate because a lot of the local money has been parked in real estate, is there any threat to that money coming out?
A: I don't know. I am not an expert on real estate but a lot of money is stuck in that space and I don't see that coming out into equities at this point of time. Q: So you are saying that there is no hope for a major revival in interest for equities as an asset class till next year?
A: Definitely not. Q: What is the biggest risk to this market as we wait deeper into the year from a serious downside point of view?
A: Inflation and growth rates are two big risks. One need to see how much impact will increase in diesel and LPG prices will have on inflation. A cut in fiscal deficit normally should have a beneficial impact on inflation going forward and should bring it down. If it does not happen because of government spending or rural spending and inflation continues to remain high, then there could be severe problem because it will be difficult for interest rates to come down and then growth could slow down further. Q: What possibility do you attach to a scenario where growth does not recover over the next couple of quarters and that leads to FIIs dumping Indian stocks because they get disappointed and it has been their flows which have held the market up so far?
A: Yes, I think growth will recover a little bit because what we are seeing in the last two quarters is partly because of a cut in government spending. So, as that revives going forward from April onwards, I think we will see some improvement.
Although, I am not in the camp where one would expect 6.5 percent growth for FY14, I think it should be lower than that but some recovery would happen. Therefore, those lower levels in the market valuations would start to look okay. Having said that there are certain risks and the risk of FIIs, we have seen a huge amount of money flows coming in the last several months. The flow could slow down not only because of India, but other global reasons. If that happens then the vicious cycle of the rupee depreciating etc could restart again and that would be a pretty big danger.   Q: Given expectations of fairly tepid earnings growth in FY14 as well, people are talking about 9-10 percent earnings growth. Do you see the possibility of any further re-rating upwards this year?
A: Yes, that is quite unlikely particularly given the fact that later in the year the election fever will start to pick up and the political uncertainty will heighten, so a re-rating of the market beyond 13-14 P/Es looks very difficult. Anyway the earnings estimates have been cut.
I think earnings growth was estimated at about 13-14 percent a few months ago. That has come down to about 10 percent and even at current levels the market is now probably trading at about 14 times FY14 earnings. So, strong re-rating from current level is unlikely.