FIIs being overweight is a risk for market: Barclays Cap

Investors should play the differential between stocks to make money in the current market, says Bhuvnesh Singh, Barclays Capital. Macro concerns will impact few parts of the market, largely financials, industrials and materials, he says. But on the other hand, rupee depreciation will help export-oriented sectors like IT, healthcare or import parity sectors like petrochemicals and energy, which could show an upmove, he adds.

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According to him, FIIs are significantly overweight on India. One reason behind that is India’s correction has been largely on the back of currency over the past few months, he says. Second is the reasonable diversity between sectors, he adds. "All companies listed in India are not only oriented to Indian domestic economy, but have a significant part of the market which is more leveraged to external economy," Singh told CNBC-TV18.

Though there is a risk that the Indian markets might not go anywhere, remain in consolidation phase or actually decline going forward, he says. There is also reasonable risk coming because of currency, he adds. Because of which FIIs overweight position on India is a risk for the market, he explains.

Below is the verbatim transcript of Bhuvnesh Singh's interview on CNBC-TV18

Q: How are you reading the setup for the market now after that big rally in September?

A: I think macro concerns will impact few parts of the market, largely financials, industrials and materials. And this part of the market we remain very negative. On the other hand, as currency goes into a longer term trend of slight depreciation every year, we have a lot of export oriented sectors like IT, healthcare or import parity sectors like petrochemicals and energy, which could show an upmove. So, overall I don’t think it’s a simple answer to give on market basis. It’s more between sectors and stocks - there will be a significant differentiation. So going forward investors should play this differential between the stocks to make money in the current market.

Q: We also saw decent foreign institutional investors (FIIs) flows. You have been on road shows, meeting clients. What is your sense of how FIIs are approaching India at these levels?

A: Most of the investors remain significantly overweight on India. One reason behind that is that India’s correction has been largely on the back of currency over the past few months. This is something that has caught investors by surprise. And the second reason is the reasonable diversity between Indian sectors. All the companies listed in India are not only oriented to Indian domestic economy but we have a significant part of the market which is more leveraged to external economy. So this remains in favour.

Q: Given that FIIs are overweight on India, is there a risk of FII selloff or a pullout as macros haven’t improved in the last few months?

A: I think there remains a reasonable risk - that Indian markets go nowhere, remain in consolidation phase or actually decline going forward. There is a reasonable risk coming because of currency too. So definitely FIIs overweight position on India is a risk for the market. It will be an overhang for sometime especially as we do not see any significant macro changes in the market over the next six months.

Q: The other worry is what happens with the earnings season this quarter because there are some grim estimates doing the rounds. What are you expecting from earnings? Do you expect more downgrades coming through?

A: Currently if you look at earnings, BSE 100 earnings growth is still expected to be 10-11 percent. In contrast last year we delivered 3-4 percent earnings growth. I think there still remains a reasonable downside to earnings and we still expect the final earnings number for BSE to be in mid single digit rather than the number we are at now. And keep in mind that would make the current year the largest earnings downgrade year in the past five years. So, with that I think the market should definitely take a bit of a breather.

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Q: If that current year is mid single digit, is what you are expecting then for FY14 what is your Sensex earnings per share (EPS) target and given that downside risk that you just spoke about. Is there a valuation concern?

A: I think valuations in India are not expensive but not in cheap zone either. So if you look at it, instead of taking a five year view, if you take a 15-20 year view on India, it is still expensive. On price to book basis you could see some of the cyclical sectors go down another 20-30 percent before they bottom out. So going forward, both because of earnings risk and not really cheap valuations, we think India could go down a bit.

Q: What is your view on bank stocks now within FIIs being at their highest weightage?

A: We are significantly underweight on banks, both public sector undertaking (PSU) and private sector banks. We believe investors are still not building in increase in non-performing assets (NPAs), reduction in return on equity (RoE) and growth which the sector will face over the next three years. Given those concerns and given that valuations are not cheap, we would advise investors to sell out of banking stocks.

Q: What about other defensive names. How are you placed on sectors like IT where we have seen an improvement or an increase in FII holding?

A: I don’t think IT and pharmaceuticals are richly valued. IT services sector, for example, would be broadly at 15 times forward multiple. Given that earnings trajectory has been stable at 15 percent underlying and on top of that you get currency benefits, we think IT sector is still cheap and we advise significantly overweight position on IT. Similarly in pharma, underlying earnings are rather defensive and we think at 22-25 times forward multiple, it is not cheap but can given reasonable returns.

Another sector which we think investors should start increasing position in is energy sector. Over the next three years, we think there could be significant policy changes given India's reliance on external energy imports and as government tries to improve domestic exploration, so that is another sector we are positive on.

Q: What is your view on the oil and gas sector now?

A: In oil and gas sector, the government owned companies is one place we are cautious on, given we are not sure of the subsidy burden which can fall on these companies in the near term. The private company space is something we remain very positive. On short-term basis they could act as a defensives, they may not outperform significantly but we think there is a limited downside. On three-five year basis, on thematic view, we like this sector as government policy moves could help.

Q: To your mind what is the key risk for Indian equities now in the second half?

A: I think risks in India are internal, domestic and also external. On external risk, the fund flows is a big risk and what would be the Fed moves going forward, how global economies perform. That would be key risk. Domestically any policy mishap could lead to currency correction and that remains a big risk.

Q: What are your overall sectoral overweight and underweight and even if you can mention stocks?

A: IT services, healthcare and energy remain our three big overweight sectors in India. We are also tactically overweight on consumer discretionary largely through Tata Motors. Our significant underweight sectors are materials, industrials and financials. We are neutral on consumer staples.