Cut Sensex target to 21k for 2013 end; bet on IT: Deutsche

Continued rupee weakness and recent foreign institutional investors (FIIs) pullout from Indian equities has taken a toll on the market. Deutsche Equities India has lowered its Sensex target for year-end from the earlier 22,500 to 21,000.

Explaining the rationale for the same, head of research, Abhay Laijawala told CNBC-TV18 that emerging markets like India will have to eventually accept the fact that this QE driven liquidity rally won't continue forever. Also, rupee depreciation has delayed reversal of India's macro given the impact it has on already high current account deficit. "I think 21,000 at this point in time represents 8 percent increase from current levels. There is a very strong offset coming in the form of a China slowdown which will be positive for India,” he added. However, he does not expect big reallocation of money from EMs to DMs. Erstwhile IT bellwether, Infosys will declare its Q1 earnings on Friday, Laijawala is overweight on IT and consumer discretionary. Below is the edited transcript of Laijawala’s interview to CNBC-TV18. Q: You had target of 23,000 on the Sensex for December but you have cut it to 21,000. Take us through the factors which led to this downgrade of the target? A: The target was actually 22,500 which have been taken down to 21,000. This is primarily attributed to a combination of factors.

The first important one is that since May 21, investors all over the world have to face the inconvenient truth that the QE induced liquidity rally is not going to continue forever and therefore particularly emerging markets will have brace for a period of abating capital flows. So in that environment, we do believe that our earlier target of 22,500 did not stand. In addition, the currency depreciation has also likely delayed the reversal of insurmountable trinity of sticky interest rates, elevated inflation and the deteriorating current account deficit. So, that has been tempered for a while. However, we believe that 21,000 at this point in time represents 8 percent increase from current levels. We think that there is a very strong offset coming in the form of a China slowdown which will be positive for India.

Q: What has your own observation been in terms of the kind of pressure the market has seen with regards to flows and whether that would likely continue? Just by extension of that, will 21,000 be enough for an FII investor who is sitting on deep losses in dollar terms for the most part of this year? A: We need to see India in a relative context and not from an absolute context. May 21 has now emerged as a key milestone for global markets. India has actually underperformed in terms of the currency but not done as badly in terms of the overall equity markets. Since May 21, markets like Brazil, Turkey and some of the Association of Southeast Asian Nations (ASEAN) countries have lost far more in terms of market cap than India has. One of the key reasons why FIIs have not exited from India, despite all the problems that we have and all that keeps getting highlighted in an absolute context, is the fact that in the world out there and particularly other emerging markets, the scenario is far worse. However, what is an area of concern for India is its high level of short-term debt which is debt with a residual maturity of less than a year coupled with the high current account deficit. This will keep our market and currency volatile. Now the question to ask is, what happens with Foreign Institutional Investor (FII) flows from India once other emerging markets stabilise. Does India then see more outflows?

Our view is that government policy action, visibility over these FDI liberalisation caps, expectations of more reforms will probably blunt that blow as and when that reality happens. Q: Your point about relative performance is taken but at what point do global investors start taking an absolute performance call as well because it is one thing to say India lost less than other markets but it’s a loss still. People are not making money in emerging markets for the last many quarters, years. At some point, do you fear that this whole emerging market inflow situation might start to look very shaky and this relative game might not hold up in the eyes of global investors who have bigger options like US equities now? A: We are not necessarily expecting a massive reallocation of money from the overall emerging markets class into the developed markets. Therefore, I think we will continue to see sector reallocations. However, what investors are really now looking for is a line in the sand on where the currency is going to be stabilised. The currency or the value of the Indian rupee is going to be the key driver for market sentiment and the key driver for FII flows as well. In case the rupee remains highly volatile and there is no line in the sand on where the rupee is going to stabilise, we could probably see FIIs pushing the exit button.

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Q: While taking down your Sensex target, have you also changed your sectoral preferences in the light of what’s happened since May? A: Yes, we have. What we have done is that we have moved healthcare to neutral from an underweight stance. We have also reduced our overweight on banks a bit. Our view is that investors in the current environment of volatility will be looking for far more certainty. Therefore, that’s what guided us towards making these reallocations. So, at this point in time, our overweight sectors are technology, IT services, banks and consumer discretionary. Consumer staples remain an underweight. So, key themes during the construction of the portfolio is the premium for predictability because that’s what investors should be seeking in the current environment. Rupee depreciation plays given where the currency has gone and therefore the benefits that will accrue from a weakening currency. The third is monsoon.

Q: You track commodities in great detail. What have you made of this big bounce back in crude on the one hand and this route on the metal stocks on the other? Is the market justified in trading stocks like Tisco and SAIL down to 52-week lows? A: In terms of the overall commodities, we have seen a complete dichotomy between what oil has done and what other exchange traded commodities have done. Oil has primarily strengthened over the last couple of weeks particularly from the May 21. We believe that this is more on account of the geopolitical risk, particularly, the events in Egypt and the rest of the Middle East. The resilience of oil therefore cannot sustain because since then we have seen coal prices, copper prices come off. We have also seen a pretty large decline in gold prices and therefore our assessment is that once the geopolitical risk premium abates, oil will come down quite sharply. With regards to industrial metals, we believe that there is significant overhang that has enveloped the sector on account of all the newsflow that is coming out over a weakening China. Until the expectation of a weakening China is not yet fully discounted, the overhang on the metals space will continue.

Q: You were talking about the IT basket. Within that, what would you expect to see from Infosys and do you think it has any repercussions for the rest of the sector or should it be treated as a standalone result and a standalone company’s performance? A: At this point in time, all eyes are on Infosys. Clearly investors are now looking at the potential turnaround of Infosys following the change in the overall management of the company. Therefore, this is likely to be one of the most awaited results and how the company articulates its strategy over how it intents to claw back its market share, how it intends to increase its revenue share, how it intents to diversify away from its key geographies, the United States will be carefully seen.

Q: What are your expectations from the Reserve Bank of India (RBI) over the next three months? A: Expectations of the rate cuts have most likely been tempered quite significantly on account of the depreciation of the currency. But we believe that a big offset could come in the form of any sharp decline in oil prices. I think that’s a space that we urge investors to watch very closely because the resilience in oil that one has seen over the last couple of weeks cannot sustain. If oil comes below the psychological threshold of USD 100 per barrel it will probably cause a lot of comfort in terms of where the current account deficit (CAD) is headed, because oil and gold together constitute 46 percent of total imports. With gold having corrected and accompanied by correction in oil, it could send out sense of comfort to the RBI. But for that, we need to be very sure that there is no additional depreciation of the rupee from current levels. I think it is going to be a very dynamic July, a very dynamic August and I think investors should be watching for those developments before they make any decisions on what the outlook on rates is going to be.

Q: Do you have a house view on the rupee-dollar? A: Our economists expect the rupee at 55 against the dollar by year end. Q: How does this tie in with your outlook for the US market because that really has been the lead market and perhaps the big outperformer compared to the rest of the world. What do you expect to see in the second half from those markets? A: Our global strategist and both our developed markets as well as emerging market strategists believe that developed markets are likely to continue doing well. We will continue to see the Dow move to a higher level. I am not aware of what our target is for the Dow. However, we do believe that investors will continue to favour developed markets over the emerging markets. On the subject of emerging markets, I think between 2002 and 2003 and now, we have seen all emerging markets move in a similar fashion as one asset class. I think the time has now come to differentiate between emerging markets. Emerging markets which do not have high level of external vulnerability or have very strong domestic growth indicators are likely stand out.