Still a bottom-up stock picking mkt, see 20% upside in'16: Citi

Aditya Narain, MD & India Strategist, Citi, believes that the bottom up stock picking theme for the Indian market is not at risk. Neither does he think that we are in a middle of cyclical bear phase. However, market could see-saw for a while and volatility would overshadow, says Narain as the ‘Guest Editor’ in an interview to CNBC-TV18’s Latha Venkatesh and Anuj Singhal.Although the bottom-up story continues, Narain does not expect it to be 'A'-thematic but thinks there would be multiple themes and multiple drivers along the way.  He is upbeat on Indian equities and expects 20 percent upside for the market by end of 2016.The house is overweight on financials, automobiles, cement, energy and utilities along with pharma.He likes the financial space although the mood on them is negative because according to him asset quality for them is unlikely to deteriorate and at the most could remain flat.With the China devaluation impacting most Asian markets severely, Narain says he had not expected it to be so jerky for the Yuan but believes that China is in the process of adjusting and volatility is part of it. According to him on the way down, volatility is always exaggerated and that is what we are seeing currently.Below is the verbatim transcript of Aditya Narain’s interview with Latha Venkatesh and Anuj Singhal on CNBC-TV18.Anuj: It is a bit of an uncomfortable question that I am asking a lot of people, I want to know your view. What we are seeing right now, is this just a healthy correction or just a correction or are we in middle of a cyclical bear face? A: I don’t think we are in the middle of a cyclical bear face but I do think that it is going to be up and down for a while. So, I think a) you just got to live with a little bit more volatility and b) given that the year has started so weakly you will probably see little bit more of it being up fronted. However, a cyclical bear face is a lot deeper than what I have in mind actually. Latha: What is Citi reading of this second round of big devaluation that has come from China? It now looks like August was not a one-off but it is a trend. How have you read it? A: To some extent we have been a little cautious on the currency; we have seen a certain amount of downside there. We didn’t think it would come in such a jerky manner; in fact out initial read was that it would all happen then and after that we thought it would stretch out a bit but yes it has tended to be very jerky in the immediate term. However, we do see a certain amount of weakness on the yuan. Latha: How do you read it, is this an indication that China is weaker than we thought which means global economy will be weaker in 2016 first half than we thought, is that the reading or is it that China is adjusting? A: I think it is largely that China is adjusting and people are making big calls on whether the adjustment is huge or that the bulk of it has been done. In our view, it is effectively adjusting and that is why you are tending to see a certain amount of volatility. On the way down volatility invariably tends to get a little exaggerated and that is what you are getting a sense of now. Anuj: This is something we were discussing while you were in our office, the theme for last year was bottom-up stock picking. The Nifty may not reflect that but a lot of people made a lot of money through portfolio investments, through mutual fund investments. Is that at risk as we start this year, if the Nifty goes down or Sensex keeps going down at some point that will have an impact on the midcaps? A: I think in some senses that bottom-up will continue to be a theme. However, one of the themes for the year is that it is going to be a thematic; it is not going to be a big theme that you are actually going to seek. You are going to have multiple themes and you are going to have multiple drivers none of which will be strong enough for you to say that I am following a capex recovery or I am following an interest rate trade per se but you will have a mix of these actually spread across which I think will effectively provide you the market upside and that is where I think you will also effectively get stock upside. So, I think it will still rely on stocks, it won’t have a big theme but there will probably be multiple themes to actually ride on to. Anuj: Let me put it the other way round, we have seen a lot of domestic institutional investor (DII) inflows which has sort of compensated or at least tried to compensate the foreign institutional investors (FII) outflows. Is that at risk if this market continues to remain like this? A: I think two things, one I think the base has flipped from being foreign money based to now increasingly being domestic money based. I think the big change really is that the base has flipped. The second bit is a lot of the domestic money that has actually come in over the last 6-12 months has actually not done as badly as the top-down sense is. A lot of the market has actually done well, a lot of the smaller and midcaps have done even better which is where a lot of this money is going in. So, I don’t see that as an immediate risk of any form that people have a lot of money has come in and they are effectively losing a) I think these flows are going to be structurally larger and longer b) I don’t think they have lost money for them to start coming out at this point of time. However, if you continue to see huge rallies in some parts of these markets and at a point in time much is further down the line, you see a drop off then there could be a little bit of a stagger. However, I would not see it as too much of a risk, clearly not at this point in time. In fact, the big thing is the floor base has probably switched and unless there is something dramatic with the markets or the economy I think that will hold actually for a length of time. I might add, let us not dismiss foreign flows at this point in time, the base has flipped but the icing on either side is going to be the foreign flows._PAGEBREAK_Latha: Now to earnings, where do you see the improvement? Even for Q3 people are still talking about overall, I think yesterday’s CRISIL’s report saying overall revenues by 2 percent and even if you remove the commodities it is 5 percent revenue growth. Where do you stand on earnings? A: From an earnings perspective, and that is again going to be one of the themes, one of the small themes as it were, if you were to have looked at last year, the big disappointment across the market has been that earnings have effectively tended to disappoint. What I think is encouraging at this point in time is that most numbers if you see for the market for FY17, range between 18 and 20 percent for the Sensex. However, there is actually a kind of a presumption that these numbers will effectively get cut and I think that is a nice position to be in because people are just presuming that you start at 18-20 percent, if you get 5-7 percent it will be good enough but you could easily get 15 percent quite honestly. So, I think the presumption that good numbers are going to get cut is a form of cushion. So, that is one bit. I think the other bit in terms of where they are going to come from, I think you look at what happened in earnings in FY16 and the cuts that have happened, they have tended to be concentrated in the commodity space and in the industrial space. Now, commodities remain wobbly but the reality, in general expectations are pretty soft on them, numbers have effectively been cut so the downside risk tends to be pretty diminished. The same to some extent holds for industrials where expectations have got pulled back substantially; whether enough or not one can effectively still debate. You strip these two out and you will actually see in the last year there were a couple of sectors that actually saw upgrades. So, telecom for instance, materials for instance for FY17 we were really having a look at sectors where earnings have come down and sectors where earnings have gone up and telecom has gone up because post the initial spectrum licenses everyone cut them very sharply and then there was a retracement and it was somewhat similar with parts of cement.So, I think, again, you are not going to have big drivers but firstly there is no big concentration in terms of earnings into the current year. Secondly, they are much more muted because you must remember in my view earnings to some extent tend to follow the market also when they are being formed. So, we have had a very strong market in 2014 and early 2015 and earnings expectation moved up dramatically. Now you are getting earnings made in a market that has fallen a bit but the mood has fallen even more sharply.Anuj: We were discussing this again, your belief is that commodity fall is now hurting India incrementally more than benefitting it even if we are more of a commodity user?A: In some senses what is hurting India now is effectively the instability that is happening in this entire space. So, clearly you have gains on inflation, you have gains on the current account deficit but you have also reached a stage in the economy that a bulk of these gains and the benefit of them have really been absorbed. Now, what you require is the consistency of whether it is earnings from a markets perspective or whether it is capex that happens in the marketplace and I think that is tending to get a little unwound because of these distortions and this weakness that continues. In addition what is happening is, you already have a banking sector that is kind of pushed to the wall and these added stresses start building up a little bit. So, in some senses while there will always be arguments for further weakness in commodities helping the big picture India, I think you have reached a situation where the dislocation because of these drops is now beginning to actually hurt and the bulk of the gains have effectively been eaten up. Latha: What will you look at in terms of equity related gains for 2016? A: We would be pretty positive. We think there is a good 20 percent upside for the market through to the end of the year.Latha: Where would they come from? Which stocks could spearhead it? I think Reliance Industries is an obvious stock.A: I will stay away from stocks but from a sectoral perspective our overweight’s are the financials, automobiles, energy, cement and utilities along with pharmaceutical. Latha: What makes you so positive on financials? You don’t think they need to provide more, there is an aggressive discussion that is happening between the regulator and the banks? Will you buy it now or will you get it cheaper? A: There is always an argument to get them cheaper but if you actually have a positive view on it then I think timing it to the last rupee tends to be a little hard at least for me. What I sense is that what you have at this point in time is that the mood on a lot of these financial stocks is very negative. The headlines as far as their numbers are concerned, is negative because you have potentially accelerated recognition and provisioning. However, at the same time, so that all suggests that these stocks should be going down, the sector should be going down and that to some extent is what is actually happening. However, the flip side is, if you were to look at the underlying element of it, I think asset quality is not deteriorating. I think at worst you have a flat kind of real scenario as far as asset quality is concerned and to that extent when you have a disconnect in terms of where the stock price is going and where the business is going, I think is very you end up having an opportunity. So, at this point in time stock prices are all going down, the real asset quality I wouldn’t argue it is necessarily improving but it is not getting worse. I think it has all got clouded by the cement argument in the recent past. If you were to look at the last 18 months there was telecom which was a problem, there was coal based stuff that was a problem, there was gas based stuff that was a problem, there was a lot of infrastructure issues that were seen as problems and death knells for the sector. Nobody is taking time about them now but over the last 18 months none of these have worsened, some of them have actually improved. So, I think steel has become the bugbear for the sector but the reality is four or five bugbears of the last 18 months are actually less of a problem; I won’t say they are gone but they are less of a problem.