Risk-off trade at play now; overweight on pharma: Kotak AMC

The freefall seen in global commodity prices in the last few days has triggered a risk off trade right now, feels Alroy Lobo, chief strategist and global head, equities - Asset Management-Kotak Mahindra Asset Management Company.

Investors are moving money away from emerging markets to the US, but such risk-on, risk-of trades are short in cycles and may not last for more than six months, he said in an interview to CNBC-TV18. “In the second half of the year, we can expect some uptrend for the market, but the near term risk could be in the region of around the five-eight percent downside,”he added. One should adopt a strategic view on markets beyond next six months and use this correction as an opportunity to park funds. "The key is going bottom up, just focus on good quality companies which are now available at decent valuations, focus on their cash flows, return ratios. Look for companies with improving trend in both - return profile or cash profile," he suggested. Lobo doesn’t find valuations of many sectors attractive as of now. However, the fund house remains overweight on pharmaceutical stocks and advises buying private sector banks over public sector lenders. Below is the verbatim transcript of his interview to CNBC-TV18 Q: Lots happening globally and the big fear this morning is some kind of contagious effect or collateral damage for equities because of this freefall we have seen in commodities. Would you expect to see that? A: I would say that clearly the trade is a risk off trade right now. One is seeing it in commodities and also investors moving money away from emerging markets to the US. Clearly, there is a risk off trade at play, but please recognise that these risk on-risk off trades are also short in cycles. Therefore, one cannot really extrapolate this kind of a trade to continue for more than six months. So, I would say that it gives you an opportunity at this point of time to get the market at lower levels and at attractive levels. One should take more strategic view on markets beyond the next six months. Q: They are powerful though in terms of their short term impact and the ferocity with which they can move market levels around. What kind of data are you seeing in terms of global ETF action into our market itself and whether over there you expect this outflow to accelerate and then have a greater impact on the market? A: Inflows that have come into India last year and also in the beginning of this year have not been led by active India dedicated money. We are clearly a beneficiary of emerging market allocations and global allocations. Therefore whenever there is an outflow from these funds, one clearly sees an impact on the Indian market. It is to that extent a case where one will see not only impacts on markets, but also impact on our capital account. We are seeing outflows now from emerging market ETFs. The trade seems to be more towards developed markets at this point of time, but having been seeing this over a long period of time, I normally see these trends lasting for a few months. Then the trade reverses because then valuation gaps emerge. Then, once again, emerging markets tend to look pretty attractive. However, while it is on, it could be pretty damaging for certain sectors and certain stocks. Q: If you do believe that the risk off cycle could be short and perhaps the second half of the year could be better than the first, where do you see lucrative buying opportunities now in the market? A: I would say that we are seeing pockets of valuation emerging in various sectors. Clearly, the telecom sector is one sector which has been impacted not only for fundamental reasons but other reasons so that’s offering a buying opportunity. Cement has been an underperformer for quite some time. We see that emerging in the second half of this year. I think the tech sector as seen in the first results of Infosys coming in, there could be a correction coming in the sector and lower valuations will be also favourable looking at that sector. The pharmaceutical sector continues to be a sector of our choice to play not only the currency but also to play the fact that growth in India. That would be at a premium and this is one sector which will continue to demonstrate growth characteristics. In banking, we are still biased towards private sector versus public sector companies. Q: Just in the near term, where would you say the downside potential is for the market though? A: Difficult to really pen that out because when any market corrects because of flow reasons, it is difficult to really predict where the bottom is. However, having said that’s, fundamentally we think another maybe five-eight percent is what should be defined as a bottom. Valuations like I said in number of sectors are now looking pretty attractive. If you go bottom up, you will get some good stocks at decent valuations. _PAGEBREAK_ Q: If your call is that the second half shows up some trend for the market but near term risk could be around the five-eight percent downside region, tactically, what would you do with the market right now? Is it the time to sit on your hands and wait for some of these global headwinds to blow over or are you guys going in and buying already? A: I would say that one will see asymmetric performance in markets. So, there will be some stocks which will correct far more than others. Even in these markets you will see stocks rising. So, I think the key is basically going bottom up, just focus on good quality companies, which are now available at decent valuations. Focus on their cash flows, return ratios and companies with improving trend in both - return profile or whether it is cash profile. It is very difficult to really time markets. Market sentiment changes before one even realizes it. So, if one is trying to precise the time things, one could sometimes get it pretty wrong. I would say that if you are getting stocks at decent valuations, one should chip in and buy these names at the current prices. Q: How comfortable are you with the improving macro situation, the sub six percent inflation, the drop that we have seen in gold imports? Do you think as a headwind, the macro problems are sort of out of the way? A: Margin, most of the adverse macro tradable is clearly bottoming out. The issue is the reversal is going to be very slow and gradual. Our view is one will see mild recovery in GDP growth rate in fiscal 2014 and improvement in the current account deficit. However, that does not necessarily mean that you will have a very strong balance of payments because the balance of payment will also have to look at what’s going to happen to the capital account. So, on one hand, you will see an improving current account deficit but if this risk off trade continues, the capital account also starts getting weaker. So, one need to take them together and then see what happens to the rupee because it has an impact on balance of payment. Having said that, I think margins are improving. We do believe that monetary policy is getting easier. We are expecting another 50 basis points cut in policy rates. We do believe that this will support recovery in the second half. At the moment, we are not seeing any kind of signs of a major recovery. However, we clearly believe that we have come to the bottom though the process of recovery will be relatively slow. Q: Will any of this result in earnings growth at all? This time around the shocker from Infosys has thrown people off guard. What is the sense that you are getting for the rest of the earning season and how it will shape up? A: I would say that earnings growth will be tepid for the Indian markets because the GDP itself is below potential. It is very difficult to expect earnings growth to be very strong when one is growing below potential GDP growth rate. Also in the Budget, because of the surcharge on corporate tax, clearly it is shaving off another two percent of earnings growth for fiscal 2014. So in that context, we would look at just about double digit earnings growth for the Sensex companies or Nifty companies for fiscal 2014. As far as Infosys is concerned, their third quarter result was very clear that it wasn’t a broad based recovery. The over optimism of the market in actually reading that as a broad trend itself was erroneous in many ways. This has clearly now normalised in the fourth quarter. I would not really use the Infosys results solely to predict what’s going to happen to other tech companies, or for that matter, earnings for the market. One thing is very clear that growth is slowing and one will see an impact across all sectors. So, to that extent we are living in what we call as a relative market. We need to see sectors and stocks, which are going to be less impacted by the slowdown rather than try to pick companies. This is going to report some very superior growth. It is going to be more of a relative to market kind of investment strategy this year. Q: Just want to scratch this point about liquidity a bit further. What exactly have you seen in terms of outflows? What do you expect to see in terms of a running trend? Are they already signs that margin pressure or redemption pressure is on going for some of these ETFs? A: I would say that we are seeing the initial signs of emerging market ETF outflows. They were pretty positive for a long period of time in the Indian market. In fact, like I mentioned, Indian market has benefited from allocation from these ETFs. Therefore now we are seeing the negative effects of it. This is clearly a trend towards a risk off trade where investors want to be in safer markets. One is seeing this reflected in commodities, reflected in gold and also reflected in the move away from the emerging markets. A big chunk of money has come in through this route. So it is difficult to say how much will go out. What I have seen with ETFs is that they are macro investors and they generally tend to buy markets which are cheap. Moment the valuation differential sort of converges, they are basically moving money away from those markets. So, to that extent, one will see this trade continuing till a valuation gaps emerging. Then one would see this trade once again reversing. That’s how ETF money really moves in and moves out. There is a lot of money that has come into India last year. It is difficult to really know the exact source because we don’t get public information. So, it is difficult to say how that money sort of behaves in a market like this. However, net-net, it is a variable to watch because if one has got in USD 24 billion last year and if some portion of this moves out, the impact on markets could be pretty severe. _PAGEBREAK_ Q: The most volatile stock on the Index off late has been Tata Motor, also a stock with very high ownership. How are you guys approaching that one? A: I would say there are positives and negatives in the company. One thing that is clearly an area of concern is the big capex plan in the company. Like I mentioned, if one has investors focusing on the free cash flow characteristics of companies, this is one variable that they would not be very happy with. So, I would say at this point of time, it depends on which variable sort of dominates. However, we would be relatively neutral on this name right now. Q: For an Indian market watcher, which is the most problematic pocket globally, in terms of global markets? A: I would say that in my interaction with investors, they are clearly very concerned about the components of emerging markets in general, whether it is Brazil, Russia or it is China. They have their own set of issue. Therefore, emerging market as a whole is clearly an area of concern right now for most of the investors. Also, inflation in some of these markets are clearly ahead compared to what you arte seeing in developed markets. From a developed markets standpoint, I think the issues in Europe are definitely far more severe compared to any other part of the globe. I don’t think issues there will resolve themselves quickly. The only good news is that there has been a deliberate attempt from all the agencies concerned and the regulators and the central banks to make sure that we have some kind of financial stability. However, what it also means is that this pain could be more prolonged. So, one will get this news flow coming in and going out. Overall, the attempt is to have a stable financial market. At this point of time I would say that the sentiment clearly has changed more towards emerging markets because of country specific issues. Though India has already gone through that pain and it is standing out as probable turnaround story, the fact of the matter is that we are still part of an emerging market index. We are still part of a BRIC index. Whenever there are outflows from these funds, it does have an allocation impact also on India. Q: Don't know if you track some of these gold finance companies but any thoughts on the impact on some of them and even banks which have a high amount of gold loan exposure? Do you think that’s a space that’s going to crack for technical reasons as well? A: I would say that it is an issue. We have actually seen stayed away from gold financing companies. However, in terms of companies which are involved with jewellery, my sense is that as gold prices come down, one will see interest once again emerging among buyers of gold at lower prices. Therefore one has to take a call between price and volume. Having said that, there was one proposal that was suppose to come in the money laundering bill, which basically indicated that any kind of purchase, more than Rs 50,000 would have to be supported by your income tax details. This proposal, my sense is clearly under review and this could be really harmful to these companies. So, it is more of those issues which could plague the industry rather than only gold prices. However, at lower gold price, my sense is that given the appetite that Indian’s have for gold, you would once again see buying interest. We would preferably look at buying into these names rather than buying into gold finance companies. Q: Are you confident that the second half of the market will be remarkably better than the first half? A: I would say we are approaching clearly an election year in India next year. If one looks at the planned estimates by the government, whether looking at increasing planned expenditure by about 29 percent clearly means that spending in my opinion would be more front ended. In that case one will get the benefits of that spend on to growth. Second is that the easy monetary policy, which we have seen from the beginning of last calendar year will have a lagged effect and will support growth as we go forward. My sense is we will also have to look at monsoons because if monsoon plays off well then just on the back of that, you will see about 30-50 basis points improvement in India’s GDP. So keeping all that in mind, it is clearly a bet that the second half in terms of growth profile will look better than the first half. We will have to see how valuations are but, like I mentioned, with every correction, some of the names in the Indian companies are looking pretty attractive. If you were to look at this dispassionately, just to on pure valuations, there is good value emerging in number of sectors and that also supports a better market in the second half. Also, during an election year, there is a fair degree of spend which finally gets into the economy and that itself also supports some element of growth. To that extent, my view is clearly the second half should see a better macro profile than what you are seeing in the first half.