See 75bps cut ahead; banks to outperform in FY14: Kotak MF

Harsha Upadhyaya, Head of Equities at Kotak Mutual Fund believes the demand scenario in the IT sector is yet to improve. As a result, he continues to remain underweight on IT. He also told CNBC-TV18 that earnings are likely to lead market performance in 2013 and he does not see any disappointments ahead.

Besides, Upadhyay does not consider valuations derating the Indian market at the moment. However, government policy is going to play a key role in valuation improvement, he opined. Going forward, he expects double digit returns from the market. He also considers a 75 basis point rate cut from the Reserve Bank of India over the next 12 to 15 months. “I think the monetary authorities have very limited room for easing. But, nevertheless over the next 12 to 15 months we believe that there is likely to be about 75-100 bps of interest rate cuts and we are positioned for that kind of interest rate cuts in our portfolios,” he explained. Upadhyay is also optimistic about a gradual economic recovery. Don't Miss: See stock specific return; bets on exports: Mirae Assets Upadhyay maintains a underweight to equal position for most telecom portfolios because he believes regulatory interference is having a bearing on the sector. He also added that a marginal fuel price hike would not have much impact on the stock moves of oil marketing companies. In FY14, he feels banking and financial services are likely to be better performers than other sectors. Here is the edited transcript of the interview on CNBC-TV18 Q: What are your thoughts on IT? The IT space has really blown out in terms of expectations and performance this quarter. How are you guys approaching IT after this big rally we have seen? A: We were underweight on IT and we were a bit hurt in the last couple of weeks. But we still believe that the demand scenario is not very strong. To that extent I think we are going to continue with our underweight position with stock specific investment ideas within the sector, be it on the analyst expectations on some of these results or other factors, we believe that the trend is not likely to sustain. We believe that there is going to be some amount of pressure on both volume growth as well as pricing going forward and that is the reason why we have been underweight on the sector. Q: What about the markets? How are you positioned on the markets at this point in time? Do you think the next leg of upmove will be driven by earnings or will it continue to be driven by liquidity? A: We have already seen the trade when we started last year, the valuations were maybe 10 to 12 percent below long-term averages and with liquidity coming in and sentiments improving, we have seen valuations inching closer to long-term averages. To that extent I think coming into 2013 we believe it is going to be largely earnings-led market performance, unless we see very big positive steps from the government which has the potential to rerate the markets. But, in our base case assumption, we do not consider valuation rerating in Indian markets. We are just looking at market performance in line with earnings growth. _PAGEBREAK_ Q: So you would not expect to see the kind of performance the market belted out last year. Would that be too ambitious? A: We do not see that kind of a rerating happening now. From that perspective and also from the perspective that earnings growth are likely to be about 12 percent for FY14, we believe that it is going to be a positive year. We would possibly see double digit returns from the market, but at the same time they may not be as strong as what we saw in 2012. Q: The big shake up yesterday came from the Reserve Bank Governor’s comments about inflation. Do you think the markets should temper expectations in terms of rate cuts? Would it change the way you are approaching the banks? A: No, not exactly. Whatever the RBI Governor mentioned is very much known to the market. I think the monetary authorities have very limited room for easing. But, nevertheless over the next 12 to 15 months we believe that there is likely to be about 75-100 bps of interest rate cuts and we are positioned for that kind of interest rate cuts in our portfolios. We are not looking at short-term market movements so closely. Q: In anticipation of the rate cutting cycle beginning, what is your view on banks itself? Would you be overweight on the banking sector? A: Currently, we are equal weight to overweight on banking sector. This trade has worked well in the last five to six months. Obviously, there has been some shift within the banking sector and we are positioned accordingly. We have moved away from some of the banks which were rich in valuations and moved into Public Sector Undertakings (PSU) banking segment where there are still concerns. But, I think on the valuation front they offer better risk-reward ratio. We have moved some of our positions from private sector to public sector and we have a reasonable mix of public as well as private sector banks in the portfolio today. Q: What could the downside risk of this market be if indeed the rate cutting cycle does not play out as early as expected and some of the macro headwinds continue? A: It is very difficult to give a particular target or a number to downside. But I would say that last year we were probably 10 to 12 percent below long-term averages in terms of valuations. We have moved close to those averages today and if some of the risk events do happen, there is every chance of market going back to a discount to long-term averages in terms of valuations. On the earnings front though we do not expect too many disappointments going forward. We believe that the earnings downgrade cycle is probably behind us. We have just seen some of the results coming in this quarter. Although, it is too early to generalize about the overall earnings season, we believe that it is going to be reasonably okay even this quarter. From that perspective and also given the kind of low expectations we have for FY14, which is just about 11 to 12 percent earnings growth, we believe that there may not be too many disappointments on that front. If there is a disappointment at all, it has to come from liquidity going out of the markets and derating of the markets. _PAGEBREAK_ Q: Are you also in the camp that believes the best of the markets’ performance is probably going to come through in the first quarter of the calendar year itself? Tactically then are you looking to increase positions at least in the first part of the year? A: It is very difficult to say. Last year was an easy year where every quarter gave positive returns. We believe this year that may not be the case because on the valuation side, we do not have that kind of room to improve further unless there are specific steps that the government takes. From that perspective, it is really difficult to say whether it is going to be back-ended or front-ended. But, I think at least expectation wise people are positioned for some important steps from the government in the run up to the budget and in the budget. To that extent, I think the market is likely to be a little firm in the initial part. Q: What do you do with telecom? Any thoughts on that? A: Some of our portfolios are overweight on telecom and we have gained a bit over there. In most of the portfolios, we are either equal weight or overweight. To that extent, that trade has worked out well. The intention there was to get into the sector when there is a semblance of pricing power returning back to the sector and some of the regulatory hurdles going away. I think we still continue to be positive on the sector and continue to hold those weights. Q: Domestic retail participation was missing quite sorely last year and some people opined that for people who missed out this may not be the best time to be getting back in. Do you agree with that? A: No, we do not really agree that this is the time to be underweight on equities or to be away from equities. If you look at historical returns, probably equities have underperformed other asset classes in the last three to five years. But that should not be taken as the trend for the next five years as well. We believe that we are probably going to see gradual economic recovery going forward. The valuations are in a fair zone. To that extent I think there is every reason to start actively looking back at equities and once there is significant revival in the investment capex, I think markets can give handsome returns for equity investors. Q: There is an expectation that the government might take up the issue of fuel price recalibration very soon. How much of the impending fuel price hike has already been priced into the market in your mind? How would you approach some of these companies involved? A: Clearly over the past few weeks the oil and gas sector, especially the Oil Marketing Companies (OMCs) have done pretty well compared to the market. A little bit of hope has already been priced in, but if there is surprise in terms of a serious deregulation then there is more to those stocks, then there is a structural change in the way people value these companies. Probably, there is more upside to these stocks then. But, if it is a small and one-off hike, then probably this tactical trade will come to an end. _PAGEBREAK_ Q: The initial ticks from earnings season have been quite positive this time around with a huge surprise coming in from Infosys. Sectorally, where do you see the biggest turnaround coming in terms of earnings this quarter? A: We are not expecting too many turnarounds in that sense. We are just expecting a single digit earnings growth for our basket this quarter and even for the full year we are expecting about 78 percent earnings growth. To that extent, I do not think there is going to be too much of divergence in terms of performance. Obviously, the banking and financials will have higher growth compared to many other sectors. But that is also priced in, in terms of their valuations. Q: What is the call that you are taking on infrastructure after the recent episodes with companies like GVK Power and Infra and GMR Infra? A: We continue to be underweight on the sector. We believe that there is still some time before we actually see revival in infrastructure capex, although we would like to see government taking further steps to revive this sector with some policy framework, but that is yet to be done. Also there are company specific issues in many of the sectors that you mentioned. We believe that it is time to stay away or be underweight on the sector at this point of time and then as we get more clarity in terms of investment cycle picking up, probably that would be the time to go and bid on these sectors. Q: While your point is taken about this not being the time to ignore equities, the experience is of consistent redemptions for most mutual funds. What has your own experience been? Have you seen any change in that trend? A: From what we have seen over the last six months, definitely there is some change. Six months back, the public did not want to listen on equities. I think that has changed and today they are at least willing to start looking at equities and that is coming out even in terms of the net redemptions that we are seeing in the industry. I think that has reduced to some extent. Some smart money has started moving into equities already. Although, on a net basis the industry continues to see net outflows which is a concern. But, once we see more clarity in terms of economic recovery I think money will flow into equities. Q: For a major part of last year the market chose to discard a lot of the negative macro data that came out. That continues till today, whether you talk about the fiscal deficit or the Current Account Deficit (CAD). Do you think it would be a dampener with respect to the uptrend of the market or will the market continue to discard these issues? A: Clearly, these are the biggest risks that we see for equities in 2013, the twin deficits of CAD and fiscal deficit. Everyone including us, is going to watch keenly the steps government is going to take to control fiscal and CAD and whether those measures are going to be credible. If we believe that it is going to sustain and we are going to control our fiscal deficit, I think there is a chance of a rerating in the market, otherwise it could turn out to be one of the biggest risks for equities in 2013.