See high possibility of minimum 5-10% correction: DSP BlackRock

Global equities may be staring at a "minimum 5-10 percent correction" in the fourth quarter as risks in currency markets translate into volatility for stocks and bonds, says S Naganath, President and Chief Investment Officer, DSP BlackRock Investment Management Company.

In an interview with CNBC-TV18, Naganath said that investors should buy into any correction that takes place as a strong pick-up in earnings trajectory expected for FY18 and FY19 makes them attractive from a two-three year perspective.

DSP BlackRock, India's 10-largest fund company, manages assets of over Rs 50,000 crore.

Naganath said he was positive on consumption as a theme as well as bank stocks. He also expressed optimism on cement as a sector but said commodity stocks remained a "tactical" play.Below is the transcript of the interview on CNBC-TV18.Latha: For starters, how worried should we be about this fall? Is it just a little bit of a jitter or do you think markets were overpriced?A: Let me talk about global equities. For some time now, since the beginning of the year, I have held the view that the first half of the year will be okay. Central banks across the world come and they ease monetary policy a bit, cut rates here a bit, etc. But in the second half of the year, one should anticipate higher volatility especially as we get into the fourth quarter. This is for global markets in general. And the principal factors are the issues surrounding the European banking system, issues around competitive currency depreciation especially in Asia, possibility of stronger dollar as a result of safe haven buying of the dollar, that contributes to weakness in currencies.Therefore the feeling was that as we got into fourth quarter you should expect much higher market volatility. As we get into October and into November - December, therefore, it is not surprising for me to see this market volatility. One should be quite cautious now as far as global equities are concerned and the possibility of further volatility of higher magnitude than what we have seen in January for example still exists.Anuj: So, is this market vulnerable to say 15-20 percent correction because it has been liquidity driven?A: It is difficult to put numbers now. All I can say is if you thought January was volatile for global equities I would say similar conditions exist at this point in time given all the risks that we see looming on the horizon. The potential is for volatility to essentially start in currency. We are seeing that now the British pound and some of the Asian currencies also slipping. That then transmits into the fixed income markets and then into the equities market. So, the possibility of 5-10 percent correction minimum between now and the end of the year globally for equities. In my opinion, the probabilities are high.Latha: Will we underperform or outperform because in January we had this added worry of this capital gains tax probably taking us lower. Now I don't know whether it is the Dutch disease or whether it is going to be a curse of an ultra stable rupee, does that put us at a disadvantage, or does that make us an outperformer?A: It puts us at a great advantage. So, coming to India I have often maintained that when you have such volatility, we will not be immune to it, we will get affected to it but to a much lesser degree. I would say that any correction -- and I have been saying that since the beginning of the year -- would be a fabulous buying opportunity because I am extremely bullish on the prospects of the economy and our equities over the next 2-3 years.Sonia: For the IT sector would you hold the theory that any correction is still a buying opportunity because this time we are expecting weak numbers from the likes of Tata Consultancy Services (TCS) etc?A: Before we talk about the IT sector generally speaking about the earnings expectation like I said the bullishness about Indian equities stems from the fact that our gross domestic product (GDP) growth rate is gathering momentum. So, whether it be 7.5 or 7.6 is not the issue. In a world which is facing sluggish growth, we are going to be a shining light as far as macro fundamentals are concerned. The second is that as far as equity investors are concerned, earnings growth, which was disappointing for the previous two fiscal years, is beginning to show quite a nice improvement. So, we expect FY17 earnings growth of about 12-13 percent, which is much higher than what we saw in fiscal 16.More importantly, if you look at the analysts they are looking at a much higher rate of growth for FY18. It is too early of course but if they say 20-21 percent even if you take it as 18-20 percent, the trajectory is one where the earnings growth is gathering momentum quite nicely. That will support or underpin strong performance by equities. So, like I said FY18 or FY19 ought to be excellent in my opinion for the economy and for equities. Specific to the IT sector there are some headwinds facing the IT sector in terms of business momentum. So, overall in the context of other sectors that we look at we will be somewhat lukewarm about the prospects of the tech sector.Anuj: What about the levers for this market? We have had two clear leaders, financials and discretionary consumption? Do you think that stays in the leadership space and that is the best place to be in?A: I think so. So, as we look ahead consumption is very important catalyst for the uptrend in the next few months and couple of years. Both urban consumption and rural consumption at the back of strong rains are going to contribute handsomely to GDP growth rate and therefore to respective sectors. Private sector capital expenditure (capex) may still be about 12-18 months away but government capex is quite strong. So, all in all consumption which typically accounts for a significant part of our GDP growth rate will get us to that 7.5 percent GDP growth rate and therefore the earnings growth numbers for Indian companies that we talked about earlier.Latha: We have been hoping for this consumption pick up for many quarters now and it is always pushed to the second half. Two or three second halves have disappointed us. Are you that sure we have not really seen it in - say Hindustan Unilever's volumes or Dabur's volumes or probably Emami was an outlier. This consumption was a hope or are you seeing it?A: By my sense is it is improving and we have to look at it in slightly different way. One is you may have listed companies that may be doing okay. But what about the e-commerce space, are people buying more through the online market places, are they buying more from non-listed entities for example. There is a lot of competition in the consumption space. So, not necessarily all of that increment in consumption maybe reflected in the listed players although I do see some improvements there. So, we should account for that that there is a lot of unlisted players who are also taking away market share from listed players and that is also consumption, isn't it?Latha: I am not taking away from the Patanjalis of the world. About the e-commerce we don't know. When they say 150 percent last year was next to nothing. So, 150 percent from an Amazon or from Flipkart I don't know how much it means. The Index of Industrial Production (IIP) numbers are always a bad lot. But still, they are showing you only one percent consumer growth?A: Much of this is anecdotal and my sense is it is improving. So, if the delta is one which is showing an uptrend I would take that as a big positive.Sonia: Last quarter the one sector that did much better than the other if you want to say so is the cement space, names like ACC etc did extremely well. Do you expect that operational performance to continue in this quarter and is that one sector that you would back?A: Our view on the cement sector is positive.Latha: What about financial? Do you think enough clean up is done, which segment of financials would you bet on?A: Again here as far as banks and financials are concerned our view has been positive for quite some time now and the assessment of the bad loan problem has been done. The provisioning has started quite some time back, the provisioning will continue maybe for some more quarters but we are in my opinion at least past the point of maximum intensity as far as the provisioning is concerned. So, while that may continue for a few more quarters that issue is slowly ebbing away.What we now need to look forward as far as banks and financial services companies are concerned is as the economy picks up momentum, if they see more loan demand, net interest margins (NIM) expansion will become a focal point. Once you see that happening also as the economy picks up momentum, the bad loan issue will recede in terms of the anxiety it has created as far as the profitability of banks is concerned.So, if you put all that together if I fast forward to 12 months from now banks are going to do extremely well. And so also financial services companies you can argue that they are probably richly valued relative to the banks. So, I would say banks will do very well and within that there is always this how much do you allocate to the public sector banks versus public sector undertaking (PSU) banks.My own view is and I have said this even earlier in the year that the PSU banks to my mind at least hold out a very interesting investment opportunity if you take a 2-3 year time frame and as the non-performing loans (NPL) issue recedes as operating earnings improve as they take to more digital banking the value of that customer franchise will be much more appreciated in the market place that should continue to good investment performance.Anuj: The other under-owned sector, which has also done well of late is metals. What is your view on that space?A: Metals, commodities you have to play it tactically. We had a steep fall in commodity prices in 2014-15. We had a bit of a rebound. Global growth is very anaemic. So, other than periodic episodes of prices of crude oil or commodities moving up the trend to my mind is still down. So, perhaps only to my mind again and maybe in 2018 or so once you have had some excess supply get away or be removed from the marketplace is when you may see a much more sustained upturn in commodity prices. So, right now this rally in commodities to my mind is going to be short-lived. So, the price trend is going to be down.Sonia: There are two global events we are going to be looking forward to before the end of the year. One, of course, is the elections in November and the other is the possibility of a Fed rate hike. Do you think either of that will impact our markets?A: I am not qualified enough to comment on the outcome of elections, we will have to see how that plays out but as far as the Fed rate hike is concerned the markets are now pricing in a high probability of a December rate hike. My only point is that could happen but in the interim if you do have some risk aversion and market anxiety on account of say European banking sector issues or further currency related volatility leading to a much stronger dollar will that then end up in a postponement of that Fed rate hike. So, we have to wait and see.Latha: You would be in the camp where that is a chance that we have to factor in, a possibility of no rate hike?A: Yes.Latha: In that context how are Indian rates moving. We already saw a decent amount of bond rally. There are people on the channel who have spoken about even 6.0 percent on the 10-year 12 months forward, your view?A: My own view was that we would probably get about a cumulative 50 bps hike say, this was the view that I held in the middle of the year, all the way through to say, first quarter next year, we have got 25 bps now. I would probably look for another 25 bps rate cut, sometimes between now and March next year. But that is about it. I don't see further rate reductions hereafter.Latha: 6.0 percent on the 10-year is exaggerated?A: Well the markets can always get over bullish or over bearish but to my mind as far as the rate reduction is concerned by the Reserve Bank of India (RBI) I would not pencil in more than another 25 bps in my opinion and transmission of rates is something we look to and see how that plays out.