‘No tipping point now that favours mid-caps'



Though foreign institutional funds have been very volatile, money will continue to get reallocated into equities of emerging markets, feels Mr Anoop Bhaskar, Head of Equity, UTI AMC. Inflation and interest rates however may need to get subdued for that to happen he adds. In an interview with Business Line, he shares his outlook on the markets and its valuations.

Excerpts from the interview:

Where do you think the markets are headed now? What is your overall outlook?

We can't have one outlook of the market currently. So, you will have to build various scenarios, depending on how crude oil and domestic inflation numbers pan out. And, therefore, different cases will have to be looked at.

If you take the first base case that we are at $100 oil in September, that could further trigger inflation. Manufacturing inflation has already crossed 8 per cent and it can stay at that level or breach 10 per cent. Then the action from the RBI would be very strong and, therefore, growth in the second half of the year could be much lower than what analysts are projecting today.

The second scenario is that oil actually goes up very sharply because of some geopolitical event and then cools off by September and by December it is below $80-90. So, in this case, the markets could go up very sharply first and then come down from there.

The third is if crude oil starts falling right away. In that event, the RBI might take only baby steps. That will be the most benign scenario for the markets to steadily keep going up. Since is very difficult to build portfolios for each scenario we are trying to be cautious and are focusing on better stock and sector selection.

So, which sectors are better investment bets now?

Again, it depends on the outlook and sector weights in the benchmark indices. For example, in India you cannot be too underweight on financials. They are 24-26 per cent of the benchmark. It is not only a large sector it also has a fairly high beta compared to the broad market.

The second largest is oil and gas; it is about 18-20 per cent. We are slightly underweight on it. We are equal weight on IT. As for automobiles, we have a significant overweight position as compared to the benchmark. We believe the sector is still fairly strong and we don't expect to see a sharp fall in the demand volumes for the next 12-18 months.

We are also overweight on consumers and cement sector. We believe that the investment cycles in cement are starting and concerns of oversupply have been addressed, as producers have cut supply. We expect demand to pick up from here. This would help companies have profitability growth driven by volumes over the next year, even if prices stay high.

We are, however, a bit cautious on the power sector as availability of fuel could become a key issue. In India, whenever there's been a bunching of capacity, it is followed by a temporary slowdown. We have seen that in cement. We could see that in power, where the merchant tariff rates for a year or so could be a little lower than what was expected.

As for pharma, it was one of the best performing sectors in 2008 because it was defensive and valuations were pretty cheap. But that is not the case this time. Most companies were trading at less than 11 times in 2008; they are now available at 20-22 times. So today, the defensives may be defensives by the nature of their industry, but they aren't so by way of their valuations. And that's the real worry.

Do you think mid-cap companies would be a position to pass on input cost hikes to their clients?

Asian Paints today is a mid-cap company. But it is not a mid-sized company in the sense that it is a market leader and therefore the price-setter in its segment. So if you are asking if companies that are 4{+t}{+h}, 5{+t}{+h} of 6{+t}{+h} in their segment can pass on hikes, the answer is no.

In fact, they may have to give greater discounts for their products to get sold or absorb input cost hikes to keep the demand intact. But number 1 and 2 players are better off. So, margins would truly be dependent on the position a company has in the sector rather than its market capitalisation category.

What about mid-cap participation in the rally? Do you think valuations are compelling enough to take exposure now?

Well, I think in January and February mid-caps fell as much as their larger counterparts. But in March they did not rise as much.

I think it also reflects the current risk appetite of investors, willing to invest more in liquid and larger names.

Small-caps are trading on a trailing basis less than 10 times now. The valuation gap between the large-caps and them is now higher than what it was in September 2008.

And that is because — whether it is HNIs or institutional, or FII — the money has moved out of the small- and mid-cap segments. They are the ones that get affected the most if there's a rate hike regime in place as these companies will have to pay higher costs for credit.

So, while valuations will be fairly attractive, there is no tipping point that puts their valuations so much in favour that one could buy small- and mid-caps over large-caps.

What about FII inflows? How best do you think investors can keep tabs on their funds flow?

Its part and parcel of the volatility we are seeing in global equities.

One needn't be paralysed by these, as such. If we don't have an event risk, have a stable government policy and inflation doesn't touch alarming levels, earnings growth in India will be fairly strong.

And considering the tepid economic activity in the developed world, money will continue to get reallocated into equities of emerging markets.

But it will require inflation and interest rates to get subdued. As and when we are closer to the peak of the interest rate cycle, the flows into India will increase.

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