Short-term corrections a great opportunity for raising equity allocation: Harsha Upadhyaya, Kotak AMC

In a chat with ET Now, Harsha Upadhyaya, CIO-Equities, Kotak AMC, shares his outlook for the markets and some sectors. Excerpts:

ET Now: Markets have seen a brisk correction in the last one week. How much more downside do you think is still left in the near term? Do you think the Nifty can climb back to fresh highs once monsoon concerns subside and the earnings season is over?

Harsha Upadhyaya: The market has really shown some amount of correction in the past couple of days. But the long-term equity investors need not worry about this correction. The market has been going up for the last about 9-10 months, and we have seen a very moderate correction as of now.

As far as the earnings season is concerned, it is going to be much better than the fourth quarter of the financial year 2014. So, to that extent, going forward, we are definitely going to see earnings improve. We also have a situation where there is a lot of comfort on both fiscal deficit numbers as well as current account deficit numbers. The rupee has been quite stable. Valuations are also very fair in our opinion.

Therefore, from this perspective, we do not see the markets keeping up gains too much in the next few weeks or months. We believe that any short-term correction that you may see in the market is a good opportunity to actually go and increase equity allocation.

ET Now: Talking about the budget, do the fiscal targets look credible and achievable? Could bolder measures have been taken to kick-start the investment engine? What are your key takeaways?

Harsha Upadhyaya: 4.1% fiscal deficit target is clearly a very welcome step. We believe this is reasonable. We also believe that the non-tax revenues are achievable. One may say that the tax revenues are slightly on the higher side. But still, it is not too far off from most assumptions.

On the non-tax revenue side, the disinvestment targets or the telecom proceeds that we are expecting are really achievable. Also, on the expenditure side, there is clearly a focus on calibrating growth through plan expenditure rather than non-plan expenditure. So, it is a very well-balanced budget and we continue to remain positive on our economic recovery.

ET Now: How are you handling the classic dilemma of balancing investments between defensives and cyclicals? Which pockets are you leaning towards to add to your holdings?

Harsha Upadhyaya: Our portfolios are focussing more on domestic-linked sectors as of now. The bulk of our portfolio is in domestic cyclical sectors or domestic financials. About 20%-25% of the portfolio is in defensives. Among defensive, we clearly like information technology because of the valuation comfort that we have vis-à-vis the other defensives such as FMCG or pharma.

As far as others go, some of the sectors where the balance sheet is in a better condition and the debt issue is not very acute are the cyclical ones which we like. Among them are automobile and cement. We also like oil and gas, because we believe that at current crude prices, this under-recovery in diesel is very minimal. In the next couple of months, we will be able to erase the under-recovery completely in diesel. Hopefully, this will usher in a new paradigm shift in oil marketing companies’ profitability as we go forward.

ET Now: How do valuations look at the start of this earnings season? Also, which ones are on the path of an earnings recovery, and which ones according to you would continue to lag?

Harsha Upadhyaya: From the valuation angle, overall the market seems to be in a fair zone. As you rightly pointed out, there are some sectors which have probably run up much ahead of their fundamentals. So, that is a pocket that one needs to be cautious about.

But otherwise, the markets are still trading in a very fair zone. We believe that in a scenario where earnings growth is going to improve from about 8% CAGR — one that we have been seeing for the last five or six years — to about 16% plus, these markets can clearly hold this kind of valuation.

As far as large cap and mid cap valuation goes, some of the discount that the mid cap segment was showing in terms of valuations has got corrected over the last couple of quarters. Now that discount does not seem to be too large. So to that extent, from here on, the game is going to be more sector-specific as well as stock-specific in terms of future upside.

ET Now: As is the case with bull runs, midcaps have had a roaring party in the last two or three months. Where do you see scope for further upgrades and rerating when it comes to midcaps?

Harsha Upadhyaya: In terms of earnings comfort, there is more comfort on defensives while valuations may be on the higher side in some pockets of defensives. Earnings growth momentum may go down, but as far as other pockets of capital goods or infra companies or asset developers are concerned, clearly one needs to take a stock-specific call rather than buying all of them, because most of these companies still have a distressed balance sheet. Future growth visibility too is not very strong. So, one needs to be stock-specific in the cyclical bit, whereas in defensives IT clearly stands out in terms of valuation comfort.

ET Now: From the large cap universe, what would be your top contra investment call? Can underperformance of consumer and discretionary stocks reverse going forward?

Harsha Upadhyaya: Clearly, the next three years are going to be very great for automobile and other consumer durable companies. We believe that in the short term they are going to be aided by the excise duty cut which has got extended till December 2014. Going forward, we will see some amount of cyclical bounce-back in terms of volume growth there. So, we are positive on that space. But as far as consumption in staples continues, we are not so positive at this point of time simply based on rich valuations that some of these companies are trading at even at current levels.

ET Now: What are the key domestic and global risks which you would be watching out for and what according to you could turn out to be the dark horse?

Harsha Upadhyaya: In terms of risk, the monsoon risk still continues, although it may have started. But in some of the regions in the country, overall still in terms of intensity as well as distribution, there is a bit of lack of rainfall. So, clearly anything linked to monsoon will continue to bear that risk.

But at the same time, one should not really panic at this point, because the clear picture on monsoon will be available only by end of August. So, until then, it is more of a speculation to say anything in that regard.

ET Now: What is your view on regulated sectors such as oil and gas, fertilisers and sugars?

Harsha Upadhyaya: We are more positive on the oil and gas sector compared to fertiliser and sugar. We believe that some of the reforms that are expected in oil and gas sector are likely to go through. The crude which reacted adversely for sometime due to the crisis in Iraq has kind of subsided. Now we are at about $106 to a barrel and we believe that these kind of international prices can have very positive impact on under-recovery as well the as subsidy mechanism, at least on diesel.

As far as the current prices are concerned, the under-recovery in diesel can be breached probably in the next couple of months. So, that is definitely a welcome development. We have already had petrol fully deregulated. So to that extent any further reform in LPG or kerosene prices will also go a long way in improving valuation in this particular sector.

As you rightly mentioned, as and when the gas pricing issue is resolved, it will give a lot of clarity to the sectors earnings growth going forward.

ET Now: Lastly, summing up the macroeconomic environment: IIP showed expansion for the second month, inflation also seems to be showing signs of topping out. The good news here is that industrial activity is picking up and inflation seems to be contracting. Do you think the worst on the macro front is behind us?

Harsha Upadhyaya: On the growth side, we are going to see slightly better numbers compared to last year. I do not think there is any scare on that as of now.

But if monsoon disappoints or agri growth slides downwards, then there may be a shave-off of may be about 50 to 75 bps on the overall economic growth. As far as inflation trajectory is concerned, the recent numbers have clearly shown that inflation has moderated. But monsoon still remains a risk.

So I do not think that the RBI will go ahead and cut interest rates immediately until the impact of monsoon is known clearly. To that extent for the next couple of months, we are going to be on a pause mode.