‘More earnings downgrades are likely’

Profit growth may end up lower than most people expect and the markets are not cheap. That’s why his funds are overweight on themes such as Information technology, says K. Ramanathan, Executive Director and Chief Investment Officer, ING Investment Managers .

Excerpts from an interview:

The quantum of FII selling in the market in the last few months has not been very high. Yet some stocks have taken a big hit. Why?

I think it is due to the absence of buyers in the market. Domestic mutual funds or insurers aren’t receiving much in terms of new inflows.

Markets sentiment is pretty weak. When markets fall on low volumes and there is little buying interest, prices can fall disproportionately.

With the US Fed putting off ‘tapering’ of quantitative easing, has the outlook improved?

The timing of US Fed tapering does impact emerging market flows. The Fed putting off tapering of quantitative easing was indeed a positive surprise. Incremental economic indicators coming from the US do reflect that recovery is good but not robust.

This, in addition to the current impasse in the US government, leads us to believe that there is a possibility of tapering being deferred even further.

This would be positive for the market and the focus will shift back to domestic economy.

However, one should remember that this is only a postponement and when tapering is back on the US Fed agenda the markets could become volatile once again.

What is your take on market valuations today?

Valuation at around 14-14.5 times Sensex earnings is fair. The market is certainly not cheap.

If one breaks up the index and looks at sectoral valuations, FMCG and pharma sectors are trading at above historical averages and financials and industrials sectors are trading at below historical averages.

Is it correct to say that some of the risk from rupee depreciation is not showing up in the balance sheets? Is there a risk to earnings from this source?

This could be the case with select companies especially those which have large foreign currency debt with no concomitant foreign currency revenues that act as a natural hedge.

However the number of such companies is very small in the overall scheme of things. Currency depreciation is more a worry from a macro perspective.

Controlling fiscal deficit becomes difficult as fuel subsidy increases due to depreciation. Depreciation also impacts inflation negatively and that has a negative impact on monetary easing which is required to spur growth.

We have had this polarisation in the market where consumer stocks and defensives are trading at very high valuations while industrials are in some cases below their 2008 lows. Have you rotated sectors on your portfolios?

We had increased exposure to IT stocks and reduced weight in consumer stocks. While valuations for financials are attractive there is no immediate trigger for them with the economy in bad shape. We are almost neutral weight in this sector. This weighting is more due to valuations rather than based on a view of sharp recovery in the months to come. Q2 results may be bad too.

For the last two years, profit growth for companies has not matched expectations. Do you think there are more downgrades to come or are we at the bottom?

There is a high probability that there are more downgrades to come. People were factoring in an improvement in the economy in the second half which now looks unlikely to come through. In IT and pharma there will be earnings upgrades. In energy and autos there may be downgrades. I think we will end up with earnings growth much lower than the 10-12 per cent that analysts expected at the beginning of the financial year.

Are you looking to buy companies which have a higher overseas leg to their operations or higher dollar revenues?

As of now we are overweight in the IT and pharma sectors.

These businesses have a higher overseas exposure. While rupee depreciation is a benefit, that is not the sole reason for the overweight. Business visibility, earnings growth, return ratios, free cash generation and valuation are other important factors that drive the overweight or underweight position in portfolios.

What would be your message to equity investors today?

Invest regularly. Don’t try to time the market. Please consult your investment advisor for asset allocation decisions. Strategic asset allocation decisions should not be taken based on short-term vagaries of the market.

COMMENT NOW