‘The economy is bottoming out’

We are positive on banking, automobiles, cement and industrials, says Venugopal Manghat, Co-Head, Equities, L&T Mutual Fund, in an email interview with BusinessLine . Edited excerpts:

The market is at an all-time high. Do fundamentals justify the run-up? What are the risks?

The market has scaled new highs in the last few months in anticipation of a recovery in the economy driven by investments. Global markets have also rallied during this period for the same reason. In that sense, our market has not done something very different.

Fundamentals are yet to catch up. The economy is coming out of a deep contraction phase and the recovery will be gradual. In line with this, corporate India has also been growing at subdued levels.

The earnings of Sensex companies have grown at about 8 per cent annually between FY08 and FY14 − this should improve significantly over the next few years. However, there are risks.

The global economic recovery may get delayed and there could be intermittent negative news flow. Also, there are increased geo-political tensions which can impact crude oil prices and foreign inflows. On the domestic side, the recovery could get delayed. Interest rates are yet to moderate and this will depend on how inflation plays out. An investor needs to take a balanced view keeping all this in mind and needs to be patient.

With interest rates unlikely to moderate any time soon, what are the implications for corporate India?

Undoubtedly, it prolongs the pain and to an extent, delays the recovery. But I think the markets have now more or less reconciled to the likely scenario of interest rates not coming down in a hurry. The estimates for this year do not factor in any reduction in interest rates and, to that extent, will not materially change the numbers or the outlook.

Also, corporate India has been trying to reduce leverage on balance sheets by selling assets and raising equity capital as the markets are more conducive now.

Your recently launched Business Cycles Fund plans to change allocations between sectors and stocks based on business cycles. What are you currently betting on – cyclicals or defensives?

The L&T Business Cycles Fund is focused on sectors depending on the stage of the economic cycle. We believe that the Indian economy is bottoming out and is turning around. This makes us positive on the cyclical sectors in the economy, which are more sensitive to economic growth. The market has so far seen a good run in cyclical sectors over the last year or so and this, to some extent, is in anticipation of the economic recovery.

Earning growth is still subdued and at the bottom of the cycle. Hence, valuations may look stretched, but as the economy picks up, especially driven by investments, earnings should also grow faster and valuations will normalise. We are positive on cyclical sectors, which include banking, automobiles, building materials including cement, industrials, etc.

Within this basket, the engineering and capital goods sector may take a while longer to recover. At current prices, defensive sectors are overpriced and are at extreme valuations. Some of the sectors are seeing moderation in growth as well. While over a longer period of time these sectors may do well, given the high valuations, we are underweight in the space.

L&T India Value Fund has done well in the last one year, thanks to gains from small- and mid-cap stocks. Are you continuing to bet big on this space?Also, why has the fund not done so well in weak market cycles?

In the second half of last year, the portfolio was altered to include mid- and small-cap stocks, given the valuation differential with large-caps at that time. Also, we consciously reduced exposure to some stocks which had appreciated over a period of time and were not offering value.

The small- and midcap stocks bought subsequently did well and contributed to the performance. At the current juncture, large-cap stocks are fairly priced for the short- to medium-term earnings. The broader market offers better opportunities from a valuation perspective and therefore, the focus would continue on mid- and small-cap stocks.

However, one would need to work harder to identify value picks now. We are focused on buying into stocks that offer value and the unlocking of this value may happen over a period of time.

In the last six to eight months, the mid- and small-cap exposure has gone up as also the exposure to the cyclical sectors. Both of these could have resulted in slightly higher volatility.

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