Pay attention to a company’s business model and valuations before buying into stocks, says I V Subramanian, CIO, Quantum Advisors, in a chat with Business Line. Excerpts from the interview:

We saw a strong rally in mid-cap stocks last year. Will this continue in 2014?

The 23-24 per cent rally in mid-caps since August 2013 has come after a steep fall in the first half of the year. But large-caps did not fall as much and therefore the recovery was slower.

While mid-caps looked attractive in August, they are not looking that cheap now. Therefore the probability of continued out-performance is low. Now the question is how the earnings growth of mid-caps will turn out to be.

As they will have to compete with large companies with regard to access to markets, management bandwidth and ability to attract and retain talent, mid-caps may find the going tough.

What should one expect from the blue-chips?

There are a couple of headwinds this year. One is the US liquidity tapering. If the tapering is going to be faster than expected, then interest rate in the western world will move up and that will have an impact on flows into India and equity performance. Second, if the election results throw up a messy government, then the performance could be impacted as the market expectation appears to favour a clear majority to one party. But retail investors should ignore the elections and focus on company fundamentals.

How much can the market fall from here if one were to assume an adverse election outcome?

From here, Sensex may fall 15-20 per cent if the outcome is adverse, as the market appears to be pricing a clear majority to one party. We continue to believe that elections don’t matter in the long term. In the past 30 years, we have had nine coalition governments and India could still grow at a decent 6-6.5 per cent.

Therefore for us, elections are not a worry. But after 2013 Delhi elections, the country’s political landscape has changed and this may keep the markets guessing and choppy.

However, should the accelerated tapering and adverse election become a reality, Sensex may test the 17,000-17,500 levels.

Should one stay with defensive themes then, until this plays out?

I would not advise that. At the end of the day one should look at valuations. In a market with a lot of headwinds even defensives can fall. The best defensive strategy is holding cash as every other sector, including the so-called defensive sectors, may decline.

We have seen a rally in cyclical and value stocks in the last six months. Should one book profits now?

I still find many stocks attractive. For instance, some of the capital good stocks that were extremely cheap in mid-2013 have done well but are not expensive yet.

There’s still enough potential in these stocks. Despite the near-term headwinds of interest rates, the valuation of PSU banks looks very attractive. So, select stocks in cyclical themes do have potential to outperform, provided you have a longer investment horizon.

Emerging markets (EMs) lagged developed markets in 2013. Can they bounce back in 2014?

EMs are certainly looking very attractive on a price to earnings and price to book basis, trading at a steep discount to the developed world. The valuation difference is similar to levels we saw in 2008, post-Lehman crisis. The entire free float market cap of Brazil is equal to what Google enjoys.

India’s market cap is less than that of General Electric. Likewise, Turkey is cheaper than Starbucks.

With the macro fundamentals for some of the EMs improving, it may be a good time to buy. The trade balance of countries such as Indonesia and India is improving. So a combination of attractive valuations and improving macros makes EMs promising.

Quantum Long Term Equity has underperformed its benchmark and peers in the last one year. Why?

The fund did what it was supposed to do — sell out of expensive stocks and buy stocks with attractive valuations or stay in cash.

It has sold off consumer staples stocks and reinvested some of that in the capital goods sector. Holding high cash may have impacted its performance.

However, it is important to evaluate its performance over a longer period. Outperformance in a frothy market driven by few stocks would mean that the fund is deviating from its stated mandate.

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