Mid-caps aren't to be shunned. Use the current weakness in the market to build a long-term portfolio saysMr Gopal Agrawal, CIO, Mirae Asset Global Investments. In an interview with Business Line, he also talks about trends commodity prices and strategies to pick stocks.

What's your outlook for the equity markets? What about current market valuations?

In the short term, markets will be range-bound. But in the medium term, considering that the top-line growth in India is very robust, we are expecting earnings to move from Rs 1,040 to Rs 1,400 in FY13. This means we are looking at very strong earnings growth over the next three years. The key driving factor for this, however, will be a reduction in subsidy and fall in interest rates.

To me, Sensex at 17,000 looks like the bottom. Investors should, therefore, use the current volatility to build their portfolios for the long run.

From the FIIs perspective, India's exports growth has been very strong last year (35 per cent to $46 billion). Our current account deficit is likely to be below 3 per cent of GDP. Besides, we have high forex reserves and the external debt is less than 20 per cent of GDP. So, given these, there is a good chance that over a period of time the Indian currency may appreciate.

This, in turn, will trigger much more FII interest into India. Fall in commodity prices and reduction in subsidy can take the markets to a high level.

Commodities have begun to cool down slightly. Do you see that trend continue?

Commodity prices have gone up so much mainly because of the combination of demand and loose monetary policy. This helped all the asset classes do well. The loose money policy isn't going away any soon.

Though the QE2 (in US) may end, the US Federal Reserve still isn't talking about shrinking the balance sheet. Unemployment there is still at 9 per cent, so I don't think they are in a hurry to shrink the balance sheet.

In such a scenario, the liquidity will remain strong, which in turn will support the commodities markets. And then you have different commodities with different demand and supply metrics.

Take oil, for instance, that is the biggest worry for India. At this point of time, there is no production growth in non-OPEC countries; Brazil will take some time to give oil from its new discovery. The only incremental supply growth can come from Saudi and Iraq. This is on the supply side.

On the demand side, Asia is doing well, Europe is weak and surprisingly the US is becoming weaker. The recent fall in oil prices can be traced to weakening demand in the US. The February oil consumption data for US reveals that during the month it consumed only 18.7 million barrels.

While Asia is definitely growing, it is the US demand that holds the key. If it goes up, then the oil market will become tighter and price will remain high. As for fertilisers, this time corn prices have been very good. So we will see higher prices for fertilisers, especially phosphatic fertiliser. This will improve the subsidy burden on India.

So is there a case for investing in commodity stocks now?

I would say one must have some portion of their portfolio in commodities. The only thing is that one should be in the right commodities.

We are positive on coal. Note that the total sea-bound trade in coal is only 700 million tonnes though the world produces much more than that. And, of that, China itself is expected to import 200 million tonnes.

So the market is expected to remain tight for coal. In the near term, with all the central bankers raising interest rates to cool down the world economies, we will see a downward spiral in commodity prices. But their long-term trend is sustainable.

What are your observations from the fourth quarter earnings performance of India Inc.? Do you think Indian companies are in a position to pass on input price hikes?

It is still early days, but there's been a strong top-line growth. The bottom-line growth has been at about 15-16 per cent on an aggregate basis. We are clearly seeing signs of margin pressure across sectors.

However, companies have said that they will effect price rises soon. So, I think most of them would be in a position to pass on hikes. In the subsequent quarters, the margin picture should improve.

Any sector favourites? How should investors select their stocks?

Unfortunately, there is no clear answer to this. Certain sectors have been beaten down today, led by external factors such as high commodity prices. So if there is a correction in it, the related sectors — such as the infrastructure basket — would see a re-rating. At this point of time, we view pharma as a defensive sector with some upside. We are positive on auto ancillary. In the oil and gas space, we are positive on refining, while gas as an opportunity in India looks very good.

Media too is looks good. I would suggest investors to focus on individual stocks than sectors for returns. They should look to invest in companies with low leverage, high ROEs and some pricing power.

Doesn't this rule out midcaps as an investment bet at this juncture?

Typically, in a rising interest rate scenario, mid-caps tend to underperform. But when interest rates begin to peak, mid-caps will move quickly to give you double digit returns in no time. Besides, the valuation gap between large, mid and small cap stocks has widened significantly now.

On an average, the valuation gap used to be 10 per cent, now it is more than 25 per cent. Back in 2005-2007, we had a low interest rate regime, oil was averaging at $70-80 per barrel on the higher side, and global economy booming. Everything was hunky dory then. But we had the 2008 credit crisis, followed by a hike in interest rates. So, these killed the mid- and small-cap companies.

As soon as we see a slide in commodity prices and interest rates, these stocks will definitely surge. I feel investors should use the current volatility as an opportunity to start building mid-cap portfolios.

So, when do you see the interest rates peaking?

Well, to each his own. I feel by October this year we will that happening. By then, the monsoon will have had a positive impact, the fuel price hike would have happened and its effect would have been played out.

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