Even as most analysts are expecting a recovery in the economy in 2014, Aditya Narain believes a full-fledged recovery is some way off. This, the Citi India Managing Director feels, will weigh on stock markets this year, which might stay in a range rather than break out sharply.
"The reality is this economy has taken time to slow and it will take time to get back," he told CNBC-TV18's Udayan Mukherjee in an interview. "The economy is going to be slow and the market is going to follow the economy."
Calling it a year for trading, he compared the current market scenario to the one seen in 1998 or 2002-2003.
"There was an economic fix that was going on, the market did not go anywhere, but if you traded well, you actually made decent amount of money," he said. "You will have bursts of enthusiasm and then a let-off."
Narain said he was positive on the telecom, pharma and IT sectors. On the macro environment, he said the rupee could positively surprise while inflation could come off later in the year but interest rates may rise 25 basis points early.
Below is the edited transcript of Aditya Narain's interview with CNBC-TV18's Udayan Mukherjee.
Q: You are predicting another underwhelming year for equities. Why is that? Why you are not more optimistic for 2014?
A: In many senses, over the last one-two years, when the market was weak, it tended to focus entirely on the economy and not pay much attention to the macro. This year too, it will pay a bit more attention to the economy rather than get too carried away with the macro.
The economy is going to take a certain amount of time getting out of the slump it is in or extrapolate serious risk-on scenarios.
I think it is going to give opportunities but I do not think it is something that can sustain. So, bottomline, the economy is going to be slow and the market is going to follow the economy.
Q: Your take is interesting because some people argue the exact opposite. That the market will ignore the economy this year because big events such as elections will be the big driving forces?
A: This year has its set of distractions but at the end of the day, they are distractions, so I wouldn't say that the market might not move 10 percent up or 10 percent down over a very short period of time.
But as you edge towards the end of the year or you sit out a slightly more extended period, it is going to come in line with where the economy is going and what the expectations of the economy are.
At this point in time or at least for those who are wildly optimistic about risk events in the economy, the reality is this economy has taken time to slow and it will take time to get back. I do not think there are any v-shape scenarios that are sitting out there and for markets to move sustainably, you require that kind of a v which I do not think you will get from the economy.
Q: You think the earnings picture will be consistent with the economic picture that you are maintaining?
A: The earnings might be better than the economic picture because earnings are driven by businesses per se.
And you will get better earnings than you will get broader economic growth simply because earnings can come from growth but they can also come from being constructive with costs, being focused in terms of what you do and what you do not do. To that extent, earnings will be slightly better than the broader economic growth that you will see.
Q: What could surprise? If your take is that the investment cycle does not do a complete u-turn in 2014, do you think either of these two factors – a good political outcome or interest rates coming off sharply in the second half -- could provide a surprise to the basic premise that you are working with?
A: That combination can be one that can give you effectively more upside but you might get a 10 percent pop but then it will stay there for a period of time until you start seeing some backing from the economy and that could get stretched a little bit more.
Q: What is the feeling you get when you speak to companies? Are they saying that this year might be a turnaround or is business sentiment still about ambling along?
A: My sense is it is effectively ambling along. I think you made progress over the last six months. Six months back, people were only looking at that downside. Now they are looking at potential upside somewhere down the line but they are still in a re-fix phase and so they want that phase to end before you are starting to look at growth.
So, it is probably a little better than what it was over the last six months but it is just that people are looking at the same level rather than downside which was the case some time back.
Q: Can you say with confidence that 2014 -- even if it is a wishy-washy year -- will be the last year of this protracted down cycle so that people who take a slightly longer-term view might say this year may not be special but if we look to 2015 now is when we start building?
A: I would be slightly hard-pressed to say 2015 will be the year when the economy will bounce back but currently you are in the midst of a stabilisation phase.
In some senses, if you have patience beyond looking six months or 12 months, this might not be a bad time to invest but the returns will tend to be a little bit more back-ended and 2015 might be an aggressive call particularly if you want to link it directly with the economy but it is a good stabilisation year but these periods tend to take time.
They tend to be much more extended than what the market tends to hope for.
Q: What are you building in in terms of the global backdrop because this is a year where we probably won't have great liquidity gush into emerging markets. Is it going to be supportive framework for global markets?
A: It is going to be a supportive framework. I think growth level globally should be little higher so our forecast is about 3.1 percent global GDP growth. But is it going to be that leg of upside which will drive domestic economies like India's? I do not think it is going to be that strong but it is supportive.
So, businesses that are linked, flows of money, the fact that things are generally stable. I think that will tend to be supportive but in itself is it a massive driver for an economy like India? I do not think so.
Q: What is the downside risk that you get a negative year for equities?
A: In some sense, we are saying it is 5 percent so the margin tends to be relatively modest. I would say there is only a moderate risk of a downside simply because you have got lower levels of valuation. Again, just as the economy cannot support material upside, it is unlikely to support material downside simply because it has actually stabilized.
So you are going to get that business-as-usual sense. So unless there are some really negative top-down developments -- be it global, be it politics, be it inflation -- I don't see material risk to the market falling meaningfully below where we are.
Q: If the market has to sell-off in 2014 you would think that it has to be a global impulse, nothing local could drive it meaningfully down?
A: Except the elections, which have always tended to surprise on one side or the other, I think it will tend to be more global. I would be very surprised if it is economic-driven.
Q: Would you still want to be defensive then in your portfolio construction?
A: In some sense yes, so our sense is you just follow the business momentum. The business momentum lies in IT services, pharmaceuticals and at the domestic level lies with telecom. That is where our bias would be.
Where we have a little bit of risk appetite is with some focus on midcaps, which are doing fine. The risk you are running every now and then is that the market gets excited about material upside is that it is not a rising tide that you are getting -- a rising tide will push up everyone as it has done in previous bull markets.
So you got to handpick those midcaps where businesses are fine, they have just got beaten down simply because there has been a risk aversion in the system. But by sheer dint of the economy inflating businesses that are troubled and cheap, I don't think that is going to happen.
Q: So you are saying it is going to be another middling year with stock selection once again providing the alpha?
A: Yes. I think the sector selection will also matter this time unlike pure stock selection but bottom-line is, it is going to be more bottom-up then top-down this year.
Last year was very interesting. I don't think you will see the extremities that you saw in 2013, big macro events, big risk-ons and risk-offs, this whole tapering fear, I don't think you will have such events or they will be much more muted but to that extent you will see bottom-up opportunities.
Q: But mostly a ranging kind of market, low volatility here you think?
A: Our sense is there will be some levels of volatility. I think rather than a low volatility I would say it is a good trading year where you will get your 10 percent up and 10 percent down but it will tend to trend towards a mean which will limit any massive moves.
Q: So you think that by the end of the year, it will still not be a year when we look back and say this is a year when after six years, a bull market started again?
A: It would be the early part of a bull market so it could be a year one of a bull market where years two and three are where you see material upsides but it wouldn't be the year that you have bought this year and in year three you would have made a lot of money.
It is you have bought this year and five years on you made a lot of money and those two years where you struggled a little bit couldn't really count for that much. I would say it is very early stages of a bull market, what it is called minus one day of replacements.
Q: Let me start with IT because that has been a favourite trade for you and your peer set. You think there is more room for valuation expansion there from where we have reached already?
A: I think there is just a marginal level of valuation expansion upside there. What you do get is some support from earnings per se.
Q: So, stock performance you expect to chase or track earnings performance?
A: In some sense by the marginal upside on valuation. You must remember in an overall context we are looking at 5 percent for the market, so to be materially overweight, you need 10-20 percent from a stock, from a large one in particular and you are done from a portfolio perspective.
Q: I didn't hear you mention FMCG. You have taken that off your favourite list?
A: That has not been on our list for a while. It has been made more underweight now simply because we think this slowdown in the economy is at the end of the day going to have a lagged impact on the consumer.
You have seen it on the discretionaries front, I think it will trickle down to the staples front and offset that against high valuations, the risk of a lack of performance or negative performance in that space is high.
Q: Would you extend that to autos as well or you are more optimistic there?
A: We are neutral at the portfolio level simply because if there are any so-called green shoots or if you get top-down events that is politics, inflation, the currency, then this sector is going to be a little sensitive to it.
But I would say from a pure underlying business front, I think it is going to be another challenging year for them.
Q: Across the spectrum or some areas you are more optimistic than others within the auto space?
A: We are little bit more optimistic on the four-wheelers than the two-wheeler space but by and large, it is across the board.
Q: What about pharmaceuticals? That has been the other favourite of the market -- you see another good year for pharmaceuticals?
A: We should. Though most recently they have tended to struggle with a lot of FDA issues floating around but here again you are basically backing a fair amount of business momentum. A great global cycle plus the fact that businesses are scaling up and tending to consolidate.
So it should be another good year for them. That is a space where you can very easily go down in terms of your stock selection, in terms of smaller companies -- slightly higher-risk appetite -- without having to worry about them being very small businesses.
Q: Where do you stand on oil and gas because after many years we are seeing some murmurs of optimism with gas price hike? Are you overweight or neutral?
A: We are neutral on that space. We were at one point in time overweight when we had the build up to this gas price hike but now that is done. In some senses, it tends to be more a call on where oil prices will go and we don't think that is going to be a material swing factor.
Q: Telecom is coming repeatedly into the stock picking radar of many of your peers, are you guys optimistic that they can eke out some outperformance this year?
A: We have been optimistic in that space over the last one year. What telecom is offering is the best-case scenario for Indian businesses to do well wherein you get the natural growth of the market and you get a business consolidation.
Now this consolidation has been market driven, it has been driven by regulatory reasons but now that it is happening, you are seeing the upside of businesses managing to price up. That is a sweet spot that can sustain for a period of time.
Q: You see significant price or margin expansion in this year?
A: In some senses the sector is set up well, the demand side is very comfortable and the amount of spend is similar to consumer staples in that, too much doesn't go out of your pocket when you are spending.
So it is little less sensitive to what is happening top-down. So to that extent we do see pricing upticks, we do see this move to data, it is going to be swifter than what the market is extrapolating at this point in time.
Q: Where do you stand on banks?
A: We sound very neutral but we were running overweight for an extended period of time. We have now cut it to neutral over the last three-four months. Simply again the banks are an exaggerated trade on the market. So the day we think either the market is going to do well or the banks are going to do well, we are going to be very optimistic on the other.
At this point in time, simply because we think the economics underlying is going to be soft, steady, our call on the banks tends to follow that. It is too early in the recovery cycle. The worst is over is the consensus but I do think the biggest pressures are kind of over.
What you have to be careful with the banks about not getting too excited is the fact that there is an extrapolation of a recovery cycle that might start getting underway and it will be stronger with the banks than it will be with the broader economy.
I think that is just running ahead. It is going to be an extended sustained non-performing loan (NPL) kind of scenario that will be there in the economy.
Q: For how many quarters you think more?
A: I think you will continue to see deterioration for about two quarters -- the pace moderating beyond that. I would say there will be two-four quarters where there is basically very little change rather than a recovery cycle, which folks might tend to hope for.
Q: So six quarters or a rounding bottom for the banking sector?
A: Yes, it is going to be extended.
Q: Both private and public?
A: In many senses, yes. It is going to be sharper for the public when it comes because realistically the private banks haven't gone down that much but the broader credit cycle is the same.
Q: What is your biggest anti-consensus call if I might put it like that this year?
A: In some senses, I think it would be consumer staples where we are materially underweight. I would say that would be…
Q: [Interrupts] On the optimistic side, any anti-consensus call where you are not with the street?
A: I would say that would tend to be more with stocks. We have some metal stocks. We have some odd bank stocks where we are taking an aggressive call, but I would say that is more stock driven rather than necessarily sectoral driven.
Q: What is your interest rate call for 2014? For a lot of people the call is whether to be in equities or fixed income and if their call is that interest rates come off 50 bps during the course of the year they would rather probably be playing double digit returns in fixed income. It is a close call?
A: We do not think it is 50 bps down. Our formal view really is that you still have 25 bps up from here.
Q: Immediately you think?
A: Not immediately, but over the next quarter or so. Bottom-line, I think on the macro, both at the currency level and at the interest rate level you are just going to operate within a small, narrow band. It is not going to be decisive this year.
Q: So you are not expecting interest rates to provide any major tailwind for equities this year?
A: It is not going to be interest rates. The surprise that you could get over the second half of the year is actually inflation, which from a market perspective can be extrapolated to interest rates at a later point in time. I think interest rates per se will tend to be a little stickier this year than what equity market folks would hope for.
Q: 2013 in many senses belonged to volatility in currency. Do your investors still ask you about what might happen with the rupee in 2014?
A: They still ask. I do not think they are looking for as decisive an answer and I do not think they are looking for a market call based on the currency, but potentially that is another area that could actually surprise on the way with the rupee appreciating.
The reality is that the one space in the broader macro theme that has been nearly fixed is the current account deficit. The run rate is under 1 percent or at about 1 percent, so that provides you the underlying cushion of optimism.
I do not think enough is being asked on the currency quite honestly. There is obviously the big global overhang on that, but interestingly if you see the move in the currency over the last couple of weeks vis-à-vis the fragile five, it has done actually pretty well and it is being seen to be as the currency that has fixed itself in a much sharper manner than its peer set.
So in some sense, if there is any optimism on the currency globally, this is the currency that is probably set to gain a lot. We are not factoring that in.
Q: Is it still too early to get into cyclicals? Lot of investors seem to be still debating that Larsen & Toubro (L&T), Bharat Heavy Electricals (BHEL) call and whether they should be getting in now?
A: I think there will be trading opportunities in this space. You have seen it over the last three-four months. You would have made good money by getting in and selling out. I think it is going to be another year of trading for them.
As I said, my sense is it is a more extended economic recovery cycle than people are hoping for at this point in time. So you will always have these bursts of enthusiasm and then a let-off. So I would say it is going to be a trading year this time.
In some senses, if you were to see the set-up of this market, if you were to go back to 1998 to 2002-2003 it was similar. There was an economic fix that was going on, the market basically did not go anywhere, but if you traded well you actually made decent amount of money. This year I would actually say is a trading year.
