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S Naganath of DSP Merrill Lynch said, the markets are likely to see an upside over the next 4-6 weeks, which could take it back to its old highs. However, he expected the markets to be extremely choppy after the Budget, between April and September '08, but added that a rally was likely in the last quarter of 2008.

Commenting on earnings, he said while there was a slowdown in earnings, in general, they were reasonably good and had not caused substantial amount of disappointment.

Excerpts from CNBC-TV18's exclusive interview with S Naganath:

Q: How do you find the markets now, these are interesting times, both for primary and secondary markets? How is the risk reward balance looking from here?

Naganath: It has been certainly interesting. We have seen a spate of negative newsflow internationally that seems to have spooked the stock market in the last week to ten days. But we are getting to a point where the markets are beginning to look oversold, and I do believe that over the next 4-6 weeks, we should see a nice bounce on the upside.

Q: How have you read the primary market action and the fact that a couple of large influential IPOs had to be pulled?

Naganath: I can’t comment on individual IPOs. I suppose whatever decisions were taken were in response to the market conditions in the last week or so. But looking forward, I think the risk reward looks like 5% on the downside and probably 15% on the upside over the next 4-6 weeks given that markets were looking oversold and the element of open interest in the F&O market seems to have come down substantially, the results season has been extremely good, the possibility of rate cuts in the next month or two are quite good, given what’s happening around the world with central banks cutting rates, also the fact that, looking ahead we have the Budget.

So all in all, I am of the view that things should start looking up as early as next week over the next month and a half.

Q: You said that earnings were fine but a lot of people have commented that it was about the weakest earnings quarter that they have seen in a long while. Are you worried that things are beginning to slow down a bit?

Naganath: Certainly for FY09, the expectations for GDP growth are somewhere between 8%-8.5%, which is much lower than the 9%-9.5% we saw in the previous couple of years or so. Against that backdrop, yes we are expecting earnings to moderate down to the 17%-18% level for FY09, and similar level of earnings for the following fiscal year.

So this is not something new. Given the high base that we have created in terms of earnings growth over the last three years, this was only to be anticipated. So I don’t find anything greatly surprising in the fact that there has been a moderation. It is because of the base effect.

It is possible that in certain pockets, we have seen some amount of earning slowdown. But otherwise, in general across the market, the earning numbers have been reasonably good, nothing that can cause substantive disappointment.

Q: Your upmove call for the next 4-6 weeks is a near-term tactical call or are you convinced that the worst is over for this year?

Naganath: It is a tactical call. I had said this earlier as well, the bounce that lasts for maybe a month to month and a half, and then the second quarter and the third quarter this year basically from the April all the way to September, is going to be a very choppy market because again you would have renewed newsflow, as western banks, and financial institutions announce their results for the March quarter. Then we could have some pockets of volatility and disappointment in terms of perhaps further write-downs, whether it is credit debt or subprime loans or other mortgage securities that they hold in their books.

And then I do expect that once all this newsflow out of the way, in the fourth quarter 2008 we should expect a smart rally. It is too early to look at 2009, but if you look at the GDP growth estimates currently put out by many economists, it is quite possible that India maybe the fastest growing economy in Asia, as China perhaps slows down as their exports begin to slowdown.

So 2009 could be a very good year for Indian equities. But 2008 would be the year when we basically consolidate after a difficult second, third quarter and then perhaps begin to rally again in the fourth quarter.

Q: What kind of an index band would you see this volatility in? Do you think the lows are in place or do you expect the lows to be violated in the volatility of mid-year that you are talking about?

Naganath: It is possible that in the mid-year my view is that perhaps will test at that point the levels that we saw in August when the subprime crisis broke out around the 14,000-15,000 levels. On the upside we could well retest the old high if the bounce that we do anticipate turns out to be fairly sharp and it can be when you have oversold markets, the rebounds are equally sharp.

Q: What about flows, we have seen USD 5 billion go out? Where is the pressure coming form do you think on this incessant withdrawal of money that has been happening for the last 4-5 weeks?

Naganath: I think if we look at USD 4-5 billion in absolute terms, obviously it sounds like a large number. If you put it in context the market is approximately USD 1.5 trillion in terms of size and thereabouts, approximately 20% from my estimate in the hands of FII that is about USD 300 billion or so. We had about 14-15 billion come in the second half of 2007.

So again if you put it all in context of overall investment by FII in a cumulative sense, the flows that we saw in the second half of last year, these flows are only expected to be given the volatile nature of the markets in the last six weeks and the sell off that we saw in late January.

So, if the markets begin to start steadying and moving up, you will find money coming back in. So I am not too concerned about the possibility of minimal inflows even if markets bounceback. I’m sure they will come back in.

Q: What would stay out of now, because valuations are somewhat different now from any sectors than they were just about a month back what looks attractive and what looks unattractive after the correction?

Naganath: What look attractive are certainly the banks. If we do see some rate cuts over the next few months I think the banks should do well particularly the state-run banks which are available at very attractive valuations. We are still positive on capital goods and the engineering sector. Some may argue that valuations there are a over little overstretched but again if one chooses carefully there are many companies out there that have done exceedingly well, have huge order books and can execute very well. So we do see a lot of stocks in that segment that can do very well over the next year or two.

I’m quite positive on the media sector, which I think is still undervalued relative to its potential over the next few years. Also pharma and FMCG perhaps be sort after now as defensive component of the portfolios and they are looking attractive. What one would not look at is difficult to say. One can probably look at underweighting the auto segment a bit, the oil refining segment, which anyway have been underweight in many portfolios for quite some time.

One is sitting on the fence in technology. One has to evaluate the extent of the impact on margins over the next few quarters. Broadly those are two or three sectors that one would sit on judgment over the next month or two before deciding if one needs to up or reducing weightage.

Source: Moneycontrol.com