Are there sure signs of a turnaround in the economy? There may not be, if one looks at the numbers. But S Naganath, chief investment officer of DSP-Merrill Lynch Asset Management, is optimistic of a turnaround after the elections.

Naganath, who has never ignored the cyclical sectors, even when the entire investing community was accumulating growth stocks, lists three factors that will cause an economic recovery. One, the change in sentiment, which has already started, will be clear after the elections. Two, this will be followed by pending investments both by the Government and the private sector. And three, foreign direct investment will see an acceleration.

"It's important to take a12-18 month view on cyclical stocks," says Naganath, who broadly categorises them into those industries which will be susceptible to international trends (imports) and those that are not affected by imports.

For instance, cement and engineering do not face the threat of imports. The engineering sector, especially capital goods, is largely project-specific. Industries like petrochemicals and steel will depend on domestic demand as well as imports, import tariff levels and exchange rate.

"Once Government investments start taking off, a number of projects in the private sector which are on the drawing board will be implemented," he points out. Cement would benefit from this, he adds.

Though the current rise in the cyclical stocks is driven by international prices of commodities firming up, Naganath says: "It is important to look at local trends in commodity prices. I am optimistic of a smart turnaround post-elections." He sees an upswing in commodity prices, "and the cyclical stocks should respond evenearlier." With one more good monsoon expected, Naganath sees rural incomes buoying demand in the economy. But is it time to shift out of the three growth sectors - FMCG, IT and pharma? Naganath does not advocate a blind and total shift. "The three should not be ignored and a degree of exposure is required here." He expects a mild slowdown, but sees returns in the long run. For instance, the software sector has to be looked at beyond 2000. "This is because a number of companies have postponed non-essential projects beyond 2000," he points out. This is quite contrary to the general belief in the market that after Y2K, earnings of software companies will slump.

Naganath is also keen on value stocks, including those in refinery and telecom sectors. "Their basic business is intact. Fundamentally, there is no reason for these stocks to decline." At current prices these stocks provide good value. An investor has to take a one-year plus view on these stocks. Naganath is not worried about the upside, "but aninvestor should worry about how much more they will fall."

The expected turnaround in the economy is also likely to percolate to banking stocks. In fact, there are already signs of interest in the segment with the sharp rise in State Bank of India's scrip. "A recovery will help the financial sector in many ways. The concerns over non-performing assets will abate, while advances to industry will pick up. This will also help improve spreads," explains Naganath.