If timing is important in the market, Andrew Holland is the man who has got it right. At the height of the global financial crisis, he quit DSP Merrill Lynch to join Ambit Capital, where he heads the equities team. At near 18,000 Sensex levels, he expects a correction sometime soon. He is concerned about the impact of rising commodity prices and higher inflation on corporate earnings. In a chat with Ashley Coutinho, he discussed major drivers for the equity market. Excerpts:

What is the short-term and long-term outlook for the market? Where do you think the market is headed?

Equities are at a fair to high valuation. Our target for the market this year is 15,000 on the downside and 19,000 on the upside. The Sensex is trading at about 18 times, which is about 10% more than its usual (PE) band and at 18,000, we are currently at the top end of our target. We are looking at Sensex earnings (EPS) of Rs 1,000 for FY11. In the short term (in the next three months) we think the market is going to fall?globally as well as in India. Despite the bailout, there?s a fair bit of problem out there in the world, especially in Europe.

The good news is that because of all the problems (in Europe) we expect the interest rates to remain lower, longer than expected. That means liquidity remains high and will flow into emerging markets. The bad news is that it also flows into commodities?and that?s usually bad for emerging markets. Higher oil prices, for example, could be inflationary for India since it imports a lot of oil. However, in the latter part of FY11 we expect the market to perform better.

Indian shares are at a two-year high. What are the key risks associated with the market?

Key risks in the short term are more global than local. The high commodity prices will eat into manufacturers? margins going forward and lead to lower profitability for Indian corporates. It will also lead to inflation and a higher fiscal deficit, which means the government will have to borrow more, leading to a crowding out of borrowing (for the private sector). Interest rates will thus go up, which will bring the market down.China is always a significant risk?one does not really know what?s going on there. China has been increasing interest rates which might slow down their growth. And any kind of slowdown in China will have a significant negative effect on the global economy.

What is your view on earnings in the near to medium term?

High commodity prices may put pressure on margins (of companies). To my mind, the earnings story will pick up in the second half of FY11 because that?s when the momentum in terms of GDP growth will kick off.

Which sectors do you think are set to do well and which ones would see a downside? Where would you advise investors to park their money, sectorally?

In the short term, I would be a bit defensive. The good thing about the budget this time was that it truly kick-started the domestic consumption story. So, we expect a lot more spending, going forward. This augurs well for sectors such as FMCG, hotels, airlines, consumer goods, auto and auto ancillaries. In the infrastructure space, we like the capital goods players more than the power companies. This is because the power companies are trading at three times their book value and have a lot to execute over the next few years.

On the negative side, telecom remains a concern because of the increasing competition and capital outflows due to 3G. We don?t like real estate either, as the supply situation is getting larger and there?s a problem of pricing. IT is another negative if the currency continues to appreciate.

What about company valuations? Do they look cheaper or expensive to you?

At 18 times one year forward 2010-11 (the Sensex) is at the top end of its trading band. In the short term, it is overvalued but in the long term (2011-12 earnings) it becomes more attractive.

Do you think the RBI will increase rates in its forthcoming monetary policy?

The RBI will have to be ahead of the curve, which I think they are. We are likely to see an increase of 25-50 basis points (bps) in the credit policy (on April 20). It?s a fine balancing act. On the one hand, you?ve got to fuel consumption and, on the other, you got to keep inflation at bay.

What is your take on the divestment set out in the Budget?

I don?t think what has happened has helped the government. They have got the pricing wrong. I don?t know if it?s because the government has gone for higher valuations or the merchant bankers have got it wrong. LIC and state institutions have bailed out the issues. Having the support of LIC is good, but I?m not sure if it is helping the right price discovery, which is what investors are looking for.

Which are the global cues to watch out for? Is the global economy out of the woods yet?

These days if you have a problem you get bailed out. The Europeans said they wouldn?t bail out; they?ve now bailed out. The (Eurozone) problem has turned out to be a lot larger than what people were first expecting it to be. The big question is: where will the growth come from in Europe? How does a Greece, Portugal or Ireland really grow without growth in Europe? The growth is not going to happen, which will create problems for these countries. What these countries should do is take the hard medicine and cut costs. Now, that has social implications. All these stimulus packages since last year are just helping sweep the real problems under the carpet. The countries need to start cutting their deficit down.

Some people say that the US is now growing, but it?s not really growing. That?s because the job losses are still quite high and the credit offtake is negative. Besides, if you took the entire stimulus away, would the economy really grow? I doubt it.

Do you think FII allocation to India will increase over the course of this year? India seems to be overvalued compared to other Asian markets?

I think it will. While there?s no way India can escape a global liquidity crunch, it has differentiated itself from an economic viewpoint. For instance, in the worst of times, it grew by 6.5%. So there?s a bit of economic de-linking from the rest of the world because India?s domestic consumption story is so strong. That has given the foreign investors a lot of comfort.