The Indian market has been unbelievably resilient over the past few months and, in fact, has outperformed its regional peers since the start of 2010. There?s a good reason for that; the economy?s on a roll, oil prices are steady and India Inc turned in a splendid set of numbers for the March 2010 quarter. Going by the sales of cars and two-wheelers, consumer demand remains buoyant while investment continue to flow into spaces like infrastructure. The IMF recently revised India?s GDP growth target to 9.5% for 2010-11. While the low base effect is slowly wearing off and commodity prices too are falling, Indian companies are expected to report a fairly impressive set of results for the current year, too, given that the monsoon is expected to be reasonably good. Much of this though, as Aditya Narain, MD and head?India Research at Citi Investment Research, points out, could be back-ended. Indeed, that?s why Citi?s estimates for the June 2010 quarter are somewhat muted and it hasn?t revised its Sensex target for the year?which is 18,100. Narain tells Shobhana Subramanian and Muthukumar K that he believes earnings will need to catch up with the market.

What are your earnings expectations for the June 2010 quarter?

We are looking at an earnings growth of 7.7% for Sensex (all inclusive) and 16% ex-oil while the broader Citi universe of companies is expected to grow by about 19% during the period. We are expecting a pretty robust year ahead?but with Q1 expectations at 16% compared with a 27% earnings growth forecast for the full year 2010-11(and the challenge of low base effect petering out in the second half), growth will need to catch up in the rest of the year. Some of the earnings of companies had essentially fallen short of expectations in the previous quarter?unlike in the past when most companies have reported earnings that were ahead of expectations. This has certainly created more pressure because earnings have to catch up. If we need to whittle down earnings growth to single-digit levels (for the Citi universe), it would be somewhat worrisome.

The overall sales growth should remain high?32% ex-oil, and 19% ex-metals, but this is lower than in the previous quarter (and in a more inflationary one). We also expect some pressure on margins. In short, expect this quarter to be more of a reality check on what has so far been a strong earnings recovery.

Could the earnings target be revised by the market?

Earnings data needs to be juxtaposed with the earnings revision cycle?which is topping out globally, including in India. There are more downgrades than upgrades, and in India, this phenomenon has begun a bit earlier. Against this backdrop, pressure on companies to perform is going to be higher for the latter part of this year. The market is today factoring in a 24-28% earnings growth for the broader market for the year ahead.

Could a fall in metal prices play spoilsport?

There is a bit of a commodity (oil, metals) bias in the Sensex earnings numbers?with their contribution being close to 40%. While the bounceback in commodity prices should drive earnings, we believe that markets will grind higher this year. In a sense, the market has moved up and is now waiting for earnings to catch up. While we don?t expect much of a disappointment in earnings, the market may also remain range-bound for the rest of the year.

What could surprise the country?s markets?

If macro-indicators remain favourable for a longer time, while they might not be necessarily translate into better earnings over the near term, there is likelihood of markets running up in expectation that corporate earnings catching up later. The upside to the market does not lie in earnings growth, as much of this has already been factored in. In fact, there is the risk element in companies not being able to meet earnings expectations.

What about market valuations?

From a historical perspective, India is today trading at a price-earnings (PE) multiple that is close to its long-term average of 15-16 times one-year forward earnings. The worry is that Indian markets look expensive compared to other global indices. The long-term PE averages for world markets as well as those for emerging markets are relatively lower at ten times. In fact, after the recent correction in the Chinese market, that too is looking cheaper.

Our Sensex target for the year is 18,100 and markets are already hovering close to these levels. While structurally emerging markets, including India, are expected to trade at higher valuations, India faces near-term price risk as it has performed relatively well during the year (and so it is at higher levels), quoting at relatively higher valuations and is dependent on offshore money for a further upside in share prices.

Is the capex cycle picking up?

The world over, there is the concern about companies getting too cautious when it comes to investment. India has overcome this apprehension and is witnessing adequate corporate investment. We have not yet reached the peaks the investment pipeline reached in 2007-08, but I believe the Indian corporate sector is more balanced than what it has been over the last ten years .

In 2002-04, since the focus was entirely on earnings and with a higher return on equity, there wasn?t much investment made by Indian corporations. But 2006-08 saw a phase of massive investment with little focus on project returns. Today, there are investments with decent project returns while leverage is under control on an aggregate basis.

Could the large number of initial public offerings (IPOs) and follow-on public offers (FPOs) that are in the pipeline spook the markets?

The pace of IPOs and FPOs will be dependent on the robustness of markets. Currently, the appetite is modest; so, while there will be decent appetite for well-priced and good offerings, there won?t necessarily be a strong demand for every offering. Having said that, there is also the likelihood of money coming from some unconventional pools of funds, if there is a good or differentiated issue, even if it?s large. The over $20-billion recent Chinese bank IPO is a classic case.

Can lower oil prices be a positive for markets?

Structurally, India is better positioned if oil and other commodities prices are low.

Which sectors is Citi overweight on?

We are currently overweight on banks, capital goods, auto. We are underweight on IT, metals and cement because of oversupply concerns.