First quarter earnings will face challenges says Apoorva Shah, EVP & senior fund manager at DSP BlackRock Mutual Fund. In an interview with Devangi Gandhi, he says the larger base of the year gone by poses an additional challenge in putting up good growth numbers, while top-line growth will be hurt for corporates in the June quarter.Excerpts …

It?s results season. What are your expectations?

Earnings are going to be challenged. The good base of last year?s Q1 results is going to add to this challenge. We have seen analyst downgrade their numbers which means that the market is expecting a decline. For the full year (FY12) the earnings expectations have been cut by 5-10% for the market as a whole.

Top line is most likely to be hurt as evident from recent Auto and retail data. It could have a widespread effect although it may take some to time. In fact, the impact on topline may be phased out through June as well the September quarter.

Are declining commodity prices a positive development for Q1 results?

On an average, the commodity prices (CRB index) has come off about 3%, which is marginal, as compared to a 30% gain seen last year. What is more important is the future outlook for the commodity prices; if people are betting that commodity prices are likely to come down further, analysts may wait a while before cutting earnings numbers further. As with lower commodities and peaking inflation, the revival may come soon. However, it is difficult to ascertain the lag effect of these developments hence one would be cautious.

How do you see the market valuations shaping up?

There are two components to a price discovery, the earnings growth and the P/E. The adjustment that is happening now is that the earnings are coming off but P/E is rising because people have the expectation of an improving scenario as they see inflation tapering off. This is leading to a market going up but it will soon face the headwind of earnings due to the slowdown which is usually evident with a lag. The market may face difficulties in rising up beyond a point and it would then depend on the fund flow because FIIs have been underweight on India from the start of the year and with the improving scenario on the inflation front, funds may give it a neutral rating.

However, it is difficult to predict as slowing inflation still lacks a confirmation while the economy has already started slowing down. We feel that the market is fairly valued and we don?t ascribe a higher P/E than normal which is around 15 times.

What is your current investment strategy?

Our strategy has been not to treat the recovery since 2009 as a normal cycle in terms of global equity scenario because the whole recovery has been led by a lot of stimulus which is not sustainable. Our portfolios have tended to not play this recovery as a normal cycle and we?ve been ?overweight? on the defensive sectors like consumer and Pharma which are anyways growing well and are the leaders of the consumption growth story.

In the last one year we have seen the Street at large shying away from mid-caps. As a result mid-caps have under-performed hugely and now they are available at a steep discount to large-cap valuations. Therefore, there is value in mid-caps but all mid-caps may not be able to sustain in such a challenging environment. Unlike the recovery in 2009 when mid-caps in general outdid the large-caps and broader markets, the situation this time around is going to be difficult for mid-caps.

We believe that in general large-caps and quality mid-caps tend to perform better.

By and large, consumption driven companies not only from the FMCG sector but also from retail, media, education and healthcare constitute our portfolio.