(Blog dated - 17th March 2013 on Fundamental Analysis in Market)
Fundamental/Market Strategists Have Great Contrarian Value in the Market...
Previously, I had written a blog on one of the India's greatest contrarian indicator in form of a hedge fund manager. In this blog I will try to explain certain "facts" about fundamental analysis through one of the well known market expert. I must say the guy is very learned and analytically strong, but market calls are not only about intellect. In fact best of the market calls can be very boring. I will try to put part of the transcript of the calls made because most the times they sound intellectually appealing (largely due to the fact that they are more of postmortem of happenings around put in smart sounding words)
Major Calls....(I will avoid commenting on calls or bold parts of the transcript)
Buy now, or else regret after 18 months: Ridham Desai
(Sep 2, 2011) (CNBC)
Q: What is your
feeling? Are we very close to the end of the pain or do you think we will face
another few quarters?
A: I think the world
does look in a very messy situation. I think the developed market environment
looks quite tricky and it's going to take probably several quarter, if not
years, for this to settle down. Indeed! We are dealing with very high
leverage in the western world. So as a response to the great financial crisis,
the western world transferred debt from private balance sheets — notably
household balance sheets — into government balance sheets. Three years later,
now we have kind of a crisis in the government balance sheet and one cannot
really sort the situation out by transferring debt from here to there.
Eventually, the western world will have to deliver, will have to bring its debt
down to more sustainable levels which are serviceable and then I think western
world will start looking better.
It does remind me of a period in the mid-1990s. Emerging
markets (EMs) of 1994-95 were in a similar situation; bad balance sheets, bad
external accounts and it took nearly 4-5 years to actually square the circle.
In fact at the end of it we had the Asian financial crisis in which a lot of
loans went bad in banking sector and there was a massive amount of
recapitalisation that had to be done. In that period S&P 500 traded
consistently in the mid-20s in terms of multiples and emerging markets de-rated
continuously.
We went into a situation where EMs started trading in single
digits by the end with the SPX trading at substantial premium to EMs. So it
took quite a few years and then the EM bull run started somewhere at the start
of previous decade. We are probably a dozen years into that now.
The SPX in contrast has gone nowhere in absolute terms, it's
almost at the same level that it was during the end of 90s and has been slowly
de-rating. Our US strategists think there is a good chance for the SPX to trade
at 10 times earnings. The question is can EMs trade at 20 times? I think it’s
quite possible. But this will take time. It's not going to happen overnight. In
the meanwhile, there will be volatility for investors in India.
India has to get a few things right itself; our reform
momentum needs to pick up a bit. We need to fix our inflation situation, which
I think is getting fixed but there are risk in the interim period. The western
world addresses the situation by massive monetary easing and it won’t
necessarily be a good news for India’s inflation because commodity prices will
go up, so there could be near-term challenges.
But if you look out
at 2-3 years, in fact even 18 months horizon, I think we will look back at this
moment as if we had been better off buying equities than not. So in summary I
would say it’s a good time to buy equities but it will require a lot of stomach
to withstand the volatility that we are likely to see over the next few months.
A: A recession in the western world is not necessarily a bad
news for India to the extent that it actually caps commodity prices. If growth
is indeed slowing down in the Western World, India will start looking even
better on a relative basis. The absolute pain is a hard thing to peg down.
It may take a little
while. This is because troubles that the western economies are facing have gone
through a massive amount of credit build up which has been going on for 30
years. The balance sheets look over geared, growth doesn’t look strong. It is
going to take a long time to fix that situation.
Imagine a corporation
which is geared up three- four times to equity and doesn’t have enough cash
flow to service its regular interest payments forget about servicing the
principal payments. That is a very difficult situation for that company and
haircuts will have to be taken. Each time a haircut is taken, it creates pain
for investors. That situation may go on for some time.
It is going to get
difficult for us to get constructive on the developed world. But on India, if
one can paint a recession scenario but not a complete freeze in the financial
markets. We assume that this doesn’t morph into a big scale financial crisis a’
la’ 2008. We do not get that type of monetary stimulus which could cause
commodity prices to go up even while growth is slowing down in the world.
The outcomes could
not be bad for India; they may actually turn out to be quite good. As you head
into the end of Q4 of this year, India may settle down into a nice trade on a
relative basis and on an absolute basis it may stabilise. That could be the
time frame which the shorter-term
investors are looking at.
For investors with a
longer-term horizon it is very hard to time these things. I would start putting
money to work right away. I would leave a little bit of gunpowder in the
barrel. In case there is a meltdown the world faces then one can come back and
put that to use. I would use that approach towards Indian equities.
Market forming base for new bull phase: Ridham Desai
(29
Sep, 2012) (CNBC)
Ridham Desai of Morgan Stanley is optimistic about the
market forming a base for a new bull phase.
"On the macro side, things are setting down for a good
trade. Corporate earnings are bottoming out. Margins will also expand in the
next twelve months," he said in an interview to CNBC-TV18. He expects
earnings growth in the next few quarter to drive Nifty up 20-25%.
Going forward, one should focus on macro and sector themes,
he suggested. "We want to widen our sector bets and become more macro and
be less concerned about picking the right stocks."
Meanwhile, he added that the reforms announced so far are
not enough, but it is a good start. He expects to the government to take some
concrete steps on infrastructure spending and fiscal consolidation.
Q: Is it time to be aggressively bullish or some of the
issues that you spoke about the tepid earnings trajectory so far – growth not
picking up yet makes you take a more moderately bullish stance at least at this
point?
A: I am actually very bullish. But it is a question of time
frame, so we have been constructive on stocks all year. The shift in our
strategy is that, so far we have been focused on picking stocks as the way to
making money on equities. Picking the right stocks has yielded very good
returns.
Even the Nifty has done well this year, but really the juice
has been in picking stocks. Going forward, you want to be more macro, more
sector oriented and more cyclical in your approach. If you see it from that
context I would say that I am more bullish now. We want to widen our sector
bets and become more macro and be less concerned about picking the right
stocks.
Q: Is there a good chance that the market can justify
rerating on the way up now or do you think market upsides will be limited to
the kind of earnings progression we see over the next four quarters?
A: In a bull case yes, we will definitely get PE rerating,
but on a base case basis I don’t think we are still in a PE rerating
environment. We get a recovery in earnings growth – earnings growth for the
Sensex for example has been low double digit over the last couple of years.
That probably moves into mid double digit.
If the market rises to that extent not a whole lot of PE
rerating, but certainly driven by earnings growth. If a bull case scenario
emerges, which is that you get very strong policy action, inflation moderates and
rates fall then of course, the PE ratio can rise. On a base case basis, the
earnings progression over the next 4-5 quarters will be enough to drive the
Nifty up 20-25 percent.
Q: There are lots of people who have not participated in the
up move so far. They have been very skeptical for many reasons including poor
macro – is it too late to get in?
A: Fundamental change is that the tail risk has gone away.
The market was always worried about tail risk. It had not entirely priced them
in, but was constantly worried about it. To that extent, market participants
were buying defensive stocks. It was the way they had expressed their concern
about tail risk.
The position in cyclicals is very low. It is most visible in
the valuation gap between defensives and cyclicals which are at multi year
lows. The case for cyclicals has clearly become much stronger over the course
of the past month with all the action that has happened on the policy front and
with the ebbing of the tail risk.
I don't think it is
late. In fact cyclicals have not really moved a lot. They have just come off,
they sold off and come back and they were mostly where they were a month ago.
There is a long way to go in terms of closing the valuation gap between
defensives and cyclicals.
I won't be surprised
in to the next 12 months if you get reasonable underperformance from defensives
and outperformance from cyclicals. By cyclicals, I mean both domestic as well
as global cyclicals so materials, energy and to some extent industrials and
financials. They are all poised to do much better than they have done in the
last 12 months.
What is exactly a
bull market: Ridham Desai explains
(14 Jan, 2013) (CNBC)
In India Investment Conference, Ridham Desai, MD of Morgan
Stanley explains what exactly is a bull market.
Here is an except:
There are three ingredients to a bull market. First you need
good valuations and arguably at the end of 2011, particularly when the markets
tumbled in December, the markets valuations on price-to-book,
price-to-earnings, trailing numbers hit the bottom. If you go back in history
when you get to bottom, valuations you are usually in safe territory, so the
valuation criteria got satisfied.
The next thing you
need is liquidity and it did happen largely from global sources and it
continues to be very strong. Emerging Markets (EM) flows are hitting record
levels. There is a lot of liquidity in the world and India is benefiting from
that. So, the second ingredient is liquidity and that is also more
The third and I think a very crucial element to sustaining a
bull market is expansion in profit margins. So over the past four years we have
seen profit margins come off quite sharply actually and they have hit decade
lows. If you look at earnings before interest, tax, depreciation, and
amortisation (EBITDA) margins for Indian companies in 2012, went back to where
they were in 2002. So, we had a full 10-year cycle all the way back down.
First, we went up, we peaked in around the starting of 2008 and then we went
down.
I think that the
margin cycle has troughed for various reasons, which I will not dwell into
greater details. If the margin cycle has troughed and we are into this margin
expansion cycle then I think there is a fair chance that we are going to see a
new bull market. So, I think we are at the throes of that.
The market is about to hit a all-time high level, coming
back to where it was five years ago and price-earnings (PE) multiple is half
the level, which basically means that corporate India has nearly doubled its
earnings in the last five years.
What looked like a very expensive market in January 2008,
has gone through a tremendous time correction where basically you made no money
for five years. That’s how equities do things, sometimes they go through
severe price correction, sometime they go through time correction, we have got
a combination of those. I think we are done with the correction in the
valuation. It is a fair chance that we should be in a multi-year bull market.
There are lots of caveats and we can keep highlighting the risk to this
scenario, but at least that should be a good step or starting point.
Earnings:
You have to be careful about these earnings growth forecast.
It is heavily anchored to the margins that companies have reported in the last
two or three years. I think over the next two to three years you will see a
disruptive positive change in margins that is how you get a change in cycle.
So, this growth when you look back will have proved to be wrong and the truth
will be too low and that will basically trigger multiple expansions.
The way a bull market
will be formed is that growth comes back, confidence returns and opinions
change about growth. It has still not happened but that will be the next leg
for this market. So, you got a little bit of liquidity and therefore prices and
valuation ratios have stabilized.
The next leg up will come because opinion on growth will
change. I think it is fairly likely because today’s growth forecasts are
anchored at all time low margin expectations. So, I worry less about headline
growth, I worry less about gross domestic product (GDP) growth. I am more
concerned about what could happen to net margins. One of the ingredients to net margins as is that we are at all time
high interest rates. Interest rates come down, in the last four years companies
have lost 1 percentage, a 100 basis points on margin only because of rise in
interest cost.
So, interest cost can
easily come down in the next 12-18 months. We have to be careful about
extrapolating earnings forecast at the current growth level.
India in for 15% rise by Dec; like financials: Ridham Desai
(1 June, 2013) (CNBC)
Indian equities are likely to yield better returns in the
second half of the calendar, but it would be a roller-coaster ride for
investors, feels Ridham Desai, MD, Morgan Stanley. Speaking to CNBC-TV18 on the
sidelines of 'India According to Morgan Stanley' conference, he said India is
in sweet- spot as far as liquidity inflows are concerned.
"Net-net our
indicator has declined by about 40 bps from 4.7 percent to 4.3 percent.
Whenever this indicator has been over 4 percent it signifies very constructive
liquidity conditions."
However, if US bond yields soar another 30-40 bps and equity
prices in India also rise then the situation might be less comforting for
attracting funds. "As US bond markets have attempted to price in unwinding
of QE that poses risk to India. FII flows are well over what we consider as a
threshold for comfortable level of ownership. That is the key risk in my view
to Indian equities going into the second half," he explained.
Equities remain
Desai’s favoured asset class for the next 12-24 months and he calls for
another 14-15 percent upside by this year end. We are coming to the end of
that, we are now entering into a new cycle where margins will expand and
therefore corporate profit growth will be better than nominal GDP growth, he
said. If you get a disappointment of 30-40 bps on GDP growth, but that is
offset by better margins, the market may not be so unhappy because at the end
of the day the market cares for earnings rather than GDP growth.
Desai is upbeat on India’s macros and feels that the
situation now is much better than last year. He sees India’s GDP steadily
inching to 6 percent in FY14. Macro stability indicators like current account
deficit (CAD) and inflation have peaked. After a long time, fiscal deficit data
has come below government’s own estimates. All these indicate that worst is
behind us. However, the pace of recovery will be gradual, he added.
Meanwhile, the Indian
currency which has depreciated to a 11 month low against the US dollar is
unlikely to weaken significantly further, he added. The rupee depreciated 5 percent in the month
of May.
On sectors, Morgan
Stanley has the highest exposure to energy and financials - banks and real
estate. It is also overweight on technology and consumer discretionary. It
is underweight on consumer staples. Desai prefers discretionary plays like
autos and media over FMCG or staples.
Q: Your conference kicks off the backdrop of 4.8 percent
Gross domestic product (GDP) print quarterly. While it was not unexpected, do
you see rapid improvements over the next couple of quarters from here
justifying that things are getting better and have bottomed out or is the macro
improvement still up in the air and confidence in recovery is still not
absolutely strong?
A: The macro is
distinctly better than where it was in 2012. It is not just about GDP growth,
which we think will steadily improve to around 6 percent for FY14, but it is
also about macro stability indicators like the current account deficit (CAD)
which we think has peaked. The fiscal deficit print for FY13 has come below
even the revised estimates. It has been a long time since the government has
reported a fiscal deficit below its own estimates.
The macro is looking
a lot better, inflation has peaked. All these indicators put together signal
that worst seems to be behind us and we are looking for better prints in the
coming months. The pace of improvement however could be slow, the investment
cycle is stabilising in our view and we don't expect a rapid increase in the
investment cycle. However, thankfully government expenditure is now off the
peak, which has taken pressure off inflation. One should see a steady improvement
in macro numbers over the next three-four quarters.
Q: Why are stock markets so volatile then because we started
off at one place and the market has just been moving this 10 percent whipsaws
on either side, up and down but essentially have not made much headway? Should
we assume then that the rally of 2012 priced in many of these things in that
sense the market got ahead of events which is why it is just digesting those
gains in such volatile fashion?
A: Yes, in hindsight we can say that. At the start of the
year the market was already expecting some degree of improvement in the macro
and as that improvement happened, stock prices took a bit of a break. We have
also had a fairly bad newsflow in the month of February and March global as
well as local, local particularly on the political front. The market had
digested all that and then we have seen a smart rally since April.
Most recently the market had to come into terms with rising
bond yields in the US which is a whole new debate as far as Indian equities are
concerned. Overall we started the year with a lot of that macro improvement in
the price and therefore we have seen this consolidation.
The second half could
prove to be slightly better in terms of returns, but I don't expect the
volatility to go away. Indeed this is an election year and at various points in
time we will get news flow around that and then we will get news flow around
global stuff both China growth and Quantitative Easing (QE). So the volatility
will stay with us.
Q: The other thing which will come up inevitably in your
conference at some point as the talking point is the way the rupee-dollar has
been moving. At 56.50 it surprised a lot of people with a 5 percent fall in the
month of May. Lot of people have brushed it off saying it is because of dollar
strength, but the dollar index has only gone up 1.5 percent in May and the
rupee is down 5.5 percent. What is bothering the rupee if the macro is indeed
improving as you are suggesting?
A: The month of May
may have been an accumulation of a fall, which may have been impending for a
while because we saw the rupee being unusually stable in the preceding months
even while equities were volatile. From a three month perspective, one may not
get that type of statistic. However a lot of it has to do with the US dollar
strength and emerging markets have struggled a little bit because of that.
There are the prospects of a QE going away at least the beginning of the end of
QE and that is going to have implications on flows with implications on the
currency.
Also one must keep in mind that India has still not adjusted
its external balances. So the worst may be behind us, but our CAD is still
quite elevated. We are still exposed to volatility inflows. Any hint of a
decline in flows will cause the currency to be a little bit volatile. So that
is what May was all about. Overall I
don't expect the rupee to weaken significantly from here unless there is major
dollar index (DXY) strength, which is not something we are calling for.
Q: You have got lots of big investors at the conference and
the debate raging in global markets is whether there is this great liquidity
patch that we have been all living in is about to come to an end if not now in
the next few months. Do you see that picture changing around sometime as we go
forward into autumn this time because that has ramifications for our currency,
for funding our CAD and generally keeping stock prices up from where they are
already?
A: You have hit the
nail on the head. The overall macro for India is looking quite good. All
domestic stories are looking a whole lot better. Corporate earnings are likely
to turn up. The key risk to the market really is coming from abroad. The way we
measure this is we use our proxy for global liquidity for India which is the
trailing earnings yield in India minus the US 10 year bond yield. Now the US 10
year bond yield has backed up around 50 bps since the end of April, but
earnings yield in India have also risen a bit. Net-net our indicator has
declined by about 40 bps from 4.7 percent to 4.3 percent.
It is still in a
sweet spot. Whenever this indicator has been over 4 percent it signifies very
constructive liquidity conditions and you have never lost money on India in
that situation. So we are still in that very sweet spot as far as global
liquidity is concerned, but if bond yields in the US rise another 30-40 bps and
equity prices in India also rise then we dealing with a less comfortable
liquidity situation. As US bond markets have attempted to price in unwinding of
QE that poses risk to India especially in the context of where foreign
institutional investor (FII) flows are.
FII flows are well
over what we consider as a threshold for comfortable level of ownership. That
is the key risk in my view to Indian equities going into the second half. Now
in this mix if you add the long-short ratio that FII are running, it actually
means that there could be some near term pain in the market as well. So keep an
eye on this, these are the sources of risk what otherwise in my view is a very
constructive and a sweet environment for Indian equities.
Q: What is your expectation for the next few months as you
look into the second half? Do you think this kind of trading nature of the
market will continue that essentially we do not collapse, but we have these
bouts of optimism and pessimism, market rally and then they selloff and this
continues for a few more months till we get closer to the end of the year and
get some more certainty going on growth picking up or even earnings growth
beginning to accelerate somewhat?
A: It is a good
description of how equity markets could pan out. We are at the beginning of a
new growth cycle. Market will take time to gain confidence, share prices will
have the tendency to run ahead of themselves and therefore will have to correct
then. Overall it is still on the way up, the lows that we marked in December
’11 are very far away.
Since then equity
markets on general basis have been trending higher and that will continue for
the next 12 months. Our year end targets calls for another 14-15 percent
upside. The second half looks little better for equities than the first half
has been, no doubt with a bit of volatility along the way.
A: Breadth in my view is a contra indicator. When breadth is
low as the case is right now; it is good for the market. When the market gains
breadth, it tends to get toppish and usually you will find that market peak
with good breadth; they do not peak with very low breadth. So, the fact that
this market is narrow only highlights the concerns that people have about
equities, the lack of conviction about equities, which is good.
It tends to tell you
that sentiment is hesitant at best, which is why only 15-20 companies or stocks
which are delivering stupendous performance are the ones that are going up. I
cannot see any bubble in sight. We are far away from a bubble in that sense and
therefore this market has got greater support.
On your question of
whether the breadth will gain as you go forward. It should, the market should
get gain breadth and that is largely going to linkup with the earning cycle.
So, as the earnings trough and as they tend to start going up, the market will also
share prices will gain breadth. Right now only those companies who have
delivered earnings, the stocks of those companies and the ones that are
delivering performance quarter after quarter are the ones that are giving
returns to shareholders.
The others are not
participating and it is not very different from any past bull market. The start
of the bull market that is always the case, there is skepticism, concern, doubt
and that is what we have right now, which is why I wouldn’t get overly
concerned about the market at all. Equities are still my favoured asset class
for the next 12-24 months, for this very reason.
Q: What is your positioning in terms of sector choices for
the next six-nine months or 6-12 months because while there has been such a lot
of debate about valuations in the defensive sectors, they have actually not
started coming off significantly. If you look at the big ones in FMCG etc, do
you think this focus on quality might still keep defensives outperforming or do
you think cyclicals will outperform defensives in a big way over the next 6-12
months?
A: Firstly on style, when we do our style work and try to
interpret what the market is up to, what we sense is that while quality factors
are still dominating performance, they are losing relative position versus
growth factors. Some growth factors that we track like leverage, capex to depreciation and earnings growth,
have now started generating returns in the portfolio versus return on equity
and free cash flows which were the dominant factors of the last four five
years.
Now it takes time for that adjustment to happen, it is still
at the nascent stage, but we are seeing that change happen. Companies which
have financial leverage are no longer loosing money whereas over the past four
five years you have consistently lost money on high debt companies. I am not
advocating you to go and buy high debt but it is an indicator that the market
is now looking for a bit of growth versus just free cash flow and return on
equity.
I have to admit that consumer companies have surprised us on
the upside. The market has overlooked the high valuations and has focused on
the fact that these companies are still generating growth so the sector
continues to do well. We have been underweight that sector since the start of
the year, o it has not exactly been rewarding for us, it has been a bit of
pain. I am willing to carry on to bear that pain because at some point the
market will start focusing on other sectors.
In contrast we have done well on our overweight positions on
energy and financials but certainly consumer staples have surprised us on the
upside. I am thinking of this trade will play up in the next 12 months because
the valuations have gotten so rich and the market will probably start looking
for growth at a reasonable price rather than growth at any price which is what
staples is all about.
In terms of sector
positioning we are overweight energy, we are overweight financials, these are
our biggest two positions so that includes banks and real estate. We are
underweight consumer staples. In the middle we are also overweight a little bit
of industrials, a little bit of technology and also consumer discretionary. So
in the consumer basket we prefer discretionary like autos and media over the
FMCG or staple names.
Nifty may slip to 4800; bet on fixed income: Ridham Desai
(26 August, 2013) (CNBC)
This is a relief
rally and those who missed the bus earlier can look to sell now, says Ridham
Desai, MD, Morgan Stanley. Desai is focusing on a bear case scenario and
foresees the Nifty sliding all the way to 4800 by year-end. Speaking
exclusively to CNBC-TV8 as a guest editor, he said that the market situation
now is similar to 2001 scenario and post recent moves it has not remained
cheap.
He believes early
elections could be a great trigger for the market, so for those looking to play
equities from a six-12 months view, fixed income products offer better
opportunity. "Betting on equities is advised only to those market
participants who hold a three-five years view," he said.
Banking sector is a
complete no-no for Desai. As of now, he feels Indian banks need
recapitalisation of USD 20-30 billion and de-rating of those companies may not
be over yet.
According to him,
anecdotal evidence suggests that interest rates are likely to remain high for a
long period of time and rupee's movement going ahead will be driven by what the
US Federal Reserve does.
Further, a rally in crude oil and gold prices is a bad sign
for the Indian economy, since these two components are the largest contributors
to already huge current account deficit (CAD), he cautioned.
Q: I was reading your report where you ask an important
question how does one know whether the market has troughed out, did you find an
answer to that?
A: Valuations and
sentiment will lead the fundamentals. So that is what we need to look at. How
cheap the market gets and how sold off the market gets. So those are the two
things to watch. Right now, the market does look like it will bounce around a
bit. It has done a bit over the last couple of days and we continue this relief
rally as I may put it. The valuations had not gotten there. The framework is
different. Ordinarily you will look at the price to earnings (P/E) ratio, the
price to book and then say, yes, we are there. In fact, the price to book
middle of last week got to a level which portends a buy call on the market. But
currently the ratio that we are looking at is very similar to 1998, which is
the trailing earnings yield or trailing equity yield minus the short-term bond
yield.
In 1998, the Reserve
Bank of India (RBI) was forced to hike rates and in response to the Asian
financial crisis and we held short rates high for long. People may not remember
this, but as long as three years, it wasn’t until 9/11 that we got an
opportunity to cut rates when the Fed cut rates because the US yields were
rising, we had to keep our yields high and then the markets multiples remained
low for a prolonged period. The markets were in this trading range and
multiples did not move because the equity yield was much lower than the bond
yield.
We are in a similar
situation right now. The equity yield is 7 percent around that 14 times
earnings so 7 percent, the bond yield is at 10 percent. There is a negative 3
percent gap. So either the bond yield goes down or the equity yield falls. If
the equity yield has to fall 3 percent that is almost a 20-25 percent knock on
equity share prices. We may not get that because markets will heal overtime but
markets are not cheap. They were cheap prior to July 16, they suddenly turned
expensive because the way we responded to the situation. Had we responded
differently and this had happened, we would have gone and bought equities but
not at this stage.
Q: Do you think that there is that elbow room now for the
Reserve Bank of India (RBI) to the lower rates, it will be seen as tactically
giving up the fight on the rupee possibly, also you have to beat this
perception of rising US yields as well and then a consumer price index (CPI) is
not down. It is still at 9.7 percent, when do you see the yields coming off at
all?
A: Let us step back
for a moment and think that the RBI reverses the rate hike that happened in the
middle of July. What do you think will happen to the rupee?
Q: I would expect an immediate sell-off at least.
A: Exactly, the rupee
will be under tremendous pressure. The bottomline is it is not our choice
anymore. It is going to be driven by what the Fed does. So we will have to hope
that by some stroke of luck, US data turns bad and the Fed has to retract its
quantitative easing (QE) taper. Unless that happens, it is going to be very
hard for us to automatically reduce rates. What we will have to do is lift
savings because you see the problem here, the genesis of the issue is the
current account deficit (CAD), which is the investment rate minus the savings
rate. Now the investment rate has gone down but your savings has gone down even
more.
Let me just go back a
little bit, the policy response that we generated post the 2008 crisis was to
drop public savings and to boost growth. Now the Indian economy in post 2008
situation was not that bad. So we got a V-shaped recovery. However, for
whatever reasons now we can keep debating those endlessly, we did not retract our
fiscal stimulus. So public savings remained depressed for too long. That pushed
in inflation.
Once inflation came
in, it became very hard to bring that down. So we are looking at public savings
which by the way got taste of fiscal deficit because everybody looks at only
the fiscal deficit. You have to look at aggregate public savings, which is the
government’s deficit at the center, the state deficit and the public
enterprises because we tend to push a lot of these things onto the public
sector enterprises that has fallen in aggregate by a whopping 450 basis points
(bps) since 2008. That is a huge drag. What is your current account deficit
gone up by? A similar percentage.
So where is the
problem? The problem lies in the public savings. So you have to lift public
savings which means that you have to go through a period of very stiff fiscal
consolidation or you have to lift real rates so that household savings
compensate the inability of the government to retract the fiscal by a similar
amount. So if real rates have to remain high, nominal interest rates will
remain high because inflation is not going to come down in a hurry. So that is
our dilemma. We don’t have the option to cut rates, the rates will remain
there until the US comes in.
What has changed
since May is that the world’s reserve currency has told us, it is no longer
interested in funding our CAD period. Until then we were having a party because
the world’s reserve currency was happily funding us because they had their
own set of problems. Once they decided they don’t want to fund us, we have to
fix our CAD.
Nifty may see 5300; buy IT, sell banks: Ridham Desai
(23
September, 2013) (CNBC)
Despite the recent
buoyancy seen in the Indian market, its fundamentals have not changed, says
Ridham Desai, managing director, Morgan Stanley. "When the Nifty moved to
an intraday low of 5100 and a high of 6100, in both the scenarios the market
was clueless as to what it wanted to do next. India continues to remain a
savings deficit country," he told CNBC-TV18 in an interview.
He further cautioned
that the Nifty may see previous low of 5,300. "Though the Fed's surprise
move to not touch the bond buying programme has come as a relief to the
markets, the Nifty can still move lower as most of the positives are already
factored in," he explains. He does not see much of an upside in the market
from current levels and advises traders to sell on every rally. He adds the
turf won't be easy for equity investors over the next three months.
Given the current
market scenario, it is difficult to make sector calls, but he still finds IT
attractive and advises traders to sell banks. According to him, it is more of a
stock picker’s market.
Q: How are you looking at the market at this juncture, do
you think they have overpriced the good news and now will have to come to terms
with a hawkish Reserve Bank of India (RBI) as well?
A: I think the ferocity of the market move on both sides has
been a bit surprising. When we got to intraday low of 5,100 and when we got to
6,100, the market is suddenly unsure of where it wants to go. The way we see
the fundamental construct, I think it is largely unchanged. India is a in a
savings deficit, we need to lift the savings rate, we can do that either or
both by increasing public savings or keeping real rate high and to that extent
it will penalize growth.
Until the US was funding our current account, it seemed all
okay then things changed in the third quarter and it required us to adjust at a
faster pace with further downside risk to growth and therefore lower share
prices. The Fed then surprised us all over again by telling us that we may have
more time in our hand and that may come as a relief for the market but I do
think at these levels the market has benefited from a lot of bunching up of good
news whether it is Syria, Fed, or even the domestic action that we have taken.
So, a lot of that is in the price and it is going to be
harder for the market to make significant headway on the up. So, I would think
that it is a good time to buy protection or even sell the market at these
levels and we should be searching for lower levels in the weeks to come.
Q: Do you see in the near term a reversal of the bullish
trend that we have seen in the last four weeks and if yes, what could the
quantum of the downside look like now?
A: I have to admit that the market has been very resilient
in the context of where India’s fundamentals are. So, for sure the market has
responded well to the incremental liquidity that has come from all over the
world and the rally in emerging markets. So, to an extent this is less to do
with India, it is more to do with what is happening across the globe especially
the recovery in what we call as the fragile five, India being one of them. It
is a global rally in that sense. I think India’s fundamentals remains
challenged, so my view is that you want to take the money off the table.
However, with regard to your question on downside; I think
we will test the previous low at some point; not necessarily 5,100 that could
also break but 5,300 was where the market troughed in the previous fall. So,
that low will get tested at some point in time over the next few weeks or
months. The Fed will come back to taper, the market is now pricing in a lot of
that good news, the RBI will have to keep policy tight because inflation is
high and because we need to lift our savings rate and the fiscal consolidation
is certainly challenged by the election cycle. So, the RBI will have to do more
than its fair share of work in adjusting India’s macro imbalances. So, it is
not going to be easy for equity investors over the coming months.
Q: Do you think RBI can go hammer and tongs at inflation.
Some time back when the RBI sounded that hawkish, it sounded like it is
breaking growth and that also scared foreign institutional investors (FIIs)?
A: I would say there is a bit of a risk that RBI has taken
on Friday which is by lowering the marginal standing facility (MSF) rate. In
the case that there is another sudden stop and the Fed – for a moment let’s
assume that Fed accelerates its taper because the data in the US turns better
than expected and the Fed realises that it may not be the right thing to defer
the September taper and it comes back with a little bit more taper. I think we
go back to where we were with more currency pressure and then we may have to
lift the short-term interest rate all over again.
So, there is a bit of risk that the RBI may have taken by
lowering the MSF and we do not know whether risk actually fructifies, whether
it manifests itself in lower asset prices, but we have to be cognizant of that
risk. I think the repo rate hike was the right thing to do and maybe there are
more in the pipeline because if inflation does not behave then the RBI will be
forced to keep rates high.
Q: What are the next couples of triggers that this market
should watch for either in the form of Q2 earnings or pending government
reforms and do you think we are more skewed adversely for this market rather
than in favour of equities?
A: I would imagine so. I think because of the levels where
we are on the Nifty more than anything else, a lot of good news has been priced
in. The German elections is the immediate event on our screens then there will
be a few statements that will come out from various Fed persons regarding their
policy change or stance change in September, so that will hit the news flow
then the US government shutdown prospects, which you have to keep in mind and
after you negotiate with these three big events then you have the earning
season which I do not think is going to be particularly good. I think it is
going to be challenging in terms of news flow over the course of the next
four-five weeks.
Valuation, weak growth to take mkt lower: Ridham Desai
(1
October, 2013) (CNBC)
Ridham Desai, MD, Morgan Stanley believes the market will
drift lower in October as overvalued equities, tepid growth, high inflation and
misallocated capital remain a cause for concern. On the other hand, US
government shutdown should not affect the Indian market more than the concerns
over the debt ceiling in mid-October. The market will remain data dependent
unless Federal Reserve’s next move.
Q: We have been talking about the pros and cons, which side
are you leaning going into October? Do you think there is still some juice for
the market for liquidity reasons or otherwise or are you getting cautious about
this month?
A: The ferocity of
the moves in August and September has surprised me, we get a 1,000 point fall
and a 1,000 point pullback and both ways it was quite unnecessary. I would
argue that the market needed to fall but the intensity of the move was
surprising. So, we go into October with the market looking a bit overvalued.
The global macro is quite benign, in fact even the US
shutdown is largely anticipated by the market so I do not expect a major
reaction though you should see some drift down in US bond yields which is not
negative for India. So, India should not react that badly to the looming
shutdown in the US than the debt ceiling in mid-October, when there will be
subsequent labour data points.
There will be a fair bit of news flow and the market will
react to each of these data points because the Fed has said that it will be
data dependent. To that extent, it is hard to anticipate when Fed makes its
next move and therefore, market will be slave to the data.
That aside, at home the growth data is likely to disappoint,
a bit of it is in the price. I do not think all of it is in the price. The
Reserve Bank of India (RBI) will be forced to keep monetary policy tighter for
longer because inflation looks a bit elevated and indeed the good news from the
monsoons is waning because we had floods in the last 15 days that have
destroyed the standing rice crop in several parts of the country.
The government’s own estimate is that the kharif output
will only grow by under 1 percent and the late floods in the last two weeks
bring that number down even further. So, we were expecting better rainfall to
drive up agri output, which may not happen at least not for summer crop; it may
happen in the rabi season because ground water levels are better.
Therefore, the growth news will remain challenging for the
markets and to that extent equities do look overvalued. The template for us is
the gap between the equity yield and the bond yield and whether you use the
short-term bond yield which is 9.5 percent or the long end which is around 8.5
percent.
Equity yields are
lower and when real rates are rising in the economy, as they are in context of
real gross domestic product (GDP) growth remains quite tepid. What the market
cares for is a positive equity yield gap and it is not getting that right now.
So, the valuation look a little rich, growth is not coming back in a hurry and
global liquidity is certainly off its top; so we are not going to go back to
the glory days of the past one year and flows will slowdown.
Investors at the margin are concerned about the fundamental
problems in the emerging markets (EMs), India included. We have misallocated
capital. In India most of that misallocation has happened to gold and that will
take some time to fix. So, flows will wane, there will be a bit of volatility
but I expect the market to drift lower.
Q: Do you think a gentle drift down to 5,500 kinds of level
on the Nifty is a fair value and then you work with that or is fair value close
to 5,000 Nifty?
A: The latter is more
likely, because it is difficult to get a handle of how low growth can get in
terms of earnings growth. Our number for the broad market is minus 6 percent
for this year. The consensus of the market is pricing in more like a high
single digit number. We are right about our growth forecast for the broad
market. The market may have to adjust lower to get there in terms of fair
value.
We are dealing with a number which is close to 5,000 rather
than 5,500 and that level is possible. In a slightly more saner fashion than
what we saw in the last two months – but you never know, this is a market
like the Fed, which is data dependent and therefore, volatility should be the
order of the day though I feel that given the amount of volatility which we
have seen in the last two months, it is but natural to expect volatility and
therefore, it doesn’t come through but a drift lower is certainly the most
likely scenario.
Q: How will you approach the market from hereon, every rally
is a selling opportunity for you, how are you working this or are you still
seeking shelter in certain sectors?
A: For us the higher
levels of market do represent opportunities to exit specially from banks where
I see problems including the private sector banks excluding a couple of them.
The non-performing loans (NPL) cycle may intensify, we should not underestimate
how bad it can get when growth slows down and rates are higher. There will be
few more companies that will get into trouble and few more NPLs will show up.
Ultimately, the
economy will heal when the deposit growth exceeds the credit growth which
happens either when deposit growth accelerates or credit growth slows down.
When deposit growth eventually exceeds credit growth, it essentially means that
commercial banks will have liquidity on their balance sheet and that is a
precondition for a new credit cycle.
I do not think that is somewhere around the corner and
unless you set that condition, you do not get a new growth cycle either. So,
it’s kind of a three-four quarter slowdown. The complication here in making
that longer call on the market - it’s not that long because we are in the
business of making one year calls, is that we have intervening election event
which is likely in April and May and that could produce a binary outcome for
the market.
If it’s a strong outcome, if they polarize election
result, the market will forget about growth concerns and it will forget about
all the macro problems and make strong headway.
If it is contrary then India slips into another two years of
slowdown of growth before it comes out of the problem. So, this binary outcome
of May is the most challenging thing for the equity investors. It looks like
until April you do not invest in equities, you take higher levels as
opportunity to sell and then wait.
What I am not sure of is that market will behave in that
fashion and when the market tends to anticipate stuff and therefore, it may
start anticipating in the election outcome for May.
If it starts anticipating a good election outcome then it
may be rising into that election outcome rather than falling and therefore, the
time to buy may come before May. So, that is something we will re-evaluate
after February but between now and February, I do not see any compulsion to be
poise in equities and we would underweight equities, lighten up on banks, not
necessarily by consumer names but technology represents a better place to be
in. It is certainly been helped by better US growth scenario and a largely
weaker rupee rather than stronger rupee.
Q: Ex of the political event which is the elections - how
many more quarters of pain do you think earnings will see - three quarters now
of what near zero percent profit growth, about 2-3 percent sales growth – how
long do you think that poor performance on the earnings parameter will continue
for the market?
A: I think we are
looking for at least three quarters if not four before the earnings actually
trough out. The framework is that we need an improvement in the investment
environment. What is bugging the investment environment is not actually the
rate of investments, I keep telling investors these days that the investment
rate in India even in this situation is actually at 34 percent of GDP which is
the second highest in the world. Yet, we have a GDP growth of 4 percent.
Historically, a 34
percent investment rate in India has generated 8 percent growth so our capital
productivity has halved. It happened because one, there has been a poorer mix,
the share of gold has gone up, the share of public investments have gone up and
the share of private investment have gone down. So, it is a poorer mix issue.
Secondly, the most
important issue is that there are several projects that are half done, three
fourth done that are generating no output so they are all part of the investment
rate, it is part of the investments that India is making but it is generating
no output because we have actually not taken those projects to fusion.
Thirdly, the
aggregate demand is weak so, capacity utilisation has fallen and therefore, our
given investment rate is not generating output. If one looks at these problems
they are not structural issues that India is facing, they are deep cyclical
issues and to an extent, this distinguishes India from large parts of the
emerging world where the issues are actually structural in nature. So, when the
dust settles on this and which is why the elections become so important because
the incoming government has to actually do all the hard work to fix this.
If they fix it,
India’s growth rate will go back to 7 percent so, there is promise in the
India story but the next 3-4 quarters look very challenging for earnings. There
will be downside risk to earnings rather than upside risk. We may be surprised
by the weakness in earnings which I don’t think is necessarily priced into
the market. The market maybe anticipating a weak October but I am not sure
whether it has already priced in a weaker January and then a weaker April. That
may have to be dealt with as the months go by.
If one goes through each and every transcript carefully, following conclusions can be made....
1) Ability to be consistently wrong on market calls and right on postmortem of market happening is unparalleled.
2) Fundamentals which are suppose to be long term changes more often than reader's ability to understand its implications.
3) There is explanation to everything.
4) Most of the time reasons are fitted to broad calls. Best part of fundamental analysis one can justify bullish or bearish calls with equally compelling reasons.
5) Ability to find reasons to new calls and more reasons than previous ones despite being consistently wrong is amazing.
