DSP ML, Demeter Adv rule out sub-12K retest, see long rally
Published on Monday, May 25th, 2009 at 8:38 AMAuthor: admin (5507 Articles)
It has been a historical week for markets, which saw the highest single day gain and highest turnover recorded. The broader indices not only followed the upward trend but were the icing on the cake. Midcap stocks rallied 50%-60% for the week while largecaps saw 20%-30% moves. The big question is whether this rally is deserved and are some stocks riding ahead of fundamentals, or is the market right in wielding in this kind of optimism after the electoral verdict?
Ashwini Agarwal of Demeter Advisors said the political outlook has changed and risk premium levels are down. “Valuations had become extremely cheap around early March.”
Speaking on the road ahead for markets, Agarwal said he does not see too much downside, unless global markets fall sharply. “It is difficult to predict a range for markets, but we don’t see the Sensex falling below 12,000. The upside will depend on political moves and response of foreign institutional investors.” Agarwal added that he can’t rule out the possibility of Sensex going to 20,000 levels in 2010.
On growth Agarwal said slower growth forecast was predicated due to scarcity of capital, but sustained foreign flows can boost economic growth to 8-10%.
Seconding Agarwal, Jyotivardhan Jaipuria, Head-Research, DSP Merrill Lynch, said the political outcome has taken markets out of woods. He sees a long-term rally in markets. “The new government has a mandate to deliver reforms, good governance. We will see an improvement in growth over the next 2-3 years.”
Jaipuria sees a very low probability of markets testing old lows again.
Here is a verbatim transcript of the exclusive interview with Jyotivardhan Jaipuria and Ashwini Agarwal on CNBC-TV18. Also see the accompanying video.
Q: Have things changed?
Agarwal: Well yes, absolutely, why not. Nobody expected a political outcome like this and whatever we have seen earlier today in terms of ministerial announcements or yesterday in terms of the government’s handling of some of its coalition partners seems to indicate that the Congress Party is in a mood to take a strong stand and deliver what it wants to deliver. That is good news for the markets. Obviously none of us expected a mandate of this order to turn in over the last weekend.
More importantly, some of us who were still feeling probably a little cautious early on last Sunday are probably seeing that the Congress is actually taking a very strong line, which is very encouraging. So yes this is very-very different from what anyone could have imagined a week ago.
Q: Can you now say with conviction that the market put in lows in place in March and the chances of going back and retesting those seem unlikely?
Jaipuria: Yes, it would be very low probability for us to retest the lows now because we have had an event which is dramatically different from what all of us were expecting. Like all opinion polls said this could be a hung Parliament, a weak government and finally we’ve ended with something which is like a really strong government. I think everybody now feels their mandate is to give good governance. And that is what is going to give them growth. To that extent, it makes it even easier for the Congress Party to reform over the next five years.
Q: So is the market moving to a higher trading range over the next few months and weeks and what in your eyes could be that range?
Agarwal: There are two factors that are working simultaneously. One obviously is the change in political outlook or economic management outlook in India. The other is risk premiums globally have been steadily coming off since early March. So both these factors have caused a huge shift in trading ranges on the Sensex. Many of us had in February expected that we were stuck in a range of maybe 9,000-11,000 or 8,000-10,000. I do not think that it would be possible to define a range accurately at this point in time because the global economic outlook is still far from very certain. But I would venture to think that it would be very improbable for India to go down way below 12,000, or maybe 11,500 or 12,000.
On the upside, it depends upon what the Congress does in the coming weeks and months in terms of economic policy and how do global investors respond to those policy changes. If one sees a huge amount of foreign inflow into the country, which is very possible, expectations about India growth, the price of the rupee versus the dollar, all these things can change significantly from what we are expecting right now, which could mean to say that 12,000 to 16,000 is the new range or whether it should be 12,000 to 18,000 or 12,000 to 14,000. These are all in a realm of probability depending upon what the government does.
Q: How much can earnings, valuations and growth support in terms of index ranges from here on?
Jaipuria: If one looks at current earnings, I do not think there is going to be a dramatic change because of what the government will do. Whatever the government does now is going to have an impact over 2-3 years. But what it is going to do is take our growth path up. So, effectively that is what people are playing. That is what is going to get priced into the markets now. I guess over the next couple of months people will give the government the benefit of the doubt, they will keep pricing in that there will be a lot of growth coming. But beyond that, we will need to see the government actually implementing reforms.
If we have a gap between what the markets expects and the way the government moves about it then there could be disappointments coming through. I think the second thing would be global because we’ve had a great global rally also. One will also have to see if the global rally starts to falter a little bit because we had a stream of positive economic data, but now the data is starting to get mixed. So, people are starting to say that we had a lot of green shoots, but now things are getting uncertain. We see the globe correcting and India will be part of that. We just cannot keep going up inspite of the globe just going down. So, those are the two factors we will have to watch out for.
Q: You have outlined a couple of points on why the market could actually stall or probably even correct from here, but a lot of people are still talking about the fact that there will be a dip to 12,000 and that is the dip that they would buy. It sounds like that theory of we will buy post elections when there is a dip because of a fractured coalition. Do you think the market will oblige with that dip which people are waiting to buy or force them to buy here or higher and that opportunity will not be granted?
Jaipuria: Typically, when the consensus is that people buy at one level, that level either does not come or it comes because of some event which makes people say that they will not buy at that level, they will wait for lower levels. So, that is always a problem with these consensus things which everybody gets fixated at. It is always what is the event which is taking the market down, suppose there is a problem in the global starts taking the markets down, these numbers keep changing downward and upward depending on how things are.
There are a lot of people who missed out on the rally. There are a lot of people, probably the Indian retailers who wants to buy and there are lots of foreigners who want to buy. But everybody after that Monday is just wondering at what levels they should buy. So, everybody is trying to asses it. Market is not exactly cheap. It is not like what one would say compelling. If anything, valuations are on the more expensive side now. So, everyone is hoping that they get a chance to buy at a cheaper level and let us see if events give them a chance.
Q: Will the market give people who have missed out the chance to enter?
Agarwal: One of the things about this market or any market for instance is that the consensus view is usually disproved. It happens because the market always prices in something which is not known or which is not obvious. If the government continues to deliver in terms of formation of the government to start with, in terms of policy announcements, in terms of their intent on what they need to do with the economic agenda over the next three years, if that news flow is good then I don’t think the markets are going to come off a lot. About 500-1,000 points on the Sensex can happen, but I don’t see significant downside beyond that.
However if the government fails to deliver, if two months down the line we figure out that this is more of the same old wine in new bottles, it is not anything different, and we are not seeing any signs of the fiscal stress abating, and interest rates and inflation globally start to cue up, then things could turnout to be very different.
I agree with Jaipuria that what can happen in the interim also is that global data points can turn down and can drag overseas markets down. That might have a little bit of pulling down impact on the Indian market as well. In those circumstances, some people who might be waiting to buy today might say, “Okay, I am going to push it back a little bit.” But it is one of those same things that at 14,000 in September everybody would have wanted to buy at 12,000, and at 12,000 everybody wanted to buy at 10,000, and at 10,000 everybody wanted to buy at 8,000. The fact is that at the bottom you never know that it is a bottom and at the top you never know it is the top.
Q: The trillion dollar question here is has the bear market ended? Do you think this is such a defining event that converts a bear to a bull market or was that happening in any case, this is just speeded it on?
Jaipuria: I guess we were having a recovery and this event has just taken markets up higher than where one would have thought it would go down to. These definitions of a bear and a bull market are very subjective. So, you have probably seen the worst of the markets downturn, you probably may not see a very sustained upturn for sometime. But at these levels if you buy and government implements reforms over the next few months, then we are going to see lot of sustained rallies in the markets over the next few years.
Q: What is your verdict on that one? Some people are still suspicious. It is too V-shape for their liking, for them to call this a bull market. But do you think it might have started by stealth?
Agarwal: In early March, when we were looking at some of the smallcap stocks, we could find stocks at two times earnings, three times earnings, we could find debt free companies trading equivalent to the cash value on the balance sheet. I am talking about the smaller companies not the large ones. I have been following India for something like 17-18 years now. I have never ever in my experience seen valuations like that. So, you were tempted to buy a lot of those smallcaps and yet you were mortally scared of putting all the money at one go because you were worried that the market knew something you didn’t. Therefore, you were buying a little bit at a time hoping that you would be able to buy more as and if things went down.
On the way up, the same logic starts to work in a very different way. If you are holding cash or if you are holding a defensive portfolio whether you are retail investor or an institutional investor, you have this feeling of missing out. Therefore as the market rises, your propensity to buy increases. So, you are going to be torn between these two extremes as the market fluctuates.
I don’t think one has seen this kind of volatility in markets since 1992 post the Harshad Mehta event when the market crashed significantly, rebounded again, and then crashed down once again. This order of price changes one has not seen. My suspicion is that there is not too much downside principally because there are far too many people who have this left out feeling and who wish to purchase at lower levels, unless of course the global data points turn so adverse that global markets are down 20-30%, in which case India might go down 15% as well or the other thing happens that in the next two-three months we figure out that there is no room to implement reforms for whatever set of reasons political or economic. In that case, I would change my view. But at this point, I don’t think there is a lot of downside.
Q: The other big story of this week is the way midcaps and smallcaps have caught up. Do you think most of the catch up is done or do you still see big valuation headroom for midcaps to rally?
Jaipuria: If you look at the trend over the last four years, midcaps are still trading at roughly 25-27% discount to largecaps in terms of valuations. Midcaps were trading at a premium to largecaps some eighteen months back. To that extent, one can say there is still some valuation room left for midcaps to perform better than bigcaps over the next six months to one year. That is some story which can continue.
Secondly, I guess what has happened now is a lot of people were starved for capital. That capital window has opened up suddenly. A lot more companies which at some point had a question mark on their survival suddenly are becoming attractive again, because they are getting the capital easily and are back into business as normal. So, there will be companies like that which will benefit and so their valuations will suddenly start looking very cheap when there is no question on the survival going forward.
Q: The first sign of improvement in the market is that a whole lot of companies have either gone and raised capital or are in the process of raising capital. Do you take a positive strain out of it that balance sheets are getting de-clogged or do you fear that such a spate of equity issuances might choke either the secondary market or betray some desperation on the part of promoters to quickly milk the rally before it ends?
Agarwal: It is a little bit of both. What Jaipuria mentioned earlier is correct that this is positive circularity in operation, in the sense that if you had a balance sheet which was overleveraged, you desperately needed money and nobody was giving you money. Today, you are in a completely different situation. You want to raise money, you put your hand up if you have a good cause, and finding money is not a problem. Even if you don’t have a good cause, finding money is not a problem. So you have two sets of companies in this environment, the first ones are who are fixing their balance sheet, and there is a serious value creation that is going to take place.
The second set of companies are those who are tripping over each other in issuing warrants to the promoters and trying to raise money just because it is available. I am not sure if the second one will prove to be extremely rewarding as far as investors are concerned, because the best case in the company doesn’t really change. So you bring in some money, it probably lifts the valuations a little bit, but you don’t make a case for a re-rating. But if a broke company was being valued and you put in capital, it is like patient who needs oxygen and you have given him oxygen, so it turns healthy all over again. So, there is a lot of value unlocking which is possible through this fund raising and which is welcome in my view.
But from a technical perspective, what you have also said is correct that the supply of paper has its own dynamic. It can fill in demand which would otherwise lift the market and the consensus view again is that in order to fill the fiscal gap, the government will have no option but to pursue divestments in a big way. So that would be another cash call on the market. In the middle of all this, if global markets take a downturn and we see a potential supply of paper of the order of USD 10-20 billion, then markets can say, “wait a minute, can we absorb all this?”
Q: The sector which has got rewarded the most is infrastructure post last weekend. Can you take the call now that with this government in place the investment cycle which most analysts had thought was tapering down, now starts picking up again and you price in much superior growth for the Larsen & Toubros (L&Ts) and IVRCLs of the world? Can you say that with confidence or conviction?
Jaipuria: That is a call that even we have taken. I guess it is a very consensus call now because two things are happened. One is the government will now be stable, it will be there for five years, it is not a weak government. To that extent, the private sector is not worried and there they will have more confidence in setting up projects now.
The second thing is that government itself will hopefully do more reforms and to that extent they will kick start projects in infrastructure space.
The other thing which was worrying the whole capex plan was the availability of finance. So, the finance problem now will get solved to some extent, because now suddenly you are seeing the finance window open up, and people are running all over to start giving you money. I think private equity people will also come back. So, the financing as well as confidence have definitely changed for the better. I think we will have a more sustained capex cycle.
The one thing which may not change is of course the profitability of companies, especially if the global scenario turns adverse again. There will still be a problem about profits not being as strong as they were probably over the last three years. But overall, I would think that this is going to lead to another sustained round of capex.
Q: What are the chances that this scenario plays out? Earlier nobody in their wild dreams would have imagined that the market could even come close to a new high by 2010. People were saying 4-5 years forget about a new high. If this year, we stabilize somewhere around 15,000 which does not look terribly unlikely, and growth picks up next year, do you think we have got a shot at something close to 20,000 in 2010, which would be a great outcome if it happens?
Agarwal: It is possible. 20,000 is 30-35% up from here. If you talk about it in valuation terms, that means that one year forward valuations including growth for FY11 which probably won’t be as bad as it will be in FY10. If one adjusts for growth, you are talking about expansion in valuations by 15-20% and that is possible.
India is a capital starved economy. If you build a policy scenario with a strong government with clarity on what is going to happen to your investments, if you bring money into the country, there are people who will bring in money. If there is reform on the insurance side, if there is reform on the retail side, there are people who are already willing to put in money. All this capital when it comes in creates growth by itself. The slower growth forecast that all of us were speaking about three-four months back or even two months back were predicated on scarcity of capital globally, risk averseness globally, and lack of policy direction at home in India.
We are right now betting that lack of policy hesitation and scarcity of capital it seems is not going to be a problem. So, if foreign inflows come in, then on a sustainable basis, growth expectations from the Indian economy over the next two-three years can go back to 8-9%, in which scenario 20% expansion multiples over the next 12 months is not such an outlandish expectation.
Source : MoneyControl
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