FIIs expect mkts to correct another 10%

Excerpts from CNBC-TV18’s exclusive interview with Robert Parker and Manishi Raychaudhari: 

Q: Are we staring at the retest of the January and March lows now?

Raychaudhuri: It is difficult to comment on that. I will give you some numbers as to what the valuations are right now. For example-if one looks at the current market multiples, it is trading at about 15.5-15.6 times one-year forward. If one looks at the last 18 months, the minimum multiple that it came out to be in the last three episodes of correction was around 15 times. There was one difference during the May-June 2006 episode of correction where it came down to around 12.5 times.

A different picture arises when you look at price-to-book multiple. The price-to-book multiple normally bottomed out at about three times and currently it is at about 3.2-3.3 which would possibly indicate that there is another 10% of correction left in the market. When we do simple arithmetic, it comes to around 14,000 or so. But markets don’t really follow these rules. But from a valuation angle, it would seem that there is possibly another 10% correction left.

Q: What is the global picture looking like? After a nice rally, most markets have given some ground. Do you think the leg down has opened up for global equities or is this just a retracement?

Parker: The first point is that over the rest of June, we have a number of risk factors. I would highlight the situation on the commodity markets, where in the last couple of days oil has moved back up again to USD 130 per barrel.

Taking a three-months view, we could see oil back down to USD 100 per barrel. But I do think that is going to take time. Over the next few weeks, we could see churning at around current levels and that is not going to be a positive for the market.

The second negative for the markets is Central Bank either raising interest rates or indicating that they are going to move towards tightening policy. That is clearly the case in India. Yesterday we had a very hawkish statement from the European Central Bank.

Interest Rate Futures over the past month have moved quite dramatically, so the Interest Rate Futures are now discounting that the Federal Reserve will raise rates by 75 basis points over the next year. If one looks at Europe, the major fear for Central Banks is the third risk factor, which is to what rate inflation rises due to high energy and food prices.

The fourth risk factor is the current state of the global credit crunch. Although, the credit crunch has moved on from the sub prime crisis, we are obviously still seeing pressure. In the inter-bank market, the credit spreads remain wide.

So, although I can put forward a case that the Indian markets are cheap relative to other markets and particularly cheap to the situation at the beginning of this year, it could easily be 2-3 weeks or possibly one month before we see a base being formed in the Indian market. In the interim I am not sure if I would be as negative saying that the market goes down 10% but certainly there is downside risk in the short-term.

Q: Are you apprehensive that there would be more monetary policy tightening after the kind of inflation numbers we are seeing? Is that a risk in the near-term for the equity market here?

Raychaudhuri: Yes, I would think so. It remains to be seen what are the exact steps that the RBI adopts. In the near-term history, RBI has been more in favour of quantitative restriction like CRR hikes than increase in the benchmark interest rates. Those methods are likely to be followed a little more.

The main risk right now is global inflation and when the near-week (this week and next) data comes out we would possibly see another 1-1.5% increase in the headline inflation numbers. So the policy response to that, which is duty cuts or administrative pressures on the commodity prices from the Government side, and the liquidity tightening in the form of CRR hike from the RBI side is likely to continue in the near-term.

Q: We are already seeing a bit of foreign institutional outflows out of India. If interest rates are to head up, do you think those will be aggravated money pullouts?

Parker: Let us quantify interest rate moves. The message is that the interest rate moves are going to be very minor indeed, So, if the ECB does raise interest rate in July that would be to 4.25% and a worse case scenario by the year-end for the European Central Bank to 4.50%. Our view is that the Federal Reserve is going to move very slowly indeed.

Likewise, in markets such as India and China, the interest moves are going to be upwards. But it is going to be slow. There is fear at the movement of interest rate hikes. I suspect that that fear is somewhat overdone and the reality is that the Central Banks will move slowly.

In terms of the impact on the Indian market and global capital flows, we have seen portfolio flows move out of emerging markets and notably those emerging markets, which are consumers of commodities.

The big capital outflows over the last three months have been notably out of China and India and some of the other South East Asian markets. Interestingly, we have seen continued capital flows into those commodity producing nations, notably Russia, Brazil and some other Latin American markets. So, in terms of how investors are positioned at the moment, they are underweight or out of the Indian market.

I would argue that you have actually got quite an interesting situation whereby investors are cashed up and the next move will be when they do they go back into India. My view is that is not going to happen over the next week or two but as we go into the third quarter and as we see this valuation base being formed in the Indian market, India could benefit from capital inflows again.