Investors wary of volatile mkts, earnings season : Experts

Here is a verbatim transcript of the interview with Sanjeev Prasad, Nilesh Shah & R. Sukumar on CNBC TV18. Also see the accompanying video.

Q: What’s your sense? The package is done but global markets are not excited. Do you see lower levels locally and globally then going forward?

Shah: I think the way the markets reacted on Friday itself is an indication of things to come over the next few weeks. I think this is been an environment where the markets has been looking out for good news and when the good news unfolds basically the market looks at it as a selling opportunity and that’s exactly what’s been happening over the last few days.

The reality is that the bailout package is just been one more event which will probably provide some kind of short-term respite to the global financial system but may not be good enough to completely mend the ways in which America has landed itself up to and the impact of that will be seen across the globe. So I think while the bailout package is good event which probably has happened, it’s gone but may not be good enough to provide some respite to this market in the medium-term. So I guess probably you will still see the downtrend continuing both in the global markets as well as in the local markets.   

Q: Is there more pain ahead of us globally and locally?

Sukumar: I think one is what is going to happen to the economies and we are going to see decline in the global GDP (Gross Domestic Product) growth rates and I do not think its running away from that. As far as the markets are concerned obviously it’s going to be turbulent but at a certain valuation there going to be buying in specific stocks and we have seen that last week in some of the stocks and even in a declining market there are some stocks which have actually moved up. So I see value based buying increasing going forward but it’s not going to provide uptick to lot of stocks, its going to be for specific stock.

Q: What’s your sense? Are we close to the near for this bear market or is it suggesting the news flow that we still have some way to go?

Prasad: To put the bailout package in perspective - what does it mean? It just means people are trying to insane some confidence into the financial system globally because what’s happening in the US is people have stopped lending to each other and they need to co-operate. So you have complete system which is frozen at this point in time. Now whether that addresses issues as far as the real economy is concerned? The answer is no; this will take a lot of time to unwind.

To give some data: if you look at the total debt of US if you add household corporate and the US government its something like 3.5 times the total GDP and this has build over a number of years. So this will take a lot of time to unwind; the whole deleveraging corpus will continue for the next several years, I think its not going to go away now in a big hurry.

Coming to the Indian markets; valuations looks fantastic, unfortunately valuations can be low for an extended period of time. If you see the Indian markets it’s trading at about 11 times of fiscal 2010 numbers – not even 11 – after yesterday’s meltdown its about 10.5 times and if you take out the mid-value then we are probably at about 9 times fiscal 2010 numbers and that attractive valuations I would think.

But there are issues with earnings and people have different confidence now in earnings for e.g. technology companies or global commodity companies and nobody knows how bad the situation could be there. So it’s just crises of confidence and till the time you see global GDP actually starting to get back to some shape this thing could continue for a long period of time.

Q: What sense are you getting from offshore investors, people you talk to about how much more pain we can see by way of deleveraging because we have seen a continuous exodus of money from India from global investors? Do you think that could get much worse?

Sukumar: Yes I think it could get worse from the momentum investors but as I mentioned some of the value investors who were hesitant to come in earlier during the bull market, I think they are seeing deep value at this point in time and we are seeing some buying coming in also we have to remember that many of the hedge funds or short on some of the stocks, the most liquid stocks actually and at some point of time when they reverse their positions that is sell some of the more illiquid stocks and buyback their shorts then it could provide some uptick to some specific counters. So in terms of net outflow we have probably seen the worse in terms of quantum of outflow. I do not think we are going to see the trend reverse and see net inflows in the next month or so but I think in terms of momentum of outflows we have seen probably the worst.

Q: On Friday the provisional sell figure from FIIs (Foreign Institutional Investors) were 1,600 crore. Are you hearing any noise about fresh hedge fund redemptions, fresh request which have been put in for which liquidity is being created and do you expect this to continue?

Shah: It’s hard to decipher whether it’s got anything to do with hedge funds. I think unlikely because most hedge funds have the month end or the quarter end date as the redemption date so I think unlikely to be the hedge fund community which would be just selling. I think it’s just that probably there are some of yet these long only investors who probably could be undergoing capitulation and just cut down exposures to global equities, to emerging markets, to Indian markets. So it’s a combination of all of that which could have driven yet some of the conventional long only funds to get in and aggressively sell.

I think in addition to that if one were to look at it; it could be some of the institutional investors who do some amount of tactical trading who would be betting on the market, breaking that critical 2,500-2,600 level and that leading to a fresh wave of downside. So I think it could be a combination of both the conventional long only guys who could be selling as well as some of the short-term trading oriented tactical traders which would be also initiating fresh shorts in the market place.  

Q: What is the reason for Reliance selling off – is it fundamentals which is leading it down or is it some confusion about issues related to warrant conversion etc?

Prasad: I think it is a combination of both the things keeping in mind the fact that Reliance at the end of the day is cyclical global corporative play and if people are really concerned about global GDP growth and you are seeing complete meltdown in the metal space, you are seeing the stocks trading at about 3.5-4 EV/EBIDTA, so there is no reason that Reliance will escape the mayhem at the same time. So people will start adjusting their multiples down and people have been giving all sorts of weird multiples to Reliance and we have been consistently arguing against not using 7 EV/EBITDA at the peak of the cycle, so the same thing will happen over here.

In early September we had put out a note saying that watch out for contraction multiples and in the case of the Reliance also, and same thing will happen in case of metal stocks.

On this promoter shareholder issue, I don’t think it is too much of an issue because what has happened they have just done some reclassification. Some of the treasury shares which were held in the form of 5 companies of about 95 million shares that has been now classified as public shareholding rather than being thrown under promoter and promoter group which was the case earlier. I don’t think they sold any share which was rumoured yesterday and anyway the promoters have exercised USD 1 million warrants last evening. So that to extent shows confidence of promoters in the company but unfortunately the way the company is positioned; its chemical business to refineries which are very exposed to what is happening globally, so if we have a slowdown as far as global GDP is concerned you will have a big impact in demand and in contrast to that you will also have large amount of new supply coming both in refinery and chemicals, so not only margins will get smashed but multiples will also come off significantly.

Q: Would you expect lower levels for Reliance going forward- could this continue to be a drag on the index?

Shah: Reliance has been an important leader of this bull market and when we saw the earlier correction in the Indian equity markets between January and July, I think Reliance Industries probably showed the highest resilience as a stock price performance. We are clearly of the view that perhaps we are getting into the last leg of decline in the Indian equity markets and that always happens with leaders  beginning to under perform or giving up a lot of the under performance that they have done in the entire bull markets.

Drawing an inference from that, it clearly indicates that there is some kind of room for Reliance Industry to head lower compared to current levels. So if we broadly believe that there is 5-10% decline expected in Indian equity markets then definitely Reliance will fall more than that. If the markets probably fall another 5%, I think it will be fair to expect Reliance to fall another 10% from current levels.

Q:How are you as fund manager positioning yourself on this whole commodities complex now because  they have taken the biggest beating whether it is some of the stocks we were mentioning or it’s the metals universe, do you think valuations have come back to tempting levels, or this is a space to avoid for you?

Sukumar: We have been underweight commodities especially in the last six months after valuations went to astronomical levels. As far as metals are concerned we are not looking at profit based multiple because if there is going to be a severe global downturn then the profits may just disappear. So we have to look at asset based valuation and if we find that there are some specific stocks of companies which are extremely well run and that they are a deep discount to the replacement value then we would look at that. But clearly earnings are going to decline significantly.

Q: The other big fear in the market is that so far we haven’t seen anything meaningful by way of mutual fund redemptions – are you beginning to see the first signs of investors panicking there and do you expect personally some redemptions to happen given that the markets are grinding to lower lows?

Sukumar: We as a house haven’t seen any panic not only during the current down turn but through the last few cycles, the retail investors never have come out and withdrawn  a lot of money during the bad phases. I haven’t seen that this time or in the previous cycles.

Q: We were talking about metal stocks earlier, do valuations looking appealing or this is a space which will go through more pain now, and its pointless looking through PE multiples?

Prasad: I would agree with that, if you are seeing problems as far as global GDP growth is concerned and that is clearly the case, I think 2009 is going to be worse than 2008 as far as global GDP growth is concerned then I don’t think we should be in two minds about that and if that were the case then we are going to see margins squeeze more than what we have seen.

Multiples are meaningless in this kind of an environment, we don’t know what real level of profits could be, I guess that is what the market is signaling, if the stocks are trading at 3.5-4 EV/EBITDA multiples it is basically signaling that the market expects EBITDA to come off significantly and I guess that is what probably is going to be the situation. The earning numbers are just too high out there. The same thing goes for Reliance also, we could see the numbers on the street are just too high at this point of time and not clearly factoring any sort of global GDP slowdown.

Q: Do you reckon that October could be one of those months where you have a last leg of big capitulation and then we sort of end the price damage because in the past sometimes October is tended to be a bit of a turning point where bottoms have been formed?

Shah: That’s the way we see the Indian equity markets going forward and we are into that last leg of a decline where leaders are giving up; so stocks like Reliance, ICICI Bank, HDFC these are the leaders and the blue chips of this bull market and I think a severe decline in them signals that we are in that last leg. How much more in terms of a decline would be hard to say but we see that at this point of time probably the decline in the broader indices probably will not be more than another 5-10% down.

The other important indicator is that the advance decline ratio doesn’t seem to be all that bad; despite all this capitulation we are not seeing advance decline ratio of 1:10; we are seeing it in a broad region of 1:4-1:5. That indicates that there is a lot of churning which is going on in market place, liquidity is flowing at least into some sectors and we clearly see for e.g. the FMCG space is trading at a lot higher levels. You are seeing for e.g. banking space which made significant lows in July and despite the fact that the market is gone back to those July lows, the banking stocks are still at significantly higher levels compared to they were in the month of July.

So there is some of sectoral rotation which is going on and probably some indication of leadership happening. So broadly our sense is that October is probably the month which could potentially mark the low for the Indian equity markets for calendar year 2008.

Q: Inflation came in at sub-12% and crude is down to USD 93/bbl. Do you think the market will start pricing this in or focusing on these positives or we will have to be range bound for a long time to come after this price damage?

Sukumar: I think the challenge for the market is demand and supply equation being adverse at this point of time. There are more sellers then buyers and that has to obviously change for the market to stabilise and move up. So it’s tough to say when the buyers will outstrip sellers. We are seeing some improvement in the trend as I mentioned earlier on but whether that’s going to happen immediately is a tough call. But if you are taking a slightly longer-term view probably that is very high probability that will happen probably at the end of the year or beginning of next year but tough to say whether it’s going to happen next month.

Q: What about earnings in the midst of all this- in the midst of this mayhem we are kicking of earnings season with a lot of trepidation of what Infosys might say because technology stocks have got battered, what do you expect to hear from them?

Prasad: I guess the most important thing would be focus on the guidance and I think this time companies will definitely reduce guidance. Both Satyam and Infosys we are looking at reducing their guidance from the upper-end to the lower-end of the band which they have been guiding. So this quarter’s earnings numbers should be okay but I think the market is looking far beyond that, there are lot of issues there and I don’t think Q2 earnings numbers have any relevance as far as markets are concerned.

If the numbers come out good then people will take it in their stride and say lets see what happens in the Q3 or what happens in the US or where is the inflation situation is turning out to be, or how the interest rate cycle is etc. If numbers turnout bad people will say we were anyway expecting this. So I am not sure earnings are going to change the mood of the market too much.

Q: What kind of levels are you looking forward to now because the current range of the market between 4,000-4,500 Nifty seems to have broken down. What’s the new rage you think?

Shah: I think for the Nifty the new range should be 3,600 to 4,000; I think we are probably at the midpoint of that and you could still see another 200 point decline in the Nifty obviously there can be some amount of price damage which can happen to individual stocks. But I guess right now I will stick my neck out and say that 3,600 to 4,000 will be the trading range for the Nifty.  

Sukumar: I think there is good chance that they will make returns if they are smart regarding the stock selection but investing across the markets and making seems to be a tough proposition in the short-term and you have to be longer-term for the market to show strength.