Sandeep Bhatia, Head - Equities at UBS and Ashwini Agarwal of Demeter Advisors don’t think there is going to be a significant change of trend until the core fundamental issues facing this market go away. Bhatia doesn't think risk appetite for Indian assets has visibly improved. He said, "In fact, I would say that the stocks of 2007 and 2006 are not the stocks of 2008 and the market is clearly looking for new leadership in sectors or stocks. So I think, property we have to be careful about."

Excerpts from CNBC-TV18's exclusive interview with Sandeep Bhatia and Ashwini Agarwal:

Q: What do you think - relief rally or change of trend?

Bhatia: I don’t think there is going to be a significant change of trend until we see the core fundamental issues that are facing this market, go away. We have seen the inflation number come in at a 42-month high. I don’t think the RBI will stop at what they have done in the last policy. We could see some movement between the policy announcements. In addition to that, we are still some way through the result season. I should say, the result season was slightly better than what I would have expected. There has not been any headline bad news except when BHEL reported in the beginning. Other than that, things have been okay but may be we need to wait. The managements are still assessing whether they need to put the bad news out right now and market is at 18 times earnings again with 17,600 on the index, so I would think that we are now again close to fully priced levels.

Q: What do you think - strong relief rally or do you think that silently there has been a change in trend again?

Agarwal: I tend to agree with Sandeep. I don’t think this is a change of trend, but what happened was that a month ago when the market was just under 15,000, the environment out there at that point in time was gloom and doom. It was an overreaction of sentiment which has caused this pullback to happen. If one takes a look at fundamentals, India is again looking pricey.

Inflation is quite high and higher cost of money is bound to happen if you read between the lines what RBI said in their credit policy, the issues haven’t really gone away. So the question is, how much do you want to pay for growth, which is definitely slowing? My sense is that yes, this relief rally is welcomed, but I don’t think this is a change of trend. I would not say that one should be lulled into thinking that the market goes back to 25,000 by any stretch of imagination. Even approaching previous highs would be very difficult.

What you have really had is absence of too much of bad news. The base case that the world is now building in, is that the dollar starts to rally and commodity prices come off and therefore inflation will come off and therefore equities should rise. My sense is that there are far too many ‘ifs and buts’ to see this scenario play out.

Q: How much more would you give it then, because it is already at 17,600 - do you think we are pushing close to the higher end of the band or could we be surprised?

Bhatia: We could probably see at best, the index at 19,500. This is really what I would think would be the year-end target, but if you want to get it right now that’s where you would see the index, in the middle of the year rather than at the end of the year, which is what we would like to see.

Q: What do you think in terms of the amount of upside, which is left looking at valuations and fundamentals right now?

Agarwal: Let us for a moment assume that both Sandeep and I are wrong, okay and let us for a moment say that this is a reversal of trend for XYZ , reasons for which will unfold as things pass, then I would say that there is no sacrosanct mark of 20 times or of 18 times, market can go upto 25-30 times whatever. But what you need is a lot of good news to come. What you need is a firm belief that India’s growth is not slowing down. Earnings growth will continue to be in the region of 25% for the next 2-3 years at least. A firm belief that inflation will come off to acceptable levels and the government will be able to spend money to get the slowing economy out of trouble. A lot of things need to happen for that scenario to pass. In absence of that scenario, I would say that you’re pretty much in the ballpark of a fully priced market.

Whether it goes up another 500 points or 1000 points, it's hard to tell but I don’t think there is a lot of room for upside.

Q: What could reverse it conversely from here? If something has to come and stop this pullback rally in its tracks, what could it be because we have skirted most of the triggers now - monetary policy out of the way, Fed meeting out of the way, earnings mostly out of the way - what's the trigger which could peg this market back again you think?

Bhatia: I would think that triggers are not the fundamentals and the fundamentals have not settled in a clear zone. Triggers are points in time where the fundamentals may emerge, but sometimes we are just human, so we look for triggers and those triggers don’t come when we are looking for them; they come when we are not looking for them. So the simple point has been that the fundamentals are still up in the air. The inflation is still very high, policy movement is still towards raising interest rates or constraining liquidity in India and if you at look what's happening in the US, the data is still bad, but it has not worsened dramatically. The April to June period is going to be critical. We are in the middle of it and unfortunately we are not seeing the data signal decisively in any one manner. So until we see that happening, the market at best remains rangebound and we are clearly touching the highs on the basis of current fundamentals.

Q: Whatever else has happened locally, we are in the midst of a nice little global equity pullback with most global markets now within striking distance of breaking even year-to-date, do you think this will continue while longer?

Agarwal: Globally it has been a bit of a relief rally of sorts, what really happened, which was very good on part of the Federal Reserve in the United States was that they ring-fenced the whole problem of confidence in the financial system earlier on in the year and slowly that started to feed through, that has helped sentiment recover. There are little bits of positive news coming out for example, the other day we saw an advertisement in the paper where Warburg Pincus said that they have closed the new fund worth USD 15 billion, stuff of this kind.

The Chinese authority has announced some sort of a tax cut earlier on this week, which calls the rally in Chinese stock prices. Fundamentally have things changed? I think not.

Oil is still very high, inflation is a global problem; I do not think it is looking to reverse in a big way and yes, sure markets are within striking distance of the year-high levels and who knows that might come to pass, but fundamentally is there a reason to believe that all the bad news is out, the answer is no.

My view is that these are turbulent times and markets are liquid and deep, so what happens is that sentiment often leads to overshoot, which is possibly what happened about a month back when everybody said that this is the beginning of a great bear market and now 10%-8% increase lulling everybody into believing that nothing is wrong, both those views are possibly wrong. So I do not know you might see this rally continue to a point where the previous highs of the year are surpassed, but fundamentally I do not think that one needs to get carried away.

Q: What about risk appetite, we have not seen much by way of inflows this year, has risk appetite visibly improved over the last few weeks as global markets have pulled back?

Bhatia: The risk appetite for Indian assets, I do not think, has visibly improved. Internally we have seen some positive flows, but that is nothing to say this basically were flows, which were looking for ideas which were at cheaper prices in the market where the outlook for growth looks more solid. I do not think for the broader market, we have seen any big change in the positive direction for risk appetite.

Q: What about earnings? You did say that you are not coming out of this earnings season at least yet feeling terrible, but do you think we will hold that 18%-20% kind of trajectory or by the end of it not?

Bhatia: I think we should hold that because that is the basis of UBS saying that the year-end target should be 19,600. If it does not see that then clearly we are going to see a much weaker market than what we have seen now. We need to hold on to those earnings growth at least that 18%-20% and that is something, which seems to be on track for the first quarter.

Q: Can you heave a sigh of relief on the interest rate front right now after what the RBI said on this policy or is it too premature to do that?

Agarwal: I think it is premature to do that. You may not see an increase in nominal interest rates going ahead, but I think tightening of liquidity and the impact of tighter liquidity is still to be fully felt either on consumer demand or on cost of money in corporate balance sheets. So I think those are the two events that I would still wait to see unfold.

Also on the earnings season our experience historically has been that stronger earnings tend to come out earlier in this season, weaker earnings tend to come out later in this season. This is a full year results season, so whole bunch of companies will report towards the end of May and a lot of the government owned companies will possibly report end of June.

So you have a situation where you have possibly seen the best flush of the results. True, the results were a little bit better than what I had thought at the beginning of this season. But clearly if you look through the results, industrials have been under pressure across the board. And a lot of the industrial results are still not out. So to believe that we are out of the woods completely, I do not think so.

Q: How are you approaching the rate sensitives now after looking at the monetary policy, the autos, the real estate which has bounced back, the index is up 7% this week and even banks?

Bhatia: I think a lot of good news has got priced in now into the real estate stocks. I do not think we would see the kind of appreciation in these stocks that we saw last year. In fact I would say that the stocks of 2007 and 2006 are not the stocks of 2008 and the market is clearly looking for new leadership in sectors or stocks. So I think property we have to be careful about. As far as automobiles are concerned, we could see some volume growth come through on a YoY basis for some stocks like Tata Motors with the new launches they have planned. The real issue for the automobile sector in my view is impact of raw materials and margin pressure that will come through. Across the board if the market remains as competitive as we envisaged it to be, I think raw material margin pressure will be a theme for 2008.

We have not seen any kind of margin pressure come through for a long time for Indian corporates, but with the kind of raw material prices prevailing globally this is something which will visit us during this year.

In the end what we will see is probably volume growth still holding up in double digits for the listed corporate sector, but some kind of margin pressure coming through and eating into earnings. My thoughts are that probably the world markets are also evaluating closely what is happening and honestly I do not think we clearly have a direction until probably things settle down in the US and raw material prices either come off. If it comes off that is great news for everybody and especially for India if they do not we are going to face tough times.

Q: Prices have changed quite a bit in the last one month; at current prices which ones look like they have some more valuation headroom left and which ones look very pricy to you again?

Agarwal: If you look at valuations and you look at what is happening to the dollar and what is happening to the currency and you want to pay a premium for certainty of growth in this choppy environment, then technology stocks still look good. Despite the run up that’s happened, I think materials, especially steel, might be another area still interesting despite all the front-page news about the government wanting to control the prices of steel in one way or another.

From a valuation’s perspective that area looks fine, I am still reasonably positive on consumer themes in India - telecom services for example that’s another area, which looks quite interesting. But many of the other defensive areas; the traditional consumer staples are very expensive. I would love to recommend them as a theme, but valuations leave no room for upside.

I am wondering on the banks. We have been positive on the private sector banks despite the turmoil and that is something that’s paid off handsomely. I mean the results have been very good and all the banks have come back quite strongly in terms of stock prices. I wonder how much pain is left in the government owned banks - I mean that might be one area, which might offer some valuation upside. So that’s one area, which looks quite interesting. That would be my summary of places to be.

Q: Two sectors, which have surprised on the way up and on the way down this quarter with earnings - telecom positively and capital goods negatively - how are you looking at these two sectors now at UBS?

Bhatia: We like telecom. I think we agree with the valuations being quite attractive at these levels. There are policy risks; there isn’t any risk on demand there. So we would like to believe that the government will not kill the gold and goes. So to that extent we like telecom.     

On capital goods, I think you have to be very selective where there are couples of assumptions on growth, assumptions on par throw off raw material costs. If one of those assumptions don’t hold true as we may know after next 12 months, then we have an issue there. I think it’s not so much the fact that whether the order flow will come or not, the order flow will continue. What we have discovered is that finally this order flow has to be executed and delivered and for that you need people who will do the job and you will need the ability to execute and manage which is where I think the differentiation in stocks will lie. So one will be more circumspect on current high valuations with the engineering sector.

Q: Do you think there is another leg down this summer lurking?

Agarwal: My sense is yes. I would continue to believe that I don’t think we have seen the worst of it yet. I believe that towards the end of the year things will start to turn around as things resolve themselves. But I think the last one month has been a little bit of running on steroids and there is another leg down waiting to happen. What will cause it, I have no idea. But the market is fully priced; there are plenty of rich valuations and I wouldn’t be lured into thinking that the worst is behind us.

Q: Do you agree with that assessment that there is another leg down somewhere?

Bhatia: Definitely so. If the current fundamentals as we envisage them, if they don’t change and they come up according to our expectations then the market will come under pressure. There has to be something radically new, which we have not thought about or discussed which should come through to change the whole paradigm positively. So unless that happens we are probably going to trend sideways at best and be very sensitive to any negative development.

Q: Are you in the camp, which believes the retest of the lows, is very possible?

Bhatia: Anything below 15,000 - the market may look attractive. Again the qualification being that the fundamentals, as we understand right now if they don’t change, then at 14,000 or 13,500, the market is very attractive. So we probably need to see further clarity on long-term fundamentals of the global economy and for India. Until we see that the market is just rangebound at best.