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(Interview Transcript)
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Manish Chokhani, Enam Consultants said that India had a dual issue of capital flows and of an over-extended stock market.He sees the FY09 Sensex EPS sat Rs 950 -1,050. He said that the earnings may compound at over 15% and at over 20% in an optimistic scenario.
Chokani said that the markets are unlikely to under shoot and that it seems unlikely that the Sensex will go down to the 12000 levels. He added that there were many companies with good valuations, like Reliance, for example. He added that the foreign investors are waiting for signals to enter market in big way.
Excerpts from CNBC-TV18’s exclusive interview with Manish Chokhani:
Q: Is it tipping towards a bear market or is it just a cyclical pause?
A: When you are 30% down you can’t debate. Everyone has got plastered and it looks, feels and smells like a bear market. We tend to overreact in our own country about things that are happening in the rest of the world. When I look around the world, the biggest problems are emanating from US and that market is down 4% year to date. I look around and see the thesis which says money will go to the growth market, and to hard assets. That thesis continues to hold, if I look at prices of oil, copper, and aluminum. I look at markets such as Brazil and Russia which are close to their January highs.
So, something has happened in India which has spooked us. More than the global factors which seemed to be sort of back to reflationary. There is something going on in India, which is spooking us. So, what’s the way out from that? It is the way you get back on track of what I still thing is a longer-term bull market, and we tend to be in a corrective period within that.
Q: Not just India, it is India and China?
A: Yes.
Q: So, are there any similarities between what we are experiencing and going through?
A: Yes and no. China had gone completely bunkers. We had talked about USD 500 billion market cap companies are out of China and the 4-5 largest market cap companies in the world were in China. China and India traditionally are not resource exporting countries. They are resource hungry countries and therefore they are the one’s who are going to be affected the most by import of resources, especially if they are following what one calls a mercantile currency policy. There is also no adequate supply response in India.
In China, you may have a stock market which is completely exuberant in the midst of a correction but the economy is not slowing down. They will have to slow it down, if they choose to tame inflationary fears there. In India, the problem is different. We over shut. We were talking even around Diwali time that this market is looking hot and one needs to be cautious and so on and so forth. But the real economy in India seems to be suffering, whether you do a combination of currency side as well as supply side. Whether you get quick responses to that is going to be a challenge for us.
Q: What has gone wrong, if you can put a finger on it, because till a while we had coupled pretty much with other emerging markets and moving in the same trajectory? But now we have been singled out for punishment. Is there something specifically economically that has gone wrong out here?
A: If you look at India, you have a current account deficit. It is hard for the Reserve Bank to go out and say, ‘Let the currency appreciate’. Then, what happens to exporters? Do we allow these inflows to come in and so on. The other side was in the stock market, where we were overextended and everyone present, companies included were shouting the markets ahead of itself.
It probably needs some time to breathe. Foreigners still haven’t deserted the country. Outstandings in the futures market stood at about USD 30-35 billion in January. Of that, foreign interest was about a third, or about USD 10 billion. That market itself has become less than half now. That token USD 5 billion of foreign interest should have gone because either they don’t have an arbitrage opportunity or there is no direction call that they want to take. Against that USD 5 billion, one has seen a net outflow of USD 3 billion.
In theory, foreigners haven’t deserted India. What seems to have happened is a crisis of confidence locally and not giving enough reason for new people to come and say let’s get back to India. The challenge is that last year one saw the consumer or export sector starting to slow down and the market and economy was powered ahead by the investment cycle. You are seeing the investment cycle is also down as well. That’s the fear really in the market.
If we now get our policy response wrong and react in a knee-jerk fashion to the inflationary pressures, which are there, one could actually just choke the economy. Already banks are talking about credit growth at 15-16%, away from the hey days of 28-29%. In any case, you are heading for a slow down.
Even when you looked at the Budget, the Finance Minister came out and talked of reflationary policies in terms of putting money in hands of people to kick start the consumer durable cycle and so on. So, that’s the conundrum people are faced with, in which direction India is going to go. Oddly enough, even on the currency side, you have got a 4-5% appreciation even in China on the back of 7% appreciation of their currency last year. If even the Chinese are willing to appreciate their currency then what’s going on in India.
Q: What will give in? All of it cannot be done. You cannot rein-in the currency yet tame inflation? Do you think it will have to be Monetary Policy and if that happens, is it bad news and can it really choke this market further?
A: The Monetary policy right now is frankly irrelevant because even if you raise rates, the fact is credit growth has slowed down. You do not want to slow it from 15% to 10%. So, I don’t think rates are an option. Even if you hike CRR, the fact is that there is ample liquidity and deposit growth is probably north of 20%. Credit growth is 15%. So, in any case the CRR is not really going to help you.
What you really need to tackle is the supply side because that is really where the pressures are coming from, whether it is food, oil, and metal prices. Sadly, currency is just one end of the equation. You can do that much by cutting tariffs or import duties or start giving some handouts to people. By doing some of that you can get the currency up 3-4% as long as you maintain an effective exchange rate. But the supply side in India has been lacking sadly.
Currently, we are saying we want to ban steel. For the last four-five years, Posco is going round and round in the country trying to put up a steel plant. Maybe if that supply had come up, we wouldn’t be shouting the way we are now.
Similarly with cement, you get a bull market after 10 years in cement and that year we want to clamp down on them. If you talk of agriculture, we have talked a lot about inclusive growth and getting the farmer involved. But when the organized sector goes into increased farm productivity you tell them to back off. Similarly, when the world market is having a bull market in agricultural commodities, the price signal we are giving our farmer is that I want to keep procurement prices low. So, each time you are giving someone a signal that don’t re-invest and don’t increase capacity over here because I have other considerations.
Same is the case on the oil front. In agriculture, the next crisis is going to come out in fertilizers because your whole move is to increase farm productivity while area under acreage is not really going to go up. So, either you get irrigation, better seeds, fertilisers, and nutrients into the soil, or encourage economic sized farming. So, it is not a short-term solution. I don’t think they have it.
In the short run, what we would probably end up doing at some point is some currency appreciation.
Q: We have spoken about many things, earnings, inflation, etc. But does policy remain a central risk to this bull market?
A: If I see where this market went, it was overextended. It fell back really because of leverage. It then de-leveraged effectively in the first quarter. While you were de-leveraging you started questioning your earnings assumption. People have gone and done foolish things whether on derivatives or execution ability. On a lot of the engineering companies one was paying up a lot and companies may not actually deliver those numbers.
Step 1 will be when you see earnings coming out that were we at least on the ground. A lot of people are talking of Rs 850 earnings for the index this year. So, the first test would be to see do we hit that? Because from that base whether we grow 15% next year or 20%, depending on which bull/bear camp you are on, you look at somewhere between Rs 950 to Rs 1050 in terms of earnings.
But the fun is, if you put that out a year from now. Sitting next year in March-April, we are probably going to look at Rs 1,250 kind of earnings number irrespective of what happens this year. In that context, the market now is going to look very cheap from where we are sitting today, given that there is this 15-16% embedded value of subsidiaries of Reliance, ICICI, or Tata Motors among others.
In that context, the first bet is let’s see what happens with earnings. The second bet is what happens with policy response, particularly the Credit Policy. The third sort of leg-up will be when you get the June quarter confirmation that the trajectory one is forecasting of close to Rs 1000 index earnings for next year seems to be on course.
Q: Do you think that assumption is at risk, given some of the things that have come out in the last few days? BHEL has been a disappointment. There has been the odd ICICI Bank. Do you think we need to revisit those assumptions?
A: It is easy if you cut this market and sit back and see it dispassionately. If I take the composition of our market cap, roughly seven companies make up 25% of our market cap. In those seven, you have got telecom, Reliance, ONGC, NTPC, DLF, and then you have got banks. None of these in terms of earnings look like they are going to be a major disappointment or a major miss.
Q: Not even banks?
A: Not even banks because what you want in a bank is really the credit spread and leverage to be maintained because you will get these - like people fear - derivative losses. In your mind, this will be a one-time write-off and then hopefully people don’t repeat the stupidity that they did, if at all they’ve done that in the following year.
In your normalized earnings out for next year, you are not going to get very spooked there. In the current year, you might see some pressures in PSU banks coming in because of the Pay Commission, wage hikes, etc. But the key at the end of the day is do you make RoE, do you therefore get the leverage effect, and can you deliver on those numbers? Valuations are so beaten down that even if you get earnings misses of 2-4% it doesn’t really matter in the larger scheme of things.
Q: What's your gut feeling? Do you think we will bottom out somewhere around these levels than 14,000-15,000, or is there downside risk to this market?
A: You ask god when you want to prophesize. Last year, I don’t at any point in time I could have forecasted that we are going to cross 20,000. I don’t think at anytime one felt comfortable that the markets are on sound footing and it is going to continue on this trajectory at a sustained rate. All one could say is that earnings in India will likely compound somewhere north of 15% in whatever scenario, if you get overoptimistic it will go north of 20%.
The kind of reasonable multiples therefore should be in that band for the country. Each time you go ahead of that, especially because one doesn’t believe that India is doing a lot of long-term things right on the policy front, one can’t overpay a lot in India for the future. In that context, can the market undershoot the way it overshot? My guess is no, because a lot of the leverage positions have got cleaned out. A lot of the stocks have started going into stronger hands as the market has fallen.
A lot of portfolios that I look around have now got a lot more consolidated. So, if you had 80 names, you probably have 50 names, and if you had 50, you probably have 30. It seems to be now on a stronger wicket. As long as we don’t get it wrong now and do something really stupid to shoot ourselves in the foot because even the most bearish person on your show must have not come and talked of a less than 7% GDP growth or a less than double-digit earnings growth. In the context of where the world is, this is a growth frontier.
Q: Is 12,000 unlikely then for the Sensex?
A: I am not in that camp at all, so you would have alarmists coming and a lot of people who have lot of vested interest in doing that, but I am not in that camp.
Q: What about the global situation? How likely is it that we have a globally synchronized bear market for 4-5-6 quarters in which case we also suffer?
A: The current decade is the decade of natural resources and emerging markets like ourselves. I don’t really subscribe to the synchronized bear market argument because the world is in a reflationary mode right now. All central banks are trying to get growth up. So, when you create that kind of liquidity and those kind of interest rates, that money is going to slosh and go somewhere. If I look at just the oil producers, they now generate incrementally a trillion dollars over budgets which they do at USD 60 per barrel.
If you take the differential of USD 40-50, its incrementally a trillion dollars a year. Then you take all the surpluses from the Asian countries, so that money has to find a haven. If you are a leverage person, you got out but what about that person who has got that trillion dollars? Where is that money going to be deployed? I am not happy making a 1.5% return in a currency which is going to depreciate longer-term. I don’t see that scenario. At some point, we will get surprised on the upside because I don’t think this bull market in natural resources is going to end just here.
Also, a lot of people say that if the US goes, it drags the world and. I would like to put that in context. It is a USD 13 trillion GDP economy and they used to grow at 2-3%. So, that was incrementally USD 200-300 billion which the whole world and the western press kind of built-up, as if that USD 300 billion of incremental growth is driving the whole world.
Reality is that China has USD 3.6 trillion currently and they are north of 10%, so that’s above USD 350 billion coming from there. If the US slips and with the Chinese growth, no one is talking of going to 8%. They are saying they will slow it down and bring it down to 9-10% instead of 12%. You still have solid demand in the world coming out and oddly enough coming from resource hungry kind of countries like India and China. On top of that, you have speculation going on in financial markets, that people will do what they did to equity markets. They will go and do in oil, gold, resources and so on. But that heart of it is that it is structurally not something that’s going away in a rush.
Q: So, when do things start getting on the mend? We have already into this three-months of bearish kind of market. What is your assumption of when we see the first uptick proverbially speaking?
A: That’s the difference. If you look around the world, the country in the biggest trouble is 4% off year to date. If I look around at asset classes, which one is bullish about, they seem to be still at all-time highs which is all the commodities. If you look at commodity countries of Brazil and Russia, they are close to their all-time highs. So where is this bear market? This is sort of the first question.
The bear market really is China because it is correcting from a complete overshoot. At some point that will come back when they start moving their currency a lot more aggressively as well. Is India into a bear market? There are a lot of local questions in terms of what did our corporates do last year, and do I need to worry about it when I am forecasting. What is our policy response going to be in the next 30-days that I need to worry about? What kind of trajectory should I now start forecasting. Given the fact that I will have some cue on where my y real interest rates are, in presumably what analyst use in their discounted cash flows. So, I don’t think the basic thesis in that has changed. You will have kind of three testing points in the next quarter to decide where we are going.
Q: Do you think in the next month or so, once this earnings season is over, guidance are in, and monetary policy is out, we can have a reasonable assumption of whether we are on track to resume the bull market or not?
A: I would think so. You can come here and wish for a bull or bear market. But the reality is currently clouded. I don’t think anyone should stick their neck and try to be a hero right now. Valuations are in your favour. If you take 5-10 companies then you can just forecast them out three years in varying scenarios. You can see serious money being made illustratively.
We talk of Reliance and this year their major capital expenditure gets behind them. The company effectively doubles its size because of the oil and gas as well as refining coming onstream. Valuations are not bonkers. It is an USD 80 billion company at the end of the day. When I look around the world, I see USD 400-500 billion companies. In terms of what actual cash flow they make, how on earth can you be bearish on them?
Similarly, one can talk of example after example of large companies over here. At some point, people will realize they have a multiplier impact on GDP because it is not just about the resource coming out, it is what it does to the stranded power, steel, and fertiliser assets; incremental lowering of energy cost in the country; and the impact it could have potentially on your balance of payments as well. So, there are enough events like this lined up in our country for you not to say things that are so bearish and this whole bull market can be kissed goodbye for the next 3-4 years. So, certainly no argument in favour of that.
A: It feels like that. I meet clients internationally and in India. Foreign clients have money but like most other people they say, why should I be the first to catch the falling knife? If one is down 25-30% in the first quarter of the year, then one needs a lot of courage to use your last pile of cash to go back in. People jumped in on the January 22 crack and in the mid-February crack and from there one lost money, whereas the rest of the world bounced back from there. So, it is clearly people’s who are spooked. They are holding on to their last kind of reserves there. Locally, the largest funds and insurance houses have cash but again like everyone else they are waiting to get the signal and go in.
What I suspect will happen at some point is when you get the signal. Everyone wants to jump in at the same time and then you wonder what happened to this market again, because stock has gone into kind of strong hands who are committed to what they want to hold now. So, unless there is a fundamental disappointment either in terms of earnings, what the company did, or what policy is, in which case you just stay one leg down and readjust from there. But given that those fears are probably in the price, you are going to see at that point everyone wanting to jump back in.
Q: Which would make for a V-shape recovery, is that your base case?
A: It has really been a bottoming U actually. From January, almost through till June, it sounds like V-shape at the end of it. But during it, it seemed like a really terrible U, which one is going through.
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