Oil prices still a concern for mkts: Experts

Madhusudan Kela, Head Equity Investments, Reliance Mutual Fund feels that we are in a rangebound market. According to him, every incremental dollar increase of oil is having an incremental huge pain for a country like India because it is definitely disturbing our macroeconomic fundamentals. He feels that inflation will recede in the next three-four months and an immediate interest rate cut will not be seen.

 Jyotivardhan Jaipuria, Head Research, DSP ML said, “Over the next three-four months we could see the markets go lower than where we are today because the US economy is still a question mark. Earnings in India should see a downgrade and that’s what clearly will lead to some sort of market correction.”  He said, “Somewhere, the bottom of the market should be formed over the next quarter then we will get bit of earnings downgrades coming through. Hopefully oil will come off and we will be behind some of these problems.”

Excerpts from CNBC-TV18's exclusive interview with Madhu Kela and Jyotivardhan Jaipuria:

Q: What’s your sense do you think we have hit some kind of a short-term bottom or difficult to say?

Kela: We are in a rangebound market. We still believe that the market will require serious amount of more bad news to go below the levels of 4,400 in Nifty and that is where it is resisting. However given the overall macro sense, the market will not easily break the top of 5,500 in a hurry. We are still in a range.

Q: What kind of news do you think can drive the market even below the levels where we took support from because some of the devils are known at this point is it oil which is going to be the tipping factor?

Kela: That is the biggest factor. Every incremental dollar increase of oil is having an incremental huge pain for a country like India because it is definitely disturbing our macroeconomic fundamentals. It is disturbing the subsidy picture and making the government take a lot of action, which they would have not taken in an otherwise environment. Oil actually has been the crucial thing.

If you see the speculative position in oil, it has gone upto USD 190 billion, which is the future outstanding position of oil. This used to be somewhere around USD 60 billion in 2007. We believe that there is a lot of future trading, which is taking place in oil.

Oil seems to be a one-house commodity. Everything else has corrected; we saw the shipping Index crashed by 10%, we have seen correction in all metals and in all soft commodities. We have seen correction in gold; gold have gone below USD 850 per ounce. Oil is the only thing, which we are holding on. It needs to be seen that whether we have seen the worst in the oil or a spike, which is left, which can take oil to USD 160-170 per barrel and that is where it will attract a lot of selling.

Q: We have gone and retested the January and March lows in the last fortnight do you think those will hold, we will manage to hold around these levels or are we looking like we could go even southward?

Jaipuria: Over the next three-four months we could see the markets go lower than where we are today because the US economy is still a question mark. Earnings in India should see a downgrade and that’s what clearly will lead to some sort of market correction. We have corrected quite a bit from the top. To that extent, we will keep getting these bounces up in the market and probably there will be some downside.

Q: What’s the sense you are getting about flows from the people that you speak to because we have lost more than USD 5 billion of FII flows? What’s causing the most amount of anxiety amongst global investors about India right now?

Jaipuria: Last year we got an USD 18 billion of flows which was quite disproportionate compared to everything else. What we are seeing this year is that markets, which did very well last year are seeing lot of profit taking. India is one example; China is the other because people had put in large sums of money there. In India per se, what is causing a bit of concern is inflation because inflation numbers are quite high.

Q: You speak to a lot of these hedge fund managers. What’s the problem why are they taking out such a lot of money from India? What do you hear from them?

Kela: They are also nervous given the overall big picture about India. Whether you talk of subsidy or of government financials, as Jyotivardhan Jaipuria pointed out there is a fear about the earnings downgrade.

On one hand this is the issue but for some it is an opportunity. People who are making absolute money in markets like Brazil and Russia, who are still trading on same valuation or cheaper valuations than India are driven by absolute profits. They are not driven by any patriotic feeling to invest in India.

Q: There is one feeling in the market or one group, which believes that the macros might be very bad but it may not percolate down to major earnings slowdowns in the next couple of quarters. Do you see a serious earnings downgrades happening in the next two-three quarters?

Jaipuria: It may not be major but the trend on earnings is down. We will get earnings in the range of 15-16%, slower than 25-30%, which we saw over the last few years. There will be some earnings downgrades because of the cost-push pressure. We will see some margin pressure coming through. We will also have a bit of earnings downgrade but it is not going to be major. Probably on the Sensex, we should see earnings getting downgraded by 2-3%.

Q: CEO of you mutual fund said that last count you were holding was more than USD 2 billion of cash or 25% of your assets in cash. Have you started deploying that or still sitting on a disproportionately higher amount of cash going by your own standards?

Kela:  The actual number is USD 1.5 billion. That’s the number, which we are sitting on. We have done exceedingly well for ourselves, and our investors by keeping this cash. The avoid strategy has been that we have not disturbed our portfolio significantly. We are still playing the high beta India growth story through our existing investment of the portfolio. We have not divested those and gone into defensive stocks.

This cash and our bet on IT, has played in these difficult times. Everyday we are a buyer of a stock in specific nature. Right now, there is no rush to go and deploy all this money because people have to keep in mind that this money is being given to us by 60-70 lakh retail investors. They have deployed the money in equity; they still feel very painful when you lose the money. Just give you a recent example; we did our NFO of natural resources fund where the NAV is down only 4%. If you compare these funds with any other funds, which will be launched in this period we have done very well. We had 40% cash, 50% cash in this fund. As long as it helps my ultimate investor, I have no problem adopting that strategy.

Q: I was not asking the question more from a perspective of why you have held that cash. But more to ask you on why you are reluctant to deploy it even now at these 4,400 kind of levels and that too outside the Index, where stock prices have corrected 50-70% from their highs?

Kela: Today the market is running on factors, which are beyond our control of understanding, whether it is crude oil, a near-term inflation or news flow. On a fundamental basis, a lot of these companies are definitely looking very attractive. We are prepared for scenario like oil going to USD 170 per barrel with the arms and ammunition to fight that market. If the inflation rate goes beyond 10%, cash is being kept for that purpose and wherever we get opportunity we are deploying that cash on a daily basis.

Q: What is the big risk as far as you are concerned? The market did not fall too much after the repo rate hike; do you expect interest rates to harden further presenting more headwinds for equity in the next quarter or so?

Jaipuria: The interest rates probably will move up around 25-50 bps because inflation is still high. Reserve Bank of India (RBI) will continue to tighten monetary policy, so to that extent we should see increase in interest rates. 25-50 bps by itself may not be enough to slowdown things dramatically.

Why people are focused on oil and are we really at the peak of inflation or going to see inflation keep going higher or continue to remain at these levels, will be a bigger worry. We maybe nearing a peak on inflation if we could see globally the oil prices come down or other commodity prices come down. Things will ease off a bit on the inflation front over the next two-three months.

Q: What is your sense of how long it will take for some of these serious headwinds like high inflation interest rates to recede for the equity markets?

Jaipuria: Inflation is something, which actually could start coming off a few weeks later if the monsoon turn out to be as good as they have been in the first few weeks. Part of the inflation has come from the food prices and that is something, which should see a downtrend. If we can gap this combine with a global correction in oil prices and other commodity prices, one will have a better setting in Q4 where the whole inflation worry is subsided and people start hoping that margins will start improving for companies.

Q: You started the show by saying we are in a 4,400 to 5,400-5,500 kind of range but by when do you see things starting to be on the mend because we have been in the downtrend now for about six months already?

Kela: Oil is the biggest joker in the pack. Once we have some kind of a decisive top formation in oil, the faster it rises in the short-term the sooner we are going to find the solution for this oil problem. At some point of time one of the international experts in oil had mentioned that none of the large national oil companies have started to hedge in the future market.

If you have to have the continuous spike, some of those players will come in this market and that is what we cause a significant correction. Minus that, a lot of the other problems seems to have priced in. Inflation will recede in the next three-four months and we may not see an immediate interest rate cut but that will be followed up as soon as the inflation recedes. So, if oil comes in our way and starts to fall then we may have the beginning of the party very soon.

Q: What about the interest rate situation? What is your take on that and how have you positioned yourself in the fund on the interest rate sensitive sectors?

Kela: In the short-term, we feel that interest rates have been hardening. If you look at our portfolios, we are still a large believer in the long-term India growth story. So, we have not made our portfolio defensive. We are still playing the same infrastructure, the same capex and the same financial services. Those are still significant overweight in our portfolio and given the kind of correction, which these companies are seeing, P/E to growth in these companies have definitely become more attractive than lot of defensives in this market.

Q: If you are in IT, FMCG, pharma you have done well and if you are in infrastructure or financials you have done badly; does this still continue to be the trade for the second half of 2008 for you?

Jaipuria: It may continue to be the trade over the next two and half months. Somewhere before the year- end the trade may change, people may get out of some of these defensives and then get into some of these growth sectors. We have seen a sharp correction in the growth sectors; valuations now are not as expensive as they were. They are starting to look quite cheap especially as Madhu Kela said about price to growth basis, some of these stocks are looking cheap. So to that extent they are stocks, which if you will buy now you will make money on them over the next one year. They may underperform for the next six-eight weeks.

Q: The counter argument to that is in different stages of the bull market, the leaders change around. So last year was infrastructure and banks and maybe something else will lead next time around the market takes off. You do not buy that argument of course?

Kela: Within the sector the stock leadership might change. If the foreign investor is a dominant investor in India who has got more than USD 200-250 billion, is he going to come to India to play the FMCG, is he going to play the defensive sectors or will he come and play the USD 500 billion capex story, which we have? My conviction is that the larger investors would like to play their India story. I believe that the Bull Run in India is over.

Q: Any headwinds for this whole infrastructure space because it has been a bit underperformer and some people are now raising questions on whether that whole capex story will play out as envisaged earlier because of capital problems, fiscal problems. Are you still sanguine about that?

Jaipuria: I am less worried about the capital infrastructure spend not coming soon. What could be a concern is that the commodity prices do not come up. You could start getting some margin pressure, which is more than what is really built into earnings. That is one thing to watch out for and if commodity prices start coming up then one could probably start seeing margin improvement in these sectors. That actually could be a trigger for buying these sectors.

Q: What about pharmaceuticals, is it one of those defensive sectors, which do not excite you or do you think there are opportunities there because this week’s big event has been the Ranbaxy deal?

Kela: We have been overweight in pharmaceutical sector because it is a combination of growth as well as value. One can buy pharma companies even today, which are trading between 10-15 P/E multiple, with a growth rate of possible upward of 18%-22%. If you look at the price correction in lot of commodities whether you take zinc, copper, lead, aluminium or nickel, all these commodities have seen upward of 30%-50% correction in last one year. Oil is the only thing, which has not corrected and hopefully given the trend whether it was gold or silver everything has corrected.

Q: From a strategy perspective what is your market view for the rest of 2008?

Jaipuria: We still expect markets to be lower than what we have seen in this year. Somewhere, the bottom of the market should be formed over the next quarter then we get bit of earnings downgrades coming through. Then hopefully oil will come off and we will be behind some of these problems.

Q: Do you sense that there is still a lot of money to go out of India or are people significantly underweight already and they have raised enough cash from India in the last few months?

Kela: One should not look at the overall proportion that they have not sold significantly. There is USD 5 billion on 240-250 billion base which is hardly 2% of the overall money that has gone in. What we need to see that if the situation worsens then obviously we will see still a large amount of price outflow from this country. What is interesting to note here is that the significant amount of short selling which has happened in India in the last one-two months by some of these hedge funds is by borrowing these stocks. So, all these large FII numbers, which you see on the sale side, lot of it might be attributed to that selling rather than genuine long-term investors going out of this country. If that goes to any good news market could recover very smartly in the short-term.

Q: At what point will you dump that half billion dollars of cash into the market in a reasonably short period of time?

Kela: It is 4,000 Nifty.