Nandan Chakraborty MD, Institutional Equities Research at Axis Capital says the euphoria in Indian market following the crash in crude and gold bodes well for the India’s current account deficit (CAD). He reasons that market underperformed in the past because focus shifted to Japan.
At present, Indian equities are seeing a technical bounce due to lower stock prices. Chakraborty desists from calling the current rally a Bull Run saying the real one will begin after the elections. His bet is that a massive amount of capex will be released after elections, which will unleash a sustainable rally.
Chakraborty is also against establishing a correlation between commodities and equities. A crash in one need not spill into other asset classes, he told CNBC-TV18 in an interview. When commodities go down, emerging markets also go down, but India over the last one year has not necessarily moved at the same times as other emerging markets.”
Speaking about the impending monetary policy on May 3, Nandan Chakraborty said the need of the hour is liquidity injection and not so much as a rate cut. The former will have a greater impact than the latter.
Below is the verbatim transcript of his interview to CNBC-TV18
Q: India has underperformed since the start of this year, but last couple of days there has been some genuine reason for India to unwind some of that underperformance do you think?
A: Markets moved out of emerging markets as a whole. Then they moved into Japan and so on, which is why we suffered. Obviously this crash in crude and gold prices bodes well for the Current Account Deficit (CAD) that is one reason.
The other is what happens when absolute levels of stock prices are low then despite other things it starts. It is just a technical bounce which happens. It is a combination of both factors I guess.
Q: The fear with this crack in commodities though is that it may lead to some kind of collateral damage in terms of funds pulling out from other markets. In the past would you say that has been the trend that such a big fall in one asset class has usually lead to damage in others?
A: You cannot keep going back into history and drawing the same correlations in each time. Each time is different. I will give you an example. Gold and other commodities do not usually move at the same time. There is risk aversion versus there is risk-off. This time what happened was when commodities go down, emerging markets also go down in general. However, India at least over the last one year has not necessarily moved at the same times as other emerging markets. Though in general it always does and even this year it did.
However, it is moving away as a pack. India’s problems are more internal in terms of what we are doing, in terms of our political uncertainty and the macro economy. Those are the real concerns. In time once you have the election there is a huge pipeline of capex as we have published recently, which will come up in FY14-16 period.
So, there is a massive amount to look forward to post-elections. For pre-elections one has to be careful because it is going to be extremely volatile market. It all depends on what emerges over the next six months both internally as well as externally.
Q: What is the probability that what we are seeing in commodities sort of presages some kind of deep growth issue, which crops up in global markets or global economies later this year. Do you think that is a risk that global growth might actually disappoint, something for which commodities are beginning to selloff already in sight of?
A: Yes, that is possible. That is one of the theories. On the other hand the amount of liquidity that is available in the bond markets of the US is just phenomenal. When it goes to such a huge limit, when it comes back into US equities and therefore it goes into EMs is also unforecastable.
What I mean is normally people think that it is US versus emerging markets, risk-on versus risk-off. This has been the trend for the last few years, which is why we have started thinking in that direction. This time one has to think a bit differently that at a time when bonds will go back into US markets, then with a lag what will happen it will come back to good markets like India.
When money goes into US equities which is where it has been going out for the last few years. Once there is enough money in US equities versus US bonds some part of it will be allocated into non-home markets. However, that has to collect first. The problem out here has been that the lack of macroeconomic positives.
We think that a new bull market may easily start once you have a government in place. People are confident about unless this government takes some steps soon. So, a new bull market will really start only after the new government gets into place. Till then we will have these rallies and we will have to trade them as it comes.
Q: Would you raise expectations in terms of monetary policy relief though because of the events of the last few days both on these commodities crashing, the ease off in inflation. Do you think it maybe an easier policy now?
A: Yes it will. Interest rate cuts have played out somewhat, but it is not being transmitted into the economy. What we really need is liquidity infusing measures, whether through Oil Marketing Companies (OMC) or through Cash Reserve Ratio (CRR) cuts. That is what is going to drive.
One of our main thesis is that liquidity is going to be injected into the system in a huge way in this financial year. So, more important than rate cuts is the liquidity injection. Most people including us expect some sort of rate cut, maybe 25 bps in the next month. As it has to be a bit front-ended. However, I do not think that is as important as liquidity injection.
Q: Part of our problem is on its way to getting fixed, with the surprising fall in gold and crude over the last few days the CAD and the whole rupee issue which has been bothering a lot of investors but what about the other core issue of growth and earnings. Do you think that will get resolved automatically or that will continue to be a headwind for this market for the next two-three quarters?
A: On the ground as we keep watching various corporate, the feedback that we are still getting from them is that things are very weak still. Consumption is too apart from capex. On the ground it still seems bad, but we can see incipient signs of, discounts reducing, inventories starting to clear.
What will happen is this quarter which is the January-February-March quarter that has gone by where we have almost flat year on year Sensex earnings. There will be some performance from probably oil and gas because subsidies come in. After April-June onwards, we will look back and say that was the trough and the reasons for things rising in terms of GDP growth and so on have been xyz.
In essence what will happen in this period for the next six months is, 1) you will have huge amount of unused government Budget that was not used and parked with the RBI of about Rs 80,000 crore. That is going to be released because the government actually capped its fiscal deficit artificially. 2) The news spend that will come in of about Rs 300000 crore in the Budget then we had this income tax exemptions and so on.
Then we have some amount of money coming from direct cash transfers, which in the initial period may not be monitored.
So, it will actually come into the system for consumption. Then we also have the lagged effect of various interest rate cuts and may be liquidity measures by the RBI.
Finally the number of states that are coming up for elections and the general elections, we are going to have about Rs 45,000 crore of poll spend. This huge amount that comes in from April till the end of this year bodes well for consumption. So, this year’s thesis will be consumption.
The problems are what do we watch out? 1) Does crude sustain below USD 100 or so? 2) Does the government increase MSP massively to woo farmers etc? 3) Do diesel prices continue to be hiked after September? FII inflows obviously last time and now aswell we are vulnerable to them as a country whatever else happens.
We will also have to see how successful is the DCT because if the direct cash transfer is too successful then may be its allies will ask for early elections. If it isn’t very successful, there will be social schemes by the government. So, these are some of the factors to watch. For now we still have a depreciating rupee stance of about 3 percent.
For FY14 our average is 56.5 so that also helps the Sensex EPS, though it does not necessarily help the Sensex PE. At the current Sensex there is some upside, there is not too much downside, but we are not looking at a major bull market starting in this financial year till the elections get over with. We are looking at a much more stock specific strategy because in the same industry you will have winners and losers, which is why a report says ‘11 must have stocks’.
I have taken a bit from Nicholas Taleb when he mentions that ‘in volatile times do take a barbell approach’, which is why 11 must haves are like a football team. You have a goal keeper, defenders and strikers with high risk return.
Q: How are you guys positioned on IT given what you have heard from the first couple of players? Do they find a lot of representation in your team of 11 must-haves?
A: IT is overweight position. We have been overweight IT from around about September of last year. Our thesis was that anything bad that could have happened to the IT industry did happen in the last two years.
If you were to project when things get back to normal they were extremely cheap. So, we have been bullish on IT for quite sometime since September last year and we continue to be bullish specifically on Tata Consultancy Services (TCS) and HCL Tech in particular.
Q: Where does Reliance Industries fit into that list with special reference to the way crude prices have been coming down and how do you think growth may trend for Reliance now?
A: Reliance is one of our bets where a large cap stocks you have massive amount of under-ownership among both dedicated India funds as well as local funds. It is roughly around about 1.1 times book value. If one looks at Reliance over the next three years there is about a 20 percent Compounded Annual Growth Rate (CAGR) in its volume growth.
The volume growth that you are going to see in refinery, petchem and so on is unconnected with whatever happens to politics or anything else. The negatives that people usually talk about in Reliance, which is in terms of capital allocation into things that people still do not have a clear idea on the plan for which is telecom and retail.
Those are maybe a year or two year of cash flows for a company like Reliance. I think the reason why we have it in our must-haves is that if you look at what will happen post-elections over the next three years when the cycle turns what are you going to still have in your portfolio which will still give you continuous returns? Yes, there is a problem in the short-term in Reliance in the sense that what media report say is that the gas pricing has now gone into the Vijay Kelkar Committee Report again.
So, that may delay things a bit. That is a sentimental negative. At the end of the day Reliance will be driven by its capital expenditure plans, which will happen over the next few years. That is the reason why we still have it in our top level.
Q: What are your strikers? They are the interesting names where people do not like these names, but you could make a lot of money or you could lose some.
A: People usually think of large companies as being safe bets. Large companies have a high base to make their 20-25 percent return on. Let me step back a little bit on how I chose these 11 stocks. What we said was if I have a depreciating rupee I get roughly a Sensex EPS of Rs 1,430 odd for FY14 and slightly less than Rs 1,700 for FY15. This is far higher than consensus because of my rupee depreciating stance.
If I look at that, I get a 17 percent EPS growth for each of the two years. So, I have chosen stocks basically, which will give me more than 17 percent EPS growth for the foreseeable future at a reasonable PE. Remember that a midcap can go up from a small base, but that is in fits and starts.
For a company to continue to grow at above average takes a lot of aggression. It is not necessarily a defensive bet. We usually are trained to look at target prices. We are not really trained to look at risk return as analysts, which an investor’s focus is far more on I have mentioned two strikers. One is Tata Steel and the other is Jaiprakash Associates. These are the ones, which are high risk return bets.
I know the mood is very negative on steel because of China, but if you look at what has happened to the prices in the last two years, we have had highs and lows in steel prices. We have gone up to around about USD 750 odd, right down to USD 550. So, even if you take a lowest case of USD 550, you get a 16 percent downside on Tata Steel. Whereas, if you look at USD 700 you will get a 100 percent upside on Tata Steel. So there is a very good risk return.
These are some of the strikers where despite Corus, despite the fact that in India things are not too good right now, the fact that Tata Steel has iron ore, that means it is being hit only by the coking coal part of it and what happens to Corus. So, that is one my strikers. The other one is JP Associates. There was an analyst meet last weekend, which a lot of the industry attended and JP is one where if the cement sales happen. If what they say actually transpires over the next one year that they are not going to raise capital expenditure. They are going to bring down their debt and so on, this could be another flyer. So those are my strikers.