Jul 27, 2017 04:58 PM IST | Source: CNBC-TV18

See good momentum for market in short term, but risk-reward unattractive: UBS Securities

Gautam Chhaochharia believes that the renewed political stability will give confidence to investors in the short term.

Even as steady earnings and political developments in Bihar led to fresh highs for markets, some experts continue to be wary of the rally as it is not commensurate with the fundamentals.

Gautam Chhaochharia, Head-India Research, UBS Securities believes despite good short-term momentum, the risk-reward is unattractive from a fundamental perspective.

“Political stability will help the market in the short term…there is a confidence that global investors have on this regime,” Chhaochharia, told CNBC-TV18 in an interview.

“From a long term perspective, these are not levels to be entered into. Valuations are not justified…some of them (investors) have trimmed positions in India,” he said.

Speaking on the Reserve Bank of India’s (RBI) monetary policy committee (MPC) meeting on August 2, he said he does not expect an interest rate cut.

Below is the verbatim transcript of the interview.

Anuj: The market keeps climbing wall of worries and now the market has started to get some positive news as well. Yesterday's development, politically, have also helped the market. How are you reading the current situation now?

A: The sentiment for the market and backed by the local flows into mutual funds is clearly a positive for the momentum for the markets. So short-term, you cannot argue against that but from a fundamental perspective, our view remains that the risk reward is unattractive at current market levels.

Latha: We are seeing that in several asset classes and several equity markets but this political re-rating expectations that policy stability and political stability can now get extended by another five years, will that be a factor at all when foreign investors assess market?

A: As I said in the short-term that definitely helps sentiment that political stability is helping specifically given the confidence global investors have had on this government's policy regime. having said that, politics is, even one year is a long time, so difficult to take that kind of call but yes in the near-term, yesterday's development and general political stability post Uttar Pradesh (UP) elections is definitely giving you a lot of comfort to global investors.

Reema: Are you recommending booking profits at these levels. What are foreign investors doing right now?

A: From a longer-term fundamental investing perspective these are not levels to get into the market for sure and even book profits tactically on specific stocks where you see misplaced optimism or the valuations are not justified even if we look at optimistic earnings estimate etc. In terms of booking profit, it depends on investor's style. The global investor base which we talk to, some of them have trimmed their positioning in India, so they have reduced a little bit of their overweight position but India is still the biggest overweight market for them, they are still bullish India on a relative sense. So that basic premise has not changed but we have seen a bit of trimming in terms of the relative sense they are overweight on India.

Q: I take your point about the exuberance. Yesterday, when we were having our citizen's monetary policy committee meeting ahead of the RBI policy on August 2, Dr Pronab Sen, highlighted and I regard him well because he has got the RBI right, several times in the past. His fear was that asset markets are becoming expensive and that might prey on the RBI's mind and they may not want to make even easier for money to move from foxed income to asset markets. If indeed it is a pause from the RBI on August 2, impact on the markets?

A: Again, our view is there will not be any rate cuts, that is our economist's view for the next week. At the margin, it will be a negative for sentiment, but it is not going to be a big deal from market sentiment from beyond a couple of days when they do not cut rates. And then just to step back, you have to remember that we are still talking in terms of cutting rates along with inflation. We still have not reached a stage where we have not cut rates in real terms.

Q: On a today basis, we are 400 basis points positive and even in a one-year forward, we are about 225 basis points perhaps if inflation were indeed to be at 4 percent March 31. But how have you looked at the earnings so far? Is there valuation comfort in any pocket?

A: What we did was in a recent report, we focused on valuations slightly beyond just the headline P/E multiples because typically, we talk in terms of headline P/E multiples but the underlying can be very different in terms of quality of business and earnings. So we did try to get two buckets where the near term, next three year forecast earnings and the implied growth rate longer-term can justify higher P/E multiples.

So even though we have stocks which most investors would say headline valuations are rich, those stocks could be interesting and then be justified which we call resilient list of stocks and then there are a whole host of stocks where the three year forecast, the implied growth rate, just does not justify the current valuations. So they are clear buckets and even the current earnings season, we are seeing that kind of play out.

Anuj: We have seen a huge move on the currency as well. Your sense of where the flows could be headed. Could we go through a scenario where of course the domestic liquidity is very strong and if the foreigners also throw in the towel and we have huge inflow from there, could this market just go into a bit of a exuberance phase? From your point of view, it might already be there, but could that happen over the next 3-4 months?

A: It could. We have seen that in earlier market cycles also where we see sharp moves in a short period of time because of investors being forced to choose assets. So that could happen even though valuations are at all-time highs. That is just based on history, so more liquidity chasing the same assets keeps happening. So it can happen again in the next three to four months.

Reema: You have screened stocks and put some of them in the resilient group category where you believe the visible growth justifies the P/E and then you have categorised some of them in missed priced hope where you believe that valuations are actually rich. Take us through the sectors and stocks which fall in the resilient category and which one fall in the missed priced hope category.

A: I cannot talk about individual stocks, but many companies with high headline P/E multiples do fall into a resilient category and these are typically from sectors like consumer discretionary, select automobiles, where we see the next three year forecast is quite strong or high growth rates which in a simple lay-man language means that in three years, the P/E multiple then, would not be very high because the next three year's growth is very high.

Therefore the implied long-term growth ask from these companies is not that different versus some other companies with much lower P/E multiples. So these are where we call them resilient stocks where in the current market context if investors have to look at their portfolio positioning, they are better place to have the portfolio exposed to this that there will be much more protective of any downside to the markets if at all and also, from a fundamental perspective, they have a much better and robust portfolio.

Latha: I see a lot of consumer stocks in your resilient list. Any part of the finance space that you would be positive?

A: Yes, the mortgage financiers are one bucket where we have been positive, still remain positive. This is despite the fact that if you look at the big government housing push, we have not seen their big government housing push being baked into mortgage financiers' growth numbers. So on one hand, we do bake in macro recovery in many sectors and stocks, but in mortgage finance, no one is baking in a big uptick in mortgage growth per se.
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