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Jan 05, 2018 04:28 PM IST | Source: CNBC-TV18

Upcoming Budget might be a slightly positive event: Madhav Dhar

In an interview to CNBC-TV18's Prashant Nair and Ekta Batra, Madhav Dhar, Managing Partner of GTI Capital Group, shared his readings and outlook on the fundamentals of the market, and specific stocks and sectors.

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In an interview to CNBC-TV18's Prashant Nair and Ekta Batra, Madhav Dhar, Managing Partner of GTI Capital Group, shared his readings and outlook on the fundamentals of the market, and specific stocks and sectors.

Below is the verbatim transcript of the interview.

Prashant: Could you first let us know how important you consider the Budget to be. I know your thought process, you don’t think that events matter that much, it is what happens over a period of time is more important, but for whatever it is worth, I am going to pose that question to you, Budget 2018.

A: As you said that the event will create volatility and lots of noise, but fundamental solid policy change obviously matters a lot to the direction of the economy and inflation and therefore for the markets. So it really is a function of not the accounting of the Budget and marginal changes here and there, whether there is some very fundamental change in policies that can change the trajectory of the economy and I don't have a sense of that. I don’t have a sense that there is some sweeping big bang stuff.

So odds are it will be a slightly positive, slightly non-event. However, the underlying fundamentals of the economy are much more relevant, both globally and locally, and that is a mixed bag. Somethings look good in terms of a growth pickup, particularly around the world and in India, inflation is picking up around the world and that is a worrying sign, valuations are extended and people are bullish. So that is the sum total of it and it is a mixed bag.

Ekta: I wanted to actually ask you that fiscal deficit, if we do slip, which is most likely obviously, the math is out there, and it comes in at say 3.5 or 3.7 percent, would that worry you, is that worrying you, and will it affect the market sentiment at all?

A: Again at the risk of sounding heretical, I think the quality of the deficit is a little more important than the quantity of the deficit. So if we have a deficit because farmer loans are being waived or there is a bigger fertiliser subsidy, or some other hand out, I think there is no question that will be mot good for the bond market and not good for the stock market. If there is a Budget deficit, I am just making it up, because it is going directly to very transparent, very powerful infrastructure spending, or whether it is going to really retooling elementary public school education, or it is genuine medical insurance that is implemented, and that is effecting the Budget, I think the reaction will be entirely different.

So I am one of those people who truly focus on what you are spending on beyond your means rather than the fact that you are spending beyond your means. I don’t mean to duck the question, I think it matters less than people think, especially at the margin 0.2 here, 0.3 here, but how you get to that number is very important. Not top priority in my mind.

Prashant: 2017 and even 2016, the broad way people described it was that the micros were under pressure, the macros were great. As we have turned the year, many are saying that the macros maybe looking tougher and tougher while the micros will improve. Now that may be a general top-down statement to make but if you agree with that, that macros are going to be under pressure going forward, they won’t be as strong. One of the things is oil from where it has come up which may impact that. Can the government do anything about it especially around the Budget?

A: I think firstly I broadly agree with that that the micros will start improving and the macros, the macros are mixed. I think the GDP will pick up, interest rates, inflation are sticky and this global tide of liquidity is slowly receding. So from that standpoint, macros are negative. From a growth pick up standpoint, both in terms of headline GDP and especially corporate profitability, I have very little doubt that 2018 will be a better year. However, I guess to me what really stops India from moving out into the 8.5-9-10 percent GDP range, I think that is what everybody is waiting for which is large scale privatisation, large scale infrastructure spending, genuine labour reform in this country, land holding, land use, land reform. So that is what needs to be done if you want to be taken as a serious high growth economy in the old Asian tradition.

The odds of that seem low and that is something that needs to be talked about. The government should be pushed on that agenda as oppose to saying this cannot be done because of political compulsions which I think is rubbish. However, that is the big bang stuff. One thing where I think there is encouragement, I think Air India will get privatised in sub-shape or form and largely it seems to be in a very constructive way and I think that is big time stuff, I think that will not only be a very good thing for the aviation sector in India, but that would be a big signal to both the domestic market and the economy and the international observers that India is serious about fixing things that are broken. We are not famous for fixing things that are broken, we adjust, we sweep under the carpet, we tweak at the margins, so, this will be a big deal. So speaking of big bang things, I think if Air India is cleanly privatised successfully, I think that will be a big bang reform.

Ekta: You did mention likely reforms, Air India privatisation – when you mention reforms by the government, the other two things that come to mind is maybe free pricing of petrol despite Brent crude going up in 2018 and that is obviously linked to the health of OMCs. The other thing is what is happening with the NCLT process and the NPA process when you talk about PSU banks. So would you be a buyer in these two sectors on hopes of maybe some optimism?

A: I have been sort of positively inclined and longed these stocks for couple of years anticipating recapitalisation and some incremental changes and they have already done very well. So I am not sure I am a buyer of anything at this point. However, I continue to believe that the trends are favourable in straightening out the NPA system. The bankruptcy code, and the restructuring legislation seems largely very good. It needs tweaking here and tweaking there, but at least these problems are being addressed, these banks are being recapitalised.

There may be a bigger existential issues which I don’t think India is ready for is that why do we need such a large public sector banking system, why is it different than Air India where you think you need a national carrier and you keep putting money and it keeps blowing it up. So at some level, it is not that different, but that is a much more evolved and more difficult decision for India perhaps several years down the road. However, right now, at least the problem of bad loans is being addressed, thin capitalisation is being addressed, and the trends for banking are extremely good.

So if these companies are straightened out, but don’t forget, just the capitalisation is not enough, you have to go and change boardroom dynamics, CEO compensation, hiring, firing, freedom of movement, lack of political interference. You cannot just keep recapitalising these things assuming that you have fixed them. Having said all of that, I think the trends are favourable, which is not a good answer to whether I would buy them or not, but I think the banking system is getting better and frankly looks like credit growth is finally starting to pick up from very low levels even though new projects are still anemic.

Prashant: Last time you were on the show, you said valuations, broader market are high to very high. And most people that we speak with, more often than not, privately, express almost a sense of fear that one day, it is going to end and maybe it is going to be more than just a halt but no one knows when. So put that against a quote that I want to read to you. This is Robert Buckland from Citi who wrote, having had a good year in 2016, contrarian strategies underperformed in 2017 when they were too defensive. They will be defensive again in 2018. Contrarians are not implicitly calling the end of economic and market cycle. This call is premature. We would resist the temptation to chase any new year rotation. Who would you side with and what would you do?

A: I do not think these things are so simple and valuations, to be clear, are never a trigger for a market to go down. Valuations simply tell you that once something goes wrong, how far something will go down. So, it is not a necessary condition to ending of something. But it tells you how far you are going to fall when something takes your legs from under you. So we have to focus not on valuations, but what is it that will take the legs from under you.

So let me fall back on two old proverbs. One is, bull markets never die of old age, they are killed. They are usually killed by the central bankers. So this bull market is now eight years old. It is up 400 percent in S&P, heck of a lot in emerging markets around the world. So this is an old bull. It is a very expensive bull, but right now, it is a strong bull, both globally and locally. The economies are picking up, ISM orders are fantastic, wage rates are picking up. So US as usual, has surprised the world of how resilient and strong it is. And I have always maintained it is the country of the future and will always be. You can go on underestimating what is happening there, but it seems to continue to lead the world yet again.

Having said that, the thing that worries me the most is that it is always, the end is very similar in the sense that it comes from rising interest rates. It may not always be the central bank because if central banks are spraying the world with liquidity, it will show up in bond spreads whether it is high yield spreads in the US or whether it is the quantity and quality of financing for the Indian NBFCs. That is what bears watching. Even though liquidity is very high around the world and interest rates are very low, the change at the margin of the last 18 months is clearly that rates have gone up. And I think, this time the risk will be very similar that inflation is suddenly little higher than you thought and the Fed raises rates 4-5 times in 2018 and somewhere this thing starts stumbling, the market starts stumbling. And I think that will be the likely pattern.

I have a contrarian instinct, I have a valuation grounding, as you know, but I think those are necessary conditions, not sufficient conditions for something to come to an end. So, we have to watch. I am not sure it will be oil, but oil is a signal, not necessarily of supply issues, but demand issues as growth has picked up. Labour wage rates are picking up in the US, inflation along with it. So it is classical, old fashioned stuff.

And I might add, one of the things that kept me very bullish all of last year and continuing this year is that even though things look extended, you need a full capitulation into the bullish side. People were very sceptical, India is going up and their earnings are not going up, there is no real reform. So there was a lot of that talk. Similarly, Trump has a button on the nuclear trigger and he is a crazy man and god knows what the world will be. A year later, people are quite relaxed.

I do not think you still have full capitulation, but people now believe that domestic flows into Indian stock market will continue. We do not need the foreigners, things are going well, we have got the GST. So there is a little more assumption that things are going to work out. You have bitcoin going up 17-20 times, you have a painting that sold for half a billion dollars, another yacht that sold for half a billion dollars. So you are getting finally into that little bit of that late stage go-go mode. I still do not think it is done yet. But I do not think it is another year of this. Maybe there is three months of this, maybe there is six months of this. Jeff Bezos is easily now, the richest man in the world. So, you are getting that late stage feeling.
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