Alroy Lobo, Kotak AMC expects liquidity to return to Indian market. He believes liquidity chases markets with strong economic fundamentals and India is one of the few countries that will show an improving trend going forward.
"In the second half, you would see that (liquidity) being reflected also in the stock prices," he says in an interview to CNBC-TV18.
Also Read: RIL better play on gas hike; shun autos, PSBs: HDFC Sec
Meanwhile, he believes a large amount of rupee depreciation has already been done. With the decline in gold imports, the current account will benefit and that will be positive for the rupee, he says.
Lobo expects Reserve Bank to cut policy rates by 50 bps. "More liquidity measures are now required either in the form of cash reserve ratio (CRR) cut, or in the form of very active open market operations (OMO) operations," he adds.
When talking sector specific, Lobo remains bullish on telecom and cement stocks and is underweight on infrastructure and capital goods space.
Below is the verbatim transcript of Alroy Lobo's interview on CNBC-TV18
Q: What has happened with liquidity and do you fear that there is more coming in terms of redemption or a pullout? Has some of the immediate friction been stemmed with last week?
A: As far as liquidity is concerned, if you look at India over the last 18 months we have benefitted from allocations from emerging market (EM) funds, from global funds. We haven't really seen too much of India dedicated active money coming into the country. Whenever there is pressure on liquidity because of what is happening in the US, in terms of tapering the QE, it will make some impact on global liquidity.
Liquidity always chases markets where there are economic fundamentals and from India’s stand point it is one of the few countries that will show an improving trend going forward. Therefore, I would expect liquidity to return to the Indian market. In the second half, you would see that being reflected also in the stock prices.
Q: What has been the nature of the outflows? We use the term exchange traded fund (ETF) outflows but is it where most of the money has flowed out? What have the long only done through the month of June because it has been terrible in terms of returns for someone who is investing from overseas?
A: It has been a case of global volatility across markets. You have seen impact on the bond markets as well as on the equity markets. Even the commodity prices seem to be pretty weak and so, it has affected all the asset classes. This is bound to happen whenever you have a change in the stance particularly for large country like the US in terms of their view on quantitative easing (QE) going forward.
It would be disruptive in the near term but longer term it would be pretty positive for countries which have economic fundamentals. I also see global allocation shift gradually away from bonds into equities and that is going to favour India also.
Q: For the rupee, the downside risk that many economists are talking about now is that the rupee tests the RBI patience and the RBI may be forced to lift rates as well going ahead. How do you see the depreciation in the rupee impact the monetary policy now?
A: A large amount of the rupee depreciation seems to be done. In fact one of the biggest positive surprises for the market would actually be the Balance of Payment (BoP) or the current account on many fronts. For example, gold has been one of the biggest components of imports and with the ban on gold imports we expect that component to actually start falling.
Secondly, commodity prices are weak and that will benefit our current account. Also when the rupee depreciates, exports become very competitive from India stand point and discretionary imports actually start getting curtailed. That becomes some kind of self correcting mechanism which helps correct the current account deficit. On the portfolio side as far as capital account is concerned, equity portfolios are likely to be strong.
We still expect the central bank to cut policy rates by about 50 bps. More liquidity measures are now required either in the form of CRR cut, or in the form of very active OMOs. For that matter, very significant government spending, because that would help to transmit the reduced policy rates into lending rates. So, we expect portfolio flows to respond to this liquidity measures that the RBI would perhaps implement and that would also reflect in the lending rates and help to see the economy recovering.
As far as foreign direct investment (FDI) is concerned, it is also showing lot of positive trends. We have seen a lot of multinational companies looking at India with interest like Hindustan Unilever.
Q: What kind of pitch has been set for the month of July both in the context of global cues and earnings season? Do you think it is going to be volatile for the market but largely range bound or do you fear that there may be some downward pressure for trade?
A: The market will respond to what happens to earnings. In some way companies that are impacted by the rupee depreciation will see earnings revisions based accordingly.
We are little cautions on companies that have got too much of exposure either in terms of imports or foreign currency loans. So that will start reflecting partially in the June quarter results. By and large, some of it is already into prices of certain stocks. But if you look at valuations and where the rupee is today, there is good scope for the market to give you reasonable amount of returns from these levels both in terms of currency as well as in terms of equity prices.
Q: In that context, what do you do with a space like IT which should benefit from what is happening with the currency but because of problems both in terms of the immigration bill and some strains in demand, it has began to underperform as a sector?
A: If you look at IT, there will be asymmetric performance within this sector. The Accenture results signal tough times for the IT industry in terms of the demand environment. Secondly, the immigration bill particularly with respect to the out placement clause is definitely a big negative for the IT sector.
I do not know at this point of time if it gets passed by the house of representatives, then you would see a material impact on IT companies. As of now, the bill is clearly cleared by the senate. We are expecting that they will go more closely into at least eliminating the harsh provisions as far as outplacement is concerned in the immigration bill in the House of Representatives. If that happens, then IT is well protected but till then it becomes an overhang.
Within the sector, there are some companies going into some kind of transition in terms of rebuilding their business model like Infosys which will take some time or few quarters. But there are some companies that will continue to lead in front like Tata Consultancy Service (TCS) and there will be asymmetric performance in the sector.
Q: When you say the market has a chance of giving reasonable amount of returns from here, which sector in the market are you betting on because IT has issues of its own, FMCG is having growth issues and key pockets like banks continue to be under pressure?
A: Quite a few sectors, we still like the pharmaceutical sector. It is a better play than IT at the moment. It does not have any issues with regards to the immigration bill and is clearly an export play. We still feel there is scope to make reasonable returns on the telecom sector and that is one sector that has been beaten down very significantly. We see positive developments going forward in that sector.
As far as banking is concerned, we would be cautious on banks that are more exposed to the non-performing asset (NPA) cycle but are pretty good companies still prevalent. There you will see market gravitating towards companies with high quality with lesser amount of NPA issues. It will be the trend for the next 12 months particularly with respect to banking.
As far as cement is concerned, we are positive on the cement sector. In the pre-election year, we expect cement to do pretty well and this is one sector which despite what is happening to pricing, you are seeing good cash flows in this industry.
As far as auto is concerned, we need to see growth coming back but it is interest rate sensitive so when interest rates move down and get transmitted into lending rates you will see that sector also benefitting. We would still be underweight on the infrastructure sector and on the capital goods sector. Still lot more needs to be done in these spaces before they actually unlock the intrinsic value in these companies.
Q: How much more time would it take for any revival to be seen in the capex cycle? What are the measures that you would expect from the government to aid?
A: There are still lots of policy initiatives required with respect to land acquisition, with respect to availability of fuel. We import fair degree of our requirements as far as coal is concerned and that needs to be addressed. These are the two big bottlenecks to start with as far as long-term infrastructure is concerned.
As far as manufacturing capex goes, it is a function of growth and the moment growth starts coming back you will see confidence building up in the corporate sector to once again go ahead and start investing. The corporate sector hasn’t invested for quite some time so there is lot of pent up investments to be implemented.
They need a signal that we have passed the bottoming up as far as GDP growth is concerned and are going to see an upward trajectory. This year we are going to see a mild recovery in GDP growth in the second half and it will be led one by virtue of a better monsoon this year. Second, we are expecting interest rate cuts of another 50 bps.
Third, a pre election year as far as government spending is concerned which would reflect in growth. Once you see this play out, by the next year or so you would see the market focused more on the election outcomes. But then once again the investment cycle will come back because whichever government comes into power, it will start afresh and you will see that also taking off. So the first two years would be determined by more a reduction of macro risk and the next three years of India will be determined more by the GDP growth trajectory.
Q: The market could be set for some recovery, what kind of range do you expect it to move in because the fear is that last months developments have led to a much lower ceiling for the markets trading band? What might that impute in terms of where do you expect the currency to hold that over the next couple of months?
A: In terms of ranges with respect to the Sensex, 18000 Sensex levels is a very good support level for markets. It brings it to valuation levels where you normally find if there is no global crisis the Indian market gets support somewhere around 11-11.5 times forward earnings.
As far as the upper end of the band, it moves up to something like 14.5-15 times. This could take the market by about 10-12 percent higher from these levels and therefore, that is the range we are looking at. The moment it starts coming closer to 18000 level on the Sensex, we see a very positive move in the markets because at least from a valuation perspective it looks pretty attractive at these levels.
Q: How do you expect the domestic crowd to move in the second half of the year because there has been a complete disconnect in what the liquidity did for the first few months versus how the domestics approach the market? Is there still an extremely heightened sense of caution in the domestic community, are they still selling positions down?
A: Domestic mutual funds or insurance companies are completely determined on the inflows and if inflows are not very enthusing, then they either maintain positions or have to sell off positions based on if they are facing redemption pressures. So it is very important to see inflows into this industry for the domestic investors to get far more positive on markets.
As far as asset classes are concerned, gold prices have begun to correct. Real estate is holding up or in some pockets pretty weak. The bond market still has some legs to move because of monetary policy yet to fully ease.
Once that is done, returns will be available in the equity markets and then you see a very massive shift away from these asset classes into equities. This could happen may be anywhere between 9-15 months from now. Till then the market will be little tentative as to whether they need to get into the market or not. But those investors getting at these valuations bands which I talked about at the lower end of the band, will definitely make reasonable returns in the medium term.
Q: Do you think the worst is over in terms of outflows for the market both in equities as well as in debt because last month we saw USD 7.5 billion worth of outflows? Due to the issues alluded to you, do you think we have put that behind us?
A: A lot of things are going positive for India and India has benefited from emerging market allocations. In the EM basket, there are quite a few countries where there are issues be it Brazil, China, Russia, there are issues. When there is redemption from these funds, by virtue of we benefitting from allocation effect, we also see the negative effects of the allocation. That is why you will see some money moving out when people redeem from EM funds or BRIC funds. But on a standalone basis, India is likely to see more positive interest within the EM space.
If the EM space has companies with issues then at some point in time investors will have to take the single country call and then invest into India. That is when India really shines and you see domestic investors are turning back to the market. So, that kind of road map cannot happen immediately but at least over the next 12-15 months it is quite possible.
Q: There is a flurry of excitement around some of the non-bank financial companies (NBFCs) that are looking to apply for bank licenses. How easy will it be and could it change the rules of the game for some of these companies or change the way people see and value them?
A: If you look at the guidelines, it will be tough. It is not going to be easy for the companies that are trying for bank licenses. On the medium term basis, some of them will do well but initially it is not going to be an easy ride. They require regulatory capital which will put pressure on their margins.
Some of the businesses that are related to banking have to be within the bank. To some extent, it will have an impact on the way they run their businesses. Holding company structures have to be abided with. So it is going to be time before you see these banks really emerging. Three years from now, is when you will really know who the winners, till then I would reserve my judgement on any company in this pack which will do well say in the next three years.