Market forming base for new bull phase: Ridham Desai

"On the macro side, things are setting down for a good trade. Corporate earnings are bottoming out. Margins will also expand in the next twelve months," he said in an interview to CNBC-TV18. He expects earnings growth in the next few quarter to drive Nifty up 20-25%.

Going forward, one should focus on macro and sector themes, he suggested. "We want to widen our sector bets and become more macro and be less concerned about picking the right stocks."

Meanwhile, he added that the reforms announced so far are not enough, but it is a good start. He expects to the government to take some concrete steps on infrastructure spending and fiscal consolidation.

However, inflation risks from high commodity prices and volatile political set-up are still two major concerns for India now, he cautioned.

"It doesn’t look like inflation is running away, we have not got the same response on commodity prices out of QE3 that we have got earlier, there seems to be some supply side impediments as well as demand side problems for commodity prices."

Below is the edited transcript of Desai’s interview with CNBC-TV18.

Q: Do you think in the last few days another plank of getting into a bull market kind of situation may have fallen into place?

A: I do think that we have set ourselves up in a way. There are still a few ingredients missing, but my confidence is growing that those things will fall into place in the next few months. If you look back, three things were of concern for market participants.

The first was the tail risk for India because of its current account deficit. India was exposed to any deleveraging episode from Europe because of a high current account deficit.

The action from European central banks and the US Fed has ensured that such a tail risk will not come to the fore for the next few months. It gives India time to adjust its current account deficit, which will largely come from fiscal consolidation. Hitherto we did not seem to have that much time. It was already creating a risk of downside to growth and equity markets. That is the biggest thing which has changed in a last few days.

The other problem a lot of investors had was the lack of policy action at home. Now, the government has made a few announcements, I do not think this is enough, but it is a good start. Coming from a period of almost no policy action, this is a welcome change for the market.

I hope that this gets followed by some more action especially on infrastructure spending and fiscal consolidation and then we will be set up for a strong period of policy action as well.

Third concern was on growth and inflation. Those are not going away in a hurry, but if we get proper policy action and if we get an external environment like it seems to be then eventually growth will bottom out.

It doesn't look like inflation is running away, we have not got the same response on commodity prices out of QE3 that we have got earlier, there seems to be some supply side impediments as well as demand side problems for commodity prices, so that is a sweet mix for India.

I do think that on the macro side, things are setting down for a good trade. Corporate earnings are bottoming out. If you look at money supply aggregates, they have put in a firm bottom and these money supply aggregates tend to lead revenue growth.

Revenue growth is forming a floor either it has done so in the quarter ended June or will do so in this quarter. Revenue growth slowly accelerates and I do think that margins will also expand in the next twelve months. Earnings will also improve. I would tend to agree with your prognosis that it does look like we are forming a nice base for a new bull market.

Q: Is it time to be aggressively bullish or some of the issues that you spoke about the tepid earnings trajectory so far growth not picking up yet makes you take a more moderately bullish stance at least at this point?

A: I am actually very bullish. But it is a question of time frame, so we have been constructive on stocks all year. The shift in our strategy is that, so far we have been focused on picking stocks as the way to making money on equities. Picking the right stocks has yielded very good returns.

Even the Nifty has done well this year, but really the juice has been in picking stocks. Going forward, you want to be more macro, more sector oriented and more cyclical in your approach. If you see it from that context I would say that I am more bullish now. We want to widen our sector bets and become more macro and be less concerned about picking the right stocks.

Q: What is the key risk to your hypothesis the fact that things are getting better and next year things might improve more on the margin?

A: There are three things to watch out for. First, is the risk that inflation continues to rise and most of that risk comes from global commodity prices. If global commodity prices respond to all these quantitative easing and if demand conditions recover then we may get a rise in commodity prices, which may not be entirely good for India because we are still coming out of our previous inflation cycle. We want inflation to moderate going forward.

The second risk is complacency on part of policy makers in Europe. Europe has gone through crisis, response, improvement and usually this cycle then slips into some sense of complacency.

We are not getting any signals as yet. We are still in improvement phase, but if this improvement starts getting longer and if yields in Europe are subdued for long enough then there is a risk that complacency slips in. That is always a bad thing for India if we have not adjusted our external balances until then.

The third risk is the political mix at home. I don't see it as a serious to the market on a six to twelve month horizon but it is certainly something that can create near term volatility. We could always get a mid-term poll given the current equation of the government and we cannot rule that out.

Elections per se are not bad for the markets. Go back 20 years and see how markets have done into the elections. They usually rally in the hope that we will get a stronger government, so I don't think it will be any different this time, but the moment when elections come to hand you will face volatility.

I think those are the three risks that I see. I see lesser risk of growth going into a tailspin and I see lesser risk of corporate earnings disappointing given how low expectations are but I am more worried about the external side.

Q: Is there a good chance that the market can justify rerating on the way up now or do you think market upsides will be limited to the kind of earnings progression we see over the next four quarters?

A: In a bull case yes, we will definitely get PE rerating, but on a base case basis I don’t think we are still in a PE rerating environment. We get a recovery in earnings growth earnings growth for the Sensex for example has been low double digit over the last couple of years. That probably moves into mid double digit.

If the market rises to that extent not a whole lot of PE rerating, but certainly driven by earnings growth. If a bull case scenario emerges, which is that you get very strong policy action, inflation moderates and rates fall then of course, the PE ratio can rise. On a base case basis, the earnings progression over the next 4-5 quarters will be enough to drive the Nifty up 20-25 percent.

Watch Ridham Desai's complete interview in CNBC-TV18's special show Crystal Ball on Saturday (9.30 am and 7 pm) and Sunday (7pm).