Market likely to test 14500 on events in Europe: Ambit Cap

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It has been a good start to the earnings season, but Saurabh Mukherjea, head of equities of Ambit Capital is not counting his chickens before they hatch.

Speaking to CNBC-TV18, Mukherjea said, he expects a challenging earnings season this quarter.

Meanwhile, US stocks suffered their worst loss in two weeks on Monday after comments from Germany's finance minister caused investors to fear Europe's solution to its debt crisis may not come fast enough.

Mukherjea expects to see a pullback from risk assets after the German officials's statements. "We can expect some clarity on EU bank recapitalization on October 23," he said.

German Finance Minister Wolfgang Schaeuble, speaking of an October 23 European Union summit on the debt crisis, tempered enthusiasm, saying, "we won't have a definitive solution this weekend."

Back home, Mukherjea sees the Sensex testing 14,500 based on events in Europe. "We have cut Indian GDP forecasts owing to global slowdown," he said adding, "expect banks to face pressure for another two quarters or so."

Below is part of the edited transcript of the interview. Watch the accompanying video.

Q: What have you made of the earning season so far before anything else?

A: I think by and large, the earning season is panning out to be a difficult one as we had expected it to be. Reliance Industries has been the highlight so far in terms of the challenges that they are highlighting. What surprised me about the tech companies' results is, given the growing evidence of tech slowdown in the Western world, slowdown that is manifest in IBM's results, one showing up in lateral hiring coming off in Indian IT, in spite of those signs, Indian tech management teams have refused to give any indication of that to the market. Perhaps in the coming quarter, they might be a bit more forthcoming on that subject.

Q: What about the market itself, would you give the risk rally some more ground or do you think this is about in the pullback that we are seeing ahead of that weekend event?

A: I guess, last evening, the German government put everybody's expectations on a level footing by saying that the German government isn't planning any near-term rescue event. Angela Merkel's spokesman said that it will take until early 2012 to bring about some sort of resolution to the euro crises. I think with that statement out there, you will see a pullback from risk again and we will probably go towards 16,000 on the Sensex yet again. It is unfortunate that we are so driven by events in Europe, but it is the way it will be for the next three-four months I fear.

Q: Do you think this rally is terminating once again around 5,200?

A: Between now and 23rd October, all eyes will be on Europe, given there are still some hope in spite of what the German said yesterday. There is still some hope that on 23rd October, we will see a degree of clarity on the recapitalisation for European banks. So there is some hope left that the rally could find sustenance and pucker, but until a clear statement comes from either IMF or ECB on what the near-term rescue plans are, I don't see the risk on switch coming back into play in the next fortnight.

Q: Is your call for 14,500 predicated on Europe going into turmoil again or do you think fundamentals will drive us that low some point in the next few weeks?

A: The unfortunate thing seen in India over the last 20 years is that every time we have a major global crises- FY97, FY01, FY09- investment demand in India becomes very dramatic. In all of those three years, investor demand growth fell to 1-2% and 0% in one instance. So what happens is, whilst initially focusing on the financial crisis, the effects of that on Indian GDP are fairly quick in coming through. That in turn drags fundamentals back. So yesterday, we cut our FY13 GDP target to 6.2% from 7.2% largely because we are bearing enormous amounts of data and conviction that investment demand in India will slowdown much further over the next six-nine months.

So far, the pullback has been driven mostly by sentiment and less so by fundamentals. Going forward, it will be increasingly fundamental in terms of earnings slowdown, capex slowdown which will drag the market down, and until there is a resolution to the European crisis, I don't think investment demand in India will reach any level of comfort.

Q: How deep is downside risk though for the market?

A: 14,500 level is the target we are sticking to for the next three-four months. 7% growth for this year and earnings level for the BSE 100 of around 1,150-1,160 plus a PE for the Sensex around 12.5-13 times, the combination suggests market level of around 14,500.

That suggests another 15% downside risk from where we are today, around 17,000 points on the Sensex. The main catalyst to trigger that risk is in Europe. If on 23rd October, we don't get some sort of confidence statement from the ECB on EFSF, then I think we will pullback pretty quickly.

Q: What about the local triggers for the next ten days, you will see a lot of earnings and you will see an RBI monetary policy?

A: The reason I didn't focus on them was lot of that is factored in. The market is expecting another 25 bps rate hike from the RBI. If that rate hike doesn't come, it will be interesting and a positive boost for the market in the short-term.

Secondly, the earning season is widely expected to be weak and it's playing out along expected lines. If you get more than a weak earning season, that is, get signs of clear financial distress, say, in the banking sector or among the larger infrastructure companies, then that could be a downside trigger. Visa-versa, if the banking sector results surprise on the upside in terms of NPAs and loan growth, then that would be a positive trigger.

I expect to see the banking sector's accounting challenges and there have been a few of them, I expect to see that continue for at least another couple of quarters.

Q: What do you do with something like SBI where it seems that they will get that capital infusion but the finance ministry could slap SBI in terms of performance etc?

A: I think the expectation of recapitalisation is so widely held vis-à-vis State Bank of India that I won't be surprise that we might get one this year. But my sense also is that the recapitalisation number this year will be much smaller than what the market is expecting, perhaps even 1/3rd of what the market is expecting. Second, the sort of operational cleanup that SBI is making in terms of strengthening its lending process, credit collection and so on, is a long drawn-out affair and you will see a much slower or much less aggressive lender than we have seen two years ago. So that reorientation of its earnings growth and of its RoE is something the market gradually will come to terms with. We still see downside in SBI, not as much as we saw two months ago, but I still think there is around 5-10% downside left in this stock. It is not yet time to buy SBI.

Q: Tactically, what do you prepare yourself for the tail-end of the year, that the markets will remain range bound and sluggish or do you think there is another vicious cut coming?

A: I think between now and 14,500, we have a lot of visibility, hence there is insistence on that number. Beyond that, what I have been telling my clients over the last week or so is that it's no longer enough to rely on traditional notions of defensive sectors such as IT, pharma or FMCG.

What we are asking clients to do is run off the battery of matrix such as operating cash flow, low debt equity, some degree of profit momentum, and use those sort of financial tests to pick and choose their plays.

There are stocks out there which pass these tests, for example, ONGC is a surprisingly robust player, what we call a 'battleship stock' in this climate. Voltas would be another one, and so would Torrent Power be. So across sectors, we are looking for these battleship stocks and pointing our clients towards it, rather than simply relying on the traditional notion of defensive sectors.

I think the environment will get much trickier over the next six months, take tech for example, we are probably in the first quarter of a global downturn and already the numbers are flaky. Another couple of quarters out, it will look painful for Indian IT.