See no major rally from current level: Franklin Templeton

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Due to the clarity emerging on global and local issues, R Sukumar, managing director and chief investment officer of Franklin Asian Equities, Franklin Templeton Investments believes that Indian equities could see a breakout from the trading range it has been ambling in. "I think we have seen the worst. I don't think everything is going to become very bright, but things will start looking better compared to the last few months," he explains in an interview to CNBC-TV18.

But, he cautions that the rally will not be significant from current levels. "I think the fundamentals have to improve in a sustained manner and I think clarity on some of the global issues also need to improve before the market goes to a much higher level," he said.

He further adds that this could lead to a gradual pick up in foreign institutional inflows (FIIs). However, he believes investors will want more clarity on a number of global issues before the risk appetite increases on a sustainable basis.

Talking about RBI's decision to deregulate saving account rates, Sukumar said that the move will impact the net interest margins of banks, but will increase competition in the industry.

Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.

Q: Is it looking like a turn of tide for the market given what you have seen and heard through this week globally?

A: Yes. I think we have seen the worst because in the last few months we had to contend with both local as well as lot of global issues. Now the market is getting used to it and there is more clarity emerging on both counts.

So I think we have seen the worst. I don't think everything is going to become very bright, but things will start looking better compared to the last few months.

Q: Do you think in that sense the market might start trading in a slightly higher range and that we might have put a bottom in terms of price behind us?

A: I think so. I think we have definitely seen the worst in terms of levels for the broad market, so I do think that it could trade at a higher level compared to what it has been trading. Also in terms of interest rates, we are close to the peak rates. So I think that would also be a reason why the liquidity could be better and the cost of funding would be lower. So, all these factors would probably mean that the market could trade at higher levels.

Q: How do you expect global investors to approach emerging markets right now because they have been very leery of investing? Over the last one year we have got nothing by way of flows net-net. Do you think that could change around in the next two-three months?

A: I don't think it would change but it would be a gradual process. I do not see very major pick up in flows immediately. I think it's going to be little bit of a pick up and people would like to see improvement in or more clarity on a number of global issues before the risk appetite increases on a sustainable basis.

Q: What is your own sense of how they have been positioned on India though? Has it largely been a short call on India as a market which is leading to such a powerful covering rally or is it just that people have had higher cash levels and that may start getting allocated albeit over a longer period of time?

A: I think the big moves are because of short covering. Some people might have some cash but I don't think funds in general have a whole lot of cash that they could deploy immediately. So after the big move that is caused by the short covering, we might have a pause in the market rally. I think the fundamentals have to improve in a sustained manner and I think clarity on some of the global issues also need to improve before the market goes to a much higher level.

Q: The big rally is in commodities. How would you approach that space given that there has been so much bearishness about the global economic outlook which has made them a very large underperformer through the course of the year?

A: There has been some uncertainty because of slowdown in the western economies, but I think the more pertinent issue is what is going to happen in China and what is going to happen in the Chinese real estate and construction space because China is the biggest consumer of metals. If the demand there is going to slowdown, I think that's going to have a much bigger impact than what is happening in Europe or US.

There clearly seems to be slowdown in Chinese real estate market and there has been dip in prices and also the government policy seems to be towards slowing down the sector. So if there is going to be a market slowdown in China, I think it's going to affect the demand substantially and so the commodity prices might continue at lower levels than expected for sometime to come.

Q: There was some trepidation regarding the banks as well post the policy and the changes on savings rates. How would you approach the banking sector now, and within that the debate between public or private?

A: I don't think there has been any significant change in the outlook in the last few months. There is obviously going to be more competition and already some private sector banks have increased rates substantially. I would think that over the next few months there is going to be across the board increase in savings account rates which will reduce the net interest margin. So we think that the profit margin of the banks is going to decline for next few years.

Apart from that, the provisioning is still on the rise and I think there are more restructured loans which means that future provisioning could also continue to be pretty high. So the return on equity of many of the state owned banks could be substantially lower than what we have seen in the last five years. If that is going to be the case then I think the re-rating might continue longer than one expected.

Q: When we spoke a couple of months back you pointed out that a momentum market has to be approached very differently from an investment market. Going into next year, what do you think the strategy should be? Is it looking like the market is getting some momentum going or do you think it will continue to be one of those stock pickers markets where you have to be very careful about what you choose?

A: It looks unlikely that in the next couple of quarters the demand for equities is going to outstrip the supply of equities. So we still have to keep in mind that the government is going to supply more paper as and when there is going to be more demand. So quite unlikely that we are going to have a raging bull market and I think there is going to be more supply of equity than demand for equity.

So under the circumstances, I would think that it will continue to be a stock pickers market and I think quality will continue to outperform. Obviously quality outperforms in the long run invariably but even in the next two to three quarters it looks like quality will outperform. It is highly unlikely that there is going to be a substantial recovery in some of the junk which was beaten down.

Q: What about Indian fundamentals over the next one year because the investment cycle is still very weak and earnings are tepid? Do you expect those to be fundament headwinds for revaluation of this market through FY13 or do you see a substantial improvement in that basic picture?

A: In terms of GDP growth it looks like 7-8% is what is sustainable in the next year or two because the government dis-savings have increased and so the net savings of the country has decreased. Foreign investments in the form of portfolio flows have also reduced. So I think investment to GDP is going to be lower. Even subject to cash availability then we have issues with regard to clearances, etc. So with lower investment to GDP, which I think will be the case because of all these issues, the growth forecast has to be lowered not just for the current year but probably even the subsequent year.

For India to go back to that 8% to 9-9.5% GDP growth which is the potential, some of these issues have to be resolved. The government deficit has to decrease, the current account should be in better balance and we need more clarity on implementation of projects. The government policies have to be clearer and supportive of good quality infrastructure investments. So these things have to happen before I think we can go to the potential growth rate.