Espirito Santo cautious on India in Q1; wait & watch in Mar

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In an interview to CNBC-TV18, Nick Paulson-Ellis of Espirito Santo Securities gives his opinion on how he sees India performing in 2012 amid all the domestic newsflow.

Below is an edited transcript of his interview. Watch the accompanying video for more.

Q: Will it be a great year for Indian equities? Another disastrous 20% cut perhaps may not happen but what is the year as a whole looking like?

A: In general, overall market commentators are under pressure at the beginning of the New Year to come out with forecasts for the full year but right now it is still a time to wait and watch. I don't think you can sit here at the beginning of the new year and say there is a clear view on where India goes in 2012 because too much depends on what is actually done particularly in the policy arena.

For us, we are cautious in the first quarter of this calendar year and really focusing on still staying relatively defensively positioned and waiting for clarity from the very important elections coming up in March. There is unlikely that you are going to see any progress on reform until then and then what happens in the elections, to what extent is the Congress weakened and then what happens in the budget subsequently.

That's offset to some extent by the fact that you know inflation is moderating and therefore we should see a turn in the rate cycle. But that alone is probably not enough. You need more than that to turn the rate cycle for people to regain confidence in equities for the year. So cautious for the first quarter and wait and watch and see what happens in March.

Q: How is investor sentiment placed towards India in 2012? If we can carve a niche for ourselves at this point in time, what is it at the forefront in terms of an investors mind towards India that could possibly help FII inflows?

A: In December, I went to the US and did East Coast, West Coast US and I was in the UK seeing 25 institutions in total and some of the bigger and traditional investors in India and the negativity particularly in the US is the worst I have ever seen it and it was around the initial FDI in retail announcement and then the withdrawal and there was real negativity. The two things that have caught people out - one is the currency, if you are an US investor, India fell 26% and if you are a US investor, you lost a lot more again on currency, another 15% and the policy.

Policy has become a big issue in terms of the strength of the current government administration, weak leadership and how that is feeding through in terms of the policy and the ability to get things done. Those are the biggest issues; it is about the progress. Post the elections, progress on reforms, some signaling. Not only announcements on reforms, the confidence from domestic investors in terms of corporates, the foreign investors in terms of flows, those reforms can be and will be implemented.

Q: Is it basically go into cash kind of advice?

A: No, what we published at the beginning of this month was a kind of repeat of what we did in September which was rather than looking at defensives as a theme purely in terms of sectors. The defensive sectors that had performed well last year were consumer staples and health care both did very well but particularly consumer staples has become quite expensive because it has become quite a consensus trade.

What we did is screen for defensive criteria but across all sectors. We are looking for stocks which have high yield of about 1.45%, good earnings certainty, low gearing these kinds of characteristics and that outperformed by 15.5% in the last three monthsThat kind of positioning where you are still invested but you are cautiously invested and you become more aggressive in terms of rate sensitive's, in terms of industrials, when there is more confidence in terms of policy announcements.

This is going to be a difficult quarter in terms of earnings because you will see quite a lot of earnings downgrade. The expectations are still high for this calendar year, there are still mid-teens expectations.

Q: Credit Suisse's latest report seems to be indicating that not that they are very gung-ho on the macros that you mentioned but they believe all the bad news appears to be priced in and priced in more than adequately. Don't you see value in any sector? Is there anything that you are recommending as a buy at this juncture?

A: It's an interesting theme because if you look at India as a whole, it is about 13 times earnings for one year forward earnings. The trough for India in the last decade has been 2008 and then beginning of the decade we are really just below 10 times. Headline is not. It's not even one standard deviation below the long-term average but that disguises a very different picture in terms of sectors.

So, consumer staples and healthcare are trading at good levels but then other sectors are most probably trading well below long-term averages. So there is value around. There is this divergence between midcaps and largecaps over the course of the year which at some point in the year making a call on some of these stocks. Sector wise industrials, some of the good assets owned are good, on some of the midcaps you can probably make a lot of money but it's still early to do that.

If you get it wrong in timing, you can still lose a lot of money. There is still a lot of uncertainty in Europe. It has gone quite for a couple of weeks but that's really because of the holiday season. You have got a lot of refinancing coming up for several sovereigns. You have still got announcements in terms of all the European banks getting to 9% and tier-I capital.

So there is still the kind of risk on-risk off you are going to see in Q1. That combination of factors means it's not straightforward that it is all priced in. If you look relative to other markets, all markets globally are trading below long-term averages. India is not alone in that. It's looking better value on price to book than it is on a price earnings (PE) multiple.

Q: What are you expecting from the currency in 2012?

A: Our view differs slightly from the investors we saw particularly in the US where they were quite negative and really worried about further deterioration from there. We think that part of the deterioration is fundamentals but now the big focus is on the balance of payments. It's a serious issue but it is probably slightly overdone and there is a bit of panic.

Tactically, I think the RBI got it wrong with some of the pronouncements that were made in December and then now backtracking a little bit. There has been a bit of stability. We think it will recover slightly and then probably a one-year forecast will be a 47-48 type levels again. We are not as worried about the rupee as some investors. But some investors are saying the rupee is going to go to 60 and the US investors have that level of concern.

Q: Any stocks you want to leave us with that you would be watching out?

A: It's looking for a theme within sectors that you are focussed on. Focus on good quality defensive business. In healthcare we like Lupin . Even in a sector where perhaps you want to take more risk like asset owners, capital goods, focus on defensive stocks like Mundra where you have got very strong cash generation. Those are the characteristics in stocks that we are keen on.