Budget 2012: Market may not rally sharply from current levels: StanChart

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Though the bulls have managed to stay strong in Indian market, Rahul Singh, Head of Equity Research, Standard Chartered Securities is still worried. In an interview to CNBC-TV18, he said that the market is unlikely to rally sharply from current levels.

According to Singh, the market may take a breather now as the it is looking at some decisive action on atleast couple of executive orders from the government post elections. However, a gradual rise of market in 2012 is not ruled out completely.

Meanwhile, lauding the Supreme Court's verdict of cancelling 122 licenses after January 2008, Singh said that telecom companies pricing power will improve now. He also feels that regulatory changes to drive stock performance in the telecom sector.

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

Q: What are your thoughts on the ruling yesterday? What could it mean for the sector at large and for the largecaps in that sector?

A: The ruling basically does two things in our view - one is that we have been advocating that auctions are the only the way out of this mess. So, this brings the process of auctions much closer. It will bring down the prices of spectrum. I don't see auctions going at the 3G prices because the demand supply of spectrum just looks much more balanced now than it was in the 3G auctions. So, the impact which we were looking at for Bharti, Idea, based on the TRAI prices or 3G prices would come down in my view.

The other more fundamental change which we are seeing in the sector where we should all focus our attention on is that there is going to be a paradigm shift in the way spectrum was being priced in India. We will see new entrants having to pay more now. The marginal cost of producing a minute for some of the mid-sized and the marginal players would probably go up much more than the marginal cost of producing a minute for the larger incumbents.

We see that as a clear sign that the pricing power, some of which it returned in mid 2011, is a clear signal that, that will sustain because we don't see how the marginal or the mid sized guys can remain competitive on an incremental basis because they would also have to pay a higher spectrum cost in addition to the incumbents paying excess spectrum cost. So, cost for everyone goes up, but the cost for probably the marginal players will go up a little bit more than the cost for the larger incumbents. So, we are positive on the listed plays from this verdict.

Q: Do, you think Bharti and Idea , the two stocks which went up will actually materially benefit and that the stock upside is warranted or justified?

A: Its an evolving structural change which the sector is going through and one needs to ride out the whole structural change which the industry is going through rather than trying to be very smart and trying to trade in and out of these stocks. I would ride out the next 12 months with these stocks because that is where I see the bulk of the regulatory changes happening.

The tone and tenor of the regulatory shift is very clear that everyone pays up for spectrum, but the marginal cost of a marginal player would go up much more than that of incumbents. We need to ride out this whole period of structural change rather than trying to look at it on a very short-term basis.

Q: We have had a very good rally. What is your call on the market? It surprised many people. Do you see it continuing?

A: The way we see it is we are definitely near the end of the earnings downgrade cycle. We have seen massive earnings cuts as well as consensus are forecasting 12-14% earnings CAGR, which is lower than the nominal GDP growth rate now. We are clearly at the end of the earnings downgrade cycle now. Whether we should be at 12 times, 13 times, 14 times or higher is really the question and that is partly a function of global liquidity and risk appetite also.

If you look at the last period of sustained slowdown between 2001 and 2004, we averaged around 12 times PE multiple. We are now at 13.5 times multiple. So, obviously there is a bit of mean reversion which is happening towards 14-14.5 times multiple which we have seen in the last 10 years. The market is taking a much more optimistic view of FY14 earnings, basically saying that the 10% or 12% earnings growth rate which we have now might be too pessimistic.

We think that the market takes a breather here because anything beyond 14 times which is about 3-4% from here is going to be contingent on how the policy situation shapes up. More than policy, the market is looking at some decisive action on at least a couple of executive orders from the government post elections and maybe some announcements on some of the counter cyclical capex projects before the market gets more excited from hereon.

If you look at the Sensex earnings yield versus the 10-year bond yield, there is still a negative gap which could narrow once the rate-cut starts, but what we are seeing today is also getting distorted by the fact that the global liquidity and the global risk appetite and the perception of the risk free rates is different from what we see in our Indian 10-year bond yields. That is creating a little bit of distortion. We need to be cognisant of that and not get too carried away by that.

Q: Where does the global economic situation fit in the scheme of things of the local earnings picture? Do you think India will stand in a better relative light during the course of the year if growth fades in the West as it seems not very unlikely during the course of this year? Do you think we might benefit from it or do you think that will feed global risk aversion which will hit us again later in the year?

A: That was the traditional wisdom that we would gain if the global growth slows down but what we have realised painfully in the last three-four months if that happens that would also mean some kind of reemergence of the problems in Europe essentially if we were talking about a slowdown from here or any kind of event which brings the risks in Europe to the fore again, that would mean that the risk appetite comes down.

The capital flows which is where we have been as an economy kind of exposed in the last three months and given our dependence on Europe, at least, as far as the debt capital flows are concerned, I would not be so optimistic on that scenario from an Indian market point of view because the rupee has right now stabilised but there are risks which may rise out of the European situation if it goes down again.

Also we need to watch the price of crude. There are issues on the geopolitical side which could take crude prices up. I would not really be very happy from an Indian market point of view if globally things were to slowdown because it has not gone down very well for the rupee and that creates a vicious chain because money goes out. Once that happens and you see a liquidity outflow or a liquidity driven decline in the market which is again non-fundamental that creates a cycle of its own.

Q: Would you ask your clients to buy Bharti at Rs 400 plus or do you think a lot of the recent good news may be in the price?

A: On the sector we need to take a slightly longer-term view. You could trade in and trade out. Anyone who entered at Rs 325-330 might choose to exit at these prices, but I would rather stick to my fundamental evolving view over a 12-18 month point of view rather than give advice based on what today's price is. That's a tough call to take.

The next 12 months, things for the stronger larger incumbents will continue to look up. Obviously the best days of Bharti are behind when it used to grow 30-40% because the market was under penetrated but now it's more a structural change in the industry which is driving valuations up. I would like to ride out the whole curve rather than take a short-term view of things.

Q: What's the probability that we may have slipped quietly into a bull market already because it started with a lot of skepticism? It started with low valuations, strong flows, all ingredients for a very early stage of a bull market. Do you think it is too early to talk about all of that or may be that is the case?

A: If you look at earnings, may be its too early to talk about it because we haven't seen a significant pick-up in earnings upgrades from this quarter's results. It's been a mixed bag like all Indian results have been in the last two-three quarters. As far as earnings are concerned, it's too early to talk about FY14.

The damage to FY13 earnings is already done. As far as valuations are concerned, it's at an inflection point because there are two factors - one is the global liquidity situation which has eased significantly in January with the liquidity injections in Europe and with the US' low interest rate policy. That is driving the valuations up probably, much more than what we would have got if these two factors were not there, given that it seems like we are in a sustained period of slowdown which we saw in 2002-2004.

So, what happens on the policy front? It's not just policy, or a decision making front as well as how the European situation pans out, how crude behaves and what stance does RBI take after the Budget. I think these are very critical moving parts. It's very difficult to take a call on all of them at the same time, but if everything plays out then one cannot rule it out, but I would still argue for a more gentle rise throughout the year even if all these factors play out rather than one sharp move up from here because we have already seen a sharp move up without a significant change in fundamentals for some of these companies.

So, the market would wait for more evidence and the Budget and the monetary policy before we take a conclusive call on what more from 14 times. What we have to realise is that at 14 times which is 3-5% from here, we would be at a 10-year average. We would be looking at a significant earnings pick-up in FY14 or in the second half of FY13 for that to be justified. That is where the challenge is because that is where the moving parts are in terms of the macro variables. Even if we have slipped into a bull market, I would argue for a gentler rise throughout the year rather than a sharp move up from where we are already.