Long-term India story still good: Lehman Brothers

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It was an interesting week for the market. Week on week it was up by 3% but those gains were frontloaded the first couple of days of the week and then we saw a lot of volatility in the market after a long time. For three weeks it has been vertical and the last couple of days it has been all over the place; 600-points up, 600-points down.

Pankaj Vaish , MD and Head-Equities, Lehman Brothers with regards to Indian markets said, "I  maintain that the long-term story is very good but I just do not think we have earned those credentials yet of having a 25% premium to some of the G7 established markets yet in terms of P/Es."

He further adds that it is hard to see the correction come in isolation. It will probably be synchronized with some sort of a non-localized correction said he.

Excerpts from CNBC-TV18's exclusive interview with Pankaj Vaish:

Q: What is your sense of what lies ahead in October?

A: I think it is somewhat opposite to what we saw in the middle of August when everything was doom and gloom and it looked like the subprime crisis would overwhelm everything and now it just seems to be nothing, we cannot do anything wrong. Whenever you get that sense instilled in market participants etc it is definitely a sign of caution.

I definitely feel that there are names out there that have froth associated with them and single name should not be going up 15%-20% a day for several days in a row unless you suddenly had a major invention or struck national gas etc

This sort of activity is quite indicative of froth and painful buying where you just have no choice, either money that has come in and the manager has no choice but to turn around and deploy it and those sorts of things do not make for a healthy market.

As we have seen breadth has not been very impressive, our analysts think that the valuation is even more stretched that the P/E ration might almost be touching 20 on FY09 basis. It is getting to a stage where if S&P's are trading at 15 P/E that big a gap becomes too wide to ignore, so certainly a note of caution here is quite necessary.

Q: What is your sense, do you think all those people who are underweight early in the year they are recalibrating their weightage and is that process almost over or there is a whole lot to go you think?

A: I do not know whether the process has more to go, certainly we have come from an era where India would just be a footnote of a footnote of Asia ex-Japan and now it has got the prominence that it deserved at least ten-fifteen years ago. But what has happened is as you have had problems looking for investment ideas in G7 market people by nature have been forced to look elsewhere and a flood of money has gone into alternative investments and they are fast and they are looking for trading opportunities anywhere and firms like ours help them in terms of finding access ways of getting into markets like India.

That has definitely helped. In some cases pooled money from households and in some cases it is just institutional money but India has well been discovered perhaps a bit too much at this stage because I think the valuations are getting slightly ahead of themselves.

Just like in August we wanted to say that not everything should be doom and gloom and the long-term story is good here also I would maintain that the long-term story is very good but I just do not think we have earned those credentials yet of having a 25% premium to some of the G7 established markets yet in terms of P/Es.

Q: Where do you think the correction will come from if indeed it has to come, if you think it will be a global set of news, local politics, local earnings, where do you think the pin might be pricked?

A: I think it is hard to see it just being in isolation, so it will probably be synchronized with some sort of a non-localized correction. October tends to be a cruel month and everybody has memories of that and for example if the non-farm payroll reports in New York is weak, there I think is in a dicey situation. If its weak that's somewhat bad and if it's too strong then the Fed doesn't have to ease.

So I think there are problems and they will not just be India centric in fact India does have the healthiest set of fundamentals. I just feel that some of the sectors that have run away to valuations that may well get justified down the road but it's asking for too much credibility right now on the part of investors. So that might need to pullback.

Q: A lot of people are expecting or talking about this possible October correction do you think the markets could just make people wait out this correction a bit longer and not come for a while?

A: That in fact tends to be the case if everybody is looking for it; I guess maybe we could borrow the Heisenberg Pinciple that it's hard to capture it. So that may well be the case. Whether it is October, November I just feel you got to keep your eye on medium-term valuations and they have gotten very stretched.

It is very possible, you could have a scenario where there are two-three very high profile IPO still coming down the pipeline here and they go off with flying success and everybody is euphoric again and that perhaps coincides with everybody's got their stuff to the gills of everything they wanted and there is nowhere else to go from there, so just a small meaningful correction to instill in people that this is a two-way market nothing catastrophic but just a healthy dose of correction.

Q: That usually does not happen, an orderly disciplined small correction either its running away or its running down are you expecting a deep correction whenever its happens?

A: I didn't mean a well scripted correction, what I mean is of the magnitude that we have seen in terms of growth a 10% correction should not bother anyone. Because you had the kind of growth that you had 30% year to date, so 10% should not be troubling to anyone. Even the August correction that we saw felt very gut wrenching at the time but effectively was (in fact was trailing) about 15% at the Index.

Q: You spoke about the new money, which is coming in, do you get the sense that a lot of absolute return chasing money is getting in over the last two-three weeks, which might reverse if there is some set back in terms of global news flow or do you think the old traditional investors are resetting their India weightages?

A: I think it's a mixture of both. It is true that a lot of these decisions can be reversed very quickly. So if you had for example the government falling or anything to that in fact, this money will get pulled back very quickly. In fact in August we saw our private equity deal pipe was so strong, in some cases you almost had to beg people to let you in the deals, two-three weeks of panic and suddenly the balance power changes.

Everywhere globally investments have become a fairly fleeting decision, the decision to put money in and to take it out can change very quickly as world events are changing.

On the sectoral earnings technology could be interesting because its expectations are very low right now. And they have been one of the weakest sectors year to date, the rupee now quarter-on-quarter has stabilized somewhat, now in October we have seen a little bit more of strengthening but it wasn't the huge quarter-on-quarter appreciation. So that actually could be one interesting play. It maybe potentially time to book profits on some of the highflying ones and take somewhat contrarian view on some of the beaten ones.               

Q: First with real estate and now with power there's no talk of any execution risk the way the P/E multiples have moved. Do you think its frothy or do you think the market is right to pay this kind of multiples for a sector which will expand as fast in the next 3 or 4 years?

A: Eventually it will be fine but the question is the valuations that are being asked for at this stage are assuming almost perfect execution as you said and also 4-5 years out, if you look at P/Es they still look quite high even if you are execute according to the model.

Yes, it's very possible. Yes, it's a country starved of enough power infrastructure and atleast the political will seems to be there to invest the money in it and that provides a very good backdrop and of course the companies that are involved have good credentials in terms of execution. But again it's asking for everything to lineup correctly. It can happen and hopefully it does happen but the room for error is very small.

Q: How to play the rate sensitives now?

A: The rate sensitive sector in the equity land has already responded quite nicely to the drop in rates on the short end. So you had one and two-year rates fall in excess of 100-bps and a lot of that again excitement was just because of the base effect YoY inflation coming down.

I thinkthat its going to take a little bit of time for RBI to get comfortable given the global energy pricing situation to probably think about lowering rates. But our economist in conversations with several participants do feel that policy makers are some what more relaxed and sanguine now. Probably the ground is being set but they probably need to see a little more softening in global situation before they can actually move officially.

Q: So what's your base case scenario from here to the end of 2007? How do you map the market?

A: There will be some sort of a correction in the next 4 weeks or so and depending on what the magnitude of that correction is, we will see whether we are back to good times by the end of December or whether it takes several months for it to work it out of its system.

We may have to take a little bit of view of the global situation also. Not just the geopolitical situation but also what's happening in the biggest economy in the world. It is sort off at a delicate situation right now if it can muddle through and come out okay the IT sector and everybody will start to do much better. But if it doesn't then being the biggest locomotive it does sort off hurt atleast sentiment among investors.