There's further room for January-like rally: IL&FS

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Our market is looking better than what it did a few weeks back, says Vibhav Kapoor of IL&FS. Attributing this improvement to a recovering  Europe and US situations and better-than-expected corporate earnings at home, Kapoor told CNBC-TV18 that the momentum is likely to continue.

Given the improvements and with interest rates peaking out, hopes of  rate a cut have gotten stronger which will aid FY13 earnings. The sentiment is much better, he said.

In the coming days, state elections and the FY12 Union Budget announcements are going to have a big impact in the short-term. The fact that the government can't do much about this year's fiscal deficit has been factored in by the market, but what it does about the FY13 fiscal deficit target will be crucial, he said.

He advises a buy closer to the 5000 levels. Although some stocks look fully priced now, he remains positive on the banking sector, particularly the midacp PSU banks which have a lot of value.

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

Q: We have put a fantastic series behind us. Would you say the market is still pushing towards momentum rather than a pullback?

A: Thinks are definitely looking much better than they were a few months ago. We have been in this range of 4,550-5,250 which we have been advocating for a long time. Now we are approaching the top of that range. You need to have a little bit of cautiousness here.

A lot of things have improved in terms of the global situation, Europe has become steadier and the US has been steady for quite some time. One of the biggest factors which has led to this rally has been the corporate results which have been far better so far at least and we are just halfway through the season. They have been far better than what the market was anticipating even a few weeks earlier, so that's led to this big rally.

Q: The market seems to have moved through this series against quite a wall of skepticism as well. What would you say seems more likely that it goes on to surprise and pierces this range to get to levels like 5,500 or do you think there is a correction due and we are probably relegated to the range at least for this month?

A: Things have definitely improved. The market has a different tone this time. The sentiment is much better; the interest rate cycle is definitely peaking out. The RBI has signaled that by cutting the CRR which was probably a bit of a positive surprise for the market. Corporate performance is better. While the market does seem to be overstretched a little bit at this point of time, it is probably due for a correction and maybe some consolidation. The range is definitely going to improve.

So, instead of 4,500-5,250, you would be now in that 4,850 -5,250 sort of range. But the breakout on the upside of this range is now a much bigger possibility than it was earlier and its difficult to time it but I would think that after a bit of consolidation somewhere in the next few weeks you should see an upside move from here.
 
Q: So, for the breakout on the upside of this range, would you watch out for purely it to be a liquidity driven breakout or do you think that key moniterables like an improvement in earnings, more signs from the budget in terms of fiscal consolidation etc are the more imperative moniterables for a breakout from hereon?

A: There is a risk on the sort of atmosphere in the global markets at this point in time. That's very positive by itself for the market to breakout just purely on a liquidity basis but the fundamentals also seem to be improving somewhat. We have still a lot of key moneterables - the budget is one, particularly, the fiscal deficit. That's a very tough situation and the government is really going to have to pull its act together to come out of that difficult situation. That's something which the market will definitely watch out for.

Corporate performance is a key issue here and if you look back at what sort of figures have come in so far, definitely you feel that 4,500, 4,600, 4,700 levels the market is very cheap now. We are moving ahead in time, one more quarter is over. So, FY13 earnings will now get almost fully factored in. There were some opinions earlier that FY13 earnings could see further downgrades and it could be a flat year in terms of earnings growth.

Now the market is beginning to believe that particularly with interest rates coming down and the global situation improving, you could have a reasonable earnings growth going forward. With all these factors, the market is definitely set to go higher at some point of time in the next few weeks although the budget will definitely be a very important indicator of what's going to happen.

Q: These risk on moves tend to be quite sharp and swift both in terms of what they do for the market and the duration in which it happens. What's your sense of the liquidity interest and the risk appetite right now? Is there a chance there is more follow through for our market to remain an outperformer?

A: There is a lot of improvement in the global situation. The European situation has improved although there are still a lot of moneterables there, but there is much more steadiness after the ECB put out 500 billion euro to the banks and the US has been much more steady than it was three or four months ago. There is also a lot of liquidity after all the central banks pledged for low interest rates.

The US Fed pledging that interest rates would be kept low until FY14 and with the chances of another QE3 at some point of time, the emerging markets which had really underperformed significantly last year could definitely outperform and that's what is beginning to happen in January itself.

So, unless the Indian situation itself becomes very bad for some reason or the other or if the fiscal deficit or the budget is completely below expectations of the market, there is definitely going to be an outperformance from the emerging markets and India should participate in that.

Q: Tactically, how would you approach the market now? Would you continue to make small purchases on the way up or do you think there will probably be better price points at some point through the first half of the year and its best to wait out for that. Has the market moved too fast now?

A: Earlier we were of the opinion that in the range of 5,200 or so you should be booking profits and selling stocks which you had bought earlier. This time around, that's not the right strategy tactically because the market seems to be on the brink of breaking out from this range at some point in the next few weeks. But probably the market is too stretched in the short-term and some of the stocks are beginning to look a little bit fully priced now.

It would probably be better to wait a little while, let the market consolidate and in the region of 4,900-5,000 you add on to your positions. If for some reason the market breaks out immediately from 5,250 then you need to wait for it to come back again. Buying should be still done in the region of 4,900-5,000, but one could start looking selectively at stocks now and make up your mind what you want to buy over the next two-three weeks.

Q: Have infrastructure and capital goods done their time in terms of punishment? Would you say there is a fundamental rally playing out there now or would you avoid that space?

A: One positive that's happened for the infrastructure sector is the sign that interest rates are not going to go up further and could probably come down over the next few months. That's been a positive as they were really beaten down. Some of them were at ridiculous prices. So, you have seen this first rally which I guess will stop at some point of time. Then you need these stocks to again consolidate before they move up further after interest rates really start to go down.

In the infrastructure sector, a lot of things depend upon how fast the government moves in terms of removing some of the constraints like coal shortages, coal linkages, land acquisitions, so that projects start to move faster and you see further up moves in this sector only once some of these issues are addressed.

Q: With respect to the cyclicals, at this point what should the contents in your portfolio look like? Would you lap up some of the banking names that still have some more to go according to analysts or do you think that some of these beaten down metals or real estate names look good at his point?

A: We have been positive on the banking sector. Of course, the sector didn't perform well for quite sometime but if you look at prices a few weeks ago they were at very cheap levels and they have gone up 20-30% or even 40% from those levels. But some of the PSU banks particularly the midcap segments definitely have value over the medium-term. So, financials are one sector which we continue to like. There are still some concerns going forward on the asset quality and these will remain for some more time until interest rates start to go down and the economy starts to pick up.

They still look pretty good. The time is coming where maybe a month from now after the budget if things remain pretty okay you should be looking at a longer-term timeframe than a trading timeframe. Earlier we were always talking about this range of 4,500-5,200. Now the time is coming where you could be looking to invest for 12 months or 15 months and therefore a lot of stocks which may look fully priced now will actually still give you a good return over the next 12-15 months.

Q: Would that mean there would be some unwinding of defensives in the portfolio that you would recommend? There are stocks in the FMCG space that looks frightfully expensive at this point. What would you do with some of them?

A: Some of them do look pretty expensive and they have just been star performers because the rest of the market was not performing. So, some of them will certainly begin to underperform. Although their performance in terms of fundamentals is still going to be pretty good, they are going to do pretty well, but since they are pretty expensive and have outperformed the market, once the market sentiment changes towards the cyclicals they would underperform a bit and probably it would be a good idea to reduce weightages in some of these companies.

Q: Are you saying the whole context of approaching the market should change if it's not a big rally happening in an overall bearish context but maybe the market is coming out of a cycle of huge underperformance and this could be the makings of longer-term performance and even a bull trend?

A: The latter seems to be pretty much possible now. You could be coming out of this bear market and seeing a change of trend over the next few weeks but you need to really watch out for the budget. You need to watch out for the elections in the first week of March. So, the first half of March is really going to be very critical to really be able to say with certainty that you have come out of the bear market and now you need to really change your approach and invest as if a bull market is going to start.

Given the improvement in the global situation, given the fact that interest rates could come down over the next few months, it looks like a pretty good possibility right now. But one must remember that even the interest rate reductions are going to depend a great deal on what the fiscal situation is and the RBI has clearly said that if the fiscal deficit is not under control then it would be difficult to cut rates. So, that's going to be a very important point, but I do think that if you want to put a probability to it then the chances of the ending of the bear market seem to be much brighter now than they were a few weeks ago.

Q: What would constitute a disappointment for the market from the budget point of view? Opinion generally has come around to the view that we are going to miss the fiscal deficit figure. There is probably going to be a larger figure this time as well. Is it the macros that will disappoint, is it the lack of any specifics which the budget has been low on in the last few years?

A: The budget will look at what the fiscal deficit number for the next year is going to be rather than this year because this year is already factored in, not that it's not going to be a great number. So, what fiscal deficit is budgeted for next year, what is the borrowing program of the government for next year, those are going to be two very important variables and how is that fiscal number being arrived at in terms of what assumptions are behind it, in terms of the growth of the economy as well as whether there are any sharp increases in tax rates to reduce that fiscal deficit.

So, all these issues are going to play an important role. If you look at the FII or foreign investors perspective they would be probably pretty happy if you had a smaller fiscal deficit number or a reasonable fiscal deficit number than one which is in the range of 5.5% or so. So, somewhere around 5% or below 5% with reasonable assumptions behind it would be something which would be positive for the market.

Q: We are sitting at the threshold of some resolution coming out of Greece. What is the possibility according to you of any shocker coming out of Europe dragging the markets down further, the kind we saw in the month of August and September? Would you rule that out completely?

A: You can't rule it out completely because the European situation is very complicated and all the European leaders have said it's going to take sometime for it to get resolved. That risk is always there, there is no doubt about it. That the risk of something suddenly happening in Europe and pulling global markets down, you can't discount that completely.

I think the European leaders have shown that they are keen to see such a situation averted and gradually we are pushing towards some sort of consensus on the whole situation. I wouldn't rule it out completely but the chances have reduced from what they were.