Surjit Bhalla of Principal O(x)us Investments said the current rally is not on account of easy liquidity. He does not foresee any more interest rate hikes and feels the government erred by raising interest rates. Bhalla is bullish on both banking and IT stocks.

Ramesh Damani, Member, BSE, said for the first time in history we have seen a global boom in the market of all assets whether it is real estate or bonds or equities. He feels that domestic investors with low equity exposure are driving this rally. Damani is bullish on banking and tourism-related stocks.

Excerpts from CNBC-TV18’s exclusive interview with Surjit Bhalla and Ramesh Damani:

Q: How do you feel as we approach new highs once again and as it has been a little surprising the way this market has cruised to new highs?

Damani: Last May, the markets were crashing in around May 17, there was a 30% fall on the cards in India and a lot of other emerging markets. A year later we have taken up that high, which is 12,700, and are within kissing distance of the all-time high at the Sensex. See what a difference a year makes. What we are seeing is one extraordinary event in the life of emerging markets and of financial assets across the world. There is great growth, easy liquidity and new highs in virtually every month, every dip is seen as a buying opportunity. This is how the market is behaving.

Every time the market drops, it comes back so strongly that the dips are always seen as a buying opportunity. I expected the market to remain in a range before making a break for new highs but the market seems within a kissing distance of a new high and it’s almost there.

Q: How long can this global party last, that is the question most analysts seem to be asking themselves because most markets are at new highs and while everybody is fearful of a correction, it does not seem to be in the offing?

Bhalla: Maybe because everybody is fearful of a correction it does not come above. We all are attributing the global rise to easy liquidity; one clue as to why this rally may have more legs than we think is that I do not know what it means to say that it has easy liquidity.

Interest rates are at an all-time high in India, real as well as nominal rates have been high for the last four-five years. Globally, over last year the year-and-a-half interest rates are increasing by 200-300 bps. There was easy liquidity about three years ago, which is no longer the case, yet we persist in saying that this is easy liquidity. Maybe there is something else going on in terms of growth, in particular, that is keeping all the markets up. It’s not easy liquidity anymore.

Q: Do fundamentals lie behind this kind of global mood and can they justify even higher levels from here?

Bhalla: If you look at the Indian market, the P/E ratio has gone nowhere for the last decade. For 1997, the ratio was 16:17. This is much before the internet boom and the internet pass and today we are exactly at the same place. With regard to India, I think there has to be some kind of an expansion sometime, but even if the expansion does not materialise what we should realise is that earnings are growing by 20-25%, so stock prices should go up by 20%-25%.

The whole idea is that we should now be looking at a correction because the markets have gone up by 10% and should always revert back to the mean, it is a bit like the government of India thinking that we are overheating as we have never grown at 8.5%, therefore we must go back to 7%. This is a mistake that policymakers and a lot of the financial analysts are making when they think that things should revert back to the mean. The mean is changing and expanding at a reasonably rapid pace, which is why you have had earnings growth around the world and the stock prices are growing. P/Es have never expanded, anywhere in the world, on a really systematic basis.

Q: Do you agree with this premise that this is actually a giant re-rating exercise, which might be on globally, and it might not come to an end yet?

Damani: Probably not come to an end. For the first time in history we have seen a global boom in market of all asset classes whether it is real estate or bonds or equities. This kind of a monstrous bull market has to end in a huge blow be it in private equities, where huge deals are taking place, or in leveraged buyouts or in emerging market equities.

In places like India, investors are clambering to buy domestic equities as these are at a historical low with the local populace. I feel that while it does look scary, the market is going to go higher.

Q: The big worry for the markets, which has been pinning it down for the last few months, has been the interest rate scare and now the interest rate sensitives are all bouncing back. What will happen to rates next and do you still see value in interest rate sensitive sectors?

Bhalla: I have been constantly claiming that for reasons beyond my comprehension the government is creating a inflation scare whereas inflation was well in control long before the recent exercises of RBI and the Ministry of Finance. Last year, inflation did bump up by about 2% and that increase was to be explained by what happened in prices of goods, that the monetary policy had nothing to do with, namely wheat, rice, edible oils and petroleum. Given that had worked itself out, inflation was already falling and then you had big scare from the Central government saying they were losing elections because of that or whatever else that they were able to think up. I believe inflation was under control and is well under control. Now because of the rupee appreciation, etc they have mistakenly gone in for overkill, so inflation will be even more under control.

Latest estimates of inflation for April suggests it is almost a 0% annualise expansion, that’s how low the inflation is, that’s if we take April numbers by itself. If we consider the last six months, inflation is less than 4% on an annualised rate. This is a great story for interest rate sensitive stocks and GoI erred on the side of thinking that the economy was overheating and interest rates needed to be raised. Very soon they will come to the realisation that perhaps it went a bit too far. I do not see any more interest rate hikes in India.

Q: Is that scare gone from the markets because the way rate sensitives have bounced back would indicate that lead has been lifted from the market sentiment at least, what is your take?

Damani: I think so. Everyone said that with the UP elections out of the way, interest rates will come down and we would see a slowdown in inflation rates. Both seem to be happening exactly on cue and clearly the market is betting that the next move is a reduction of interest rates in India.

Q: What do you think of public sectors banks, they have been the leaders in the last move?

Damani: You cannot refrain comparisons with what’s happening in China. There have been some astonishing moves in the Chinese market among their state-listed banks, at eye-popping valuations, and sooner or later it’s going on a trickle back to the Indian sector. There is a roadmap for these banks being merged or equity being diluted with P Chidambaram making it pretty clearly in Parliament. I believe they are attractive picks as India’s largest banks are available at a fraction of the cost of Chinese banks. I would buy a good basket of these stocks.

Q: What are you more bullish on if you are bullish on banks - public sector or private sector banks?

Bhalla: There are good banks on both sides of the street, I think a diversified portfolio is what makes a lot of sense. In addition to banks, we have started to buy software. Three months ago we erred when we felt that the rupee had topped out; it certainly didn’t and went another 5-7%. At these levels it is very hard to imagine that the government will make one mistake after another. The dollar might bounce back and in addition to banks, software is looking rather attractive.

Q: Being a long-term IT watcher have you been spooked by the rupee’s rise off late or have you seen that as an opportunity to accumulate these stocks?

Damani: The Long-term fundamentals of IT have changed for the worse, especially for big behemoth service companies. There will be a short-term rally in the dollar but in the long-term the rupee is going to strengthen almost inexorably. In the next three-four years the rupee may touch 35-33 and that dramatically alters, its classic textbook economics, the fortunes of a lot of large service companies. For the first time we still have a lot of midcap stocks in our portfolio as they tend to be in product companies or have a certain niche which gives them some amount of pricing power. The largecap companies are no longer as attractive as they used to be for the better part of 90’s and the early part of 2000.

Q: You would have been getting out of the Infosys’ and TCS’ of the world, which would have been long-term core holdings?

Damani: Yes, we sold some in 2000. After a long time we have been selling largecap stocks, which have been in my portfolio. We have reduced our exposure to those stocks.

Q: You have got an exactly opposite view?

Bhalla: I think there are two views over here. One is three-four years down the line, and I find it very difficult to go that far and unfortunately portfolio managers are not measured by what happens three-four years. I am a bit confident about the rupee as it has topped out for the next six months to a year. Secondly, a lot depends on what happens in China. Beijing is in no frightening hurry to appreciate its exchange rate yet all Indians are saying the rupee should go to 33. If the Chinese yuan stays over here, we would price ourselves out of every market in the world. I don’t quite go with the scenario that there is an inexorable rise in either the rupee or most other currencies except the Chinese currency. The Indian rupee at these levels is very comfortably valued, it’s not undervalued by a significant amount and certainly not with comparison to China. I am not in the camp that sees an inexorable rise to the rupee and the dollar going down to zero.

Q: United Spirits made a big global move by snapping up Whyte & Mackay, this has been a part of your portfolio and a stock that you have liked for a long time. What did you make of the move and do you still own that stock?

Damani: It’s the centerpiece of my portfolio and has been a great stock. It was trading at Rs 40 three years back and from now it’s 30x. It has been a wonderful stock to own in the portfolio because these are great businesses. At the end of the day we bought into a great business - the liquor business. It has a huge amount of pricing power and an almost limitless growth in a country where 50% of the population is below 21 years of age. It has been an amazing story that India’s leading liquor operator, which was available for Rs 200 crore is now worth above USD 2 billion.

Q: What are you making of this huge frenzy of mergers and acquisitions, which are happening across the world? That’s also been one important plank on which the US markets have been riding, do you see this continuing and is it just a by product of liquidity or something else?

Bhalla: My view on liquidity is very different from others. It’s not a by-product of liquidity but this is true globalisation. We have got two new firms and the transaction and transportation cost has approached close to zero. The notion of a country being the dominant factor is changing to the notion of a firm being dominant. This is going to be the evolution over the next 5-20 years. As firms become important we will talk about firms much more than we will talk about countries. In that context, I believe the mergers and acquisitions swing has just started.

Q: Another space, which you liked for a while, that is linked to tourism or hospitality whichever way you look at it, some of those stocks were buzzing around Indian Hotel, Hotel Leela and even Thomas Cook. I know you bought VIP and some of those luggage companies a while back, what is you take on this whole space and how things are shaping up there?

Damani: I remain bullish on this space. I visited North America and met Jim Rogers in New York. He told me not to invest in the domestic stock market but to go and have a great time in the country. India is one of the great tourist destinations. I think it’s going to have an extra-ordinary tourism book, which may go on for may be 5-20 years. This will be both inbound and outbound because as the Indian rupee strengthens outbound tourism becomes a lot cheaper. Globally, people will be coming to discover the pleasures of India. If you visit America, India is almost the center page everyday in major papers. This is an extra-ordinary time to be in this sector be it the hotel industry or luggage industry or aviation industry. May be you will have to look and find the picks that you are comfortable keeping but I remain extra-ordinary bullish on that sector.

Q: Where is the commodity cycle at this point because there too we have seen a relentless rally in almost all metals and crude, which is still holding well above the USD 60 mark?

Bhalla: I am glad that Jim Rogers is getting one thing right, which is tourism in India. Look at world growth three years ago and today’s growth. Three years ago, the world - six billion people - was growing at about 4% and today it’s growing at above 5% with no signs of it coming down. People, who are expecting a reversion back to the mean or what I call rear window economics, are making a lot of mistakes. In a structural change you don’t get a reversion back to the mean and the same is true in the commodity space. That doesn’t mean you don’t have cycles but you have a cycle of upwardly sloping trend and that’s what is happening to all asset classes and commodities, in particular. Commodities will continue to do well as long as the world growth is solid, so the real question should be what can derail world growth. Since we are all linked, if there is something that could derail and it derails, it could derail another. Fortunately or unfortunately, there aren’t too many factors at present that can slowdown this locomotive. This doesn’t mean it will accelerate. A steady growth of 5% per annum in world GDP really means that assets are moving at 15-20%.

Q: The other hot sector for this week or for the last couple of weeks has been media. All sorts of media stocks are getting re-rated, do you find any interest in that space or track it closely at all?

Damani: The CNBC-TV18 Group’s stocks have done really well. It’s a great group and the call has always been that Indian media properties can’t be available for such a small amount. You are there may be a year back piddling a market cap of Rs 500-1,000-1,500 crore and clearly that is not sustainable in a market that is getting media penetration or CAS. There is a long-term party going on in media stocks. We have just seen the beginning of breakouts on those stocks. These are stocks that will probably compound the better ones. It’s hard to say whom the winners would be five years from now. A basket of media stocks will probably compound at above 20% for the next 5-15 years.

Q: One of your friends made a point that if the Nifty were to be looked at from its new high, which it is very close to, is it easier to justify a 10% fixed maturity plan return than a 10% return on the stock index over the next one year. Would you agree or disagree with that?

Damani: I would probably disagree. History teaches us that when the market enters a phase like this, they tend to have huge rises towards the third phase of a bull market. For instance, 40 years ago McDowell’s was at Rs 40 and it went from Rs 800 to Rs 1,200 in four trading sessions. When we enter that stage we could see a very rapid climb upward. History has taught me never to try and time this market, and never to worry about 5-10%. We think there are reasonably good equities available. They are not grossly overpriced and we are ready to go with the tide, so I am not going to try and time the market.