Market cheap on yield basis; near-term downside limited: Nomura

A fall in yields has resulted in stocks looking cheaper than bonds for the first time in eight years, says Prabhat Awasthi, Head of Equities & MD – India at Nomura Financial Advisory & Securities."It is for the first time in 8 years that earnings yield has been slower than bond yields and equity markets are looking cheaper than bond markets," he says in a CNBC-TV18 interview.Government bond yields have fallen close to 6 percent lately even as the Sensex, at about 26,000 levels, trades at over 6 percent earnings yield given FY18 earnings forecast of Rs 1,700-1,800.Awasthi says that the earnings impact of the government's demonetisation move is unlikely to last beyond two quarters -- and that it pushes the economic and earnings recovery by a few quarters into FY18.However, he is quick to add that market might remain range-bound in the near term as there are still uncertainties and lack of positive data.

Since there has been some slowdown in economic activity due to demonetisation, the government will now certainly take counter measures to boost it and these could result in favourable monetary policy decisions.

As conditions are ripe for a decline in interest rates, he expects financial companies and discretionary like automobile companies to benefit.Below is the verbatim transcript of Prabhat Awasthi’s interview to Latha Venkatesh, Anuj Singhal and Sonia Shenoy on CNBC-TV18.Anuj: What is your sense, is the market near trough levels or getting there and is the risk reward now favouring buying into this market?A: The short term issues that sort of relate to the demonetisation as well as global environment still are very much there but obviously because the market has fallen some part of that has got priced in. The rest of the market in the short term essentially is purely from the earnings if they don't pan out as well as - or obviously nobody has cut earnings as yet because of demonetisation and if they are worse than expected then there could be some rest to the market. But my sense would be that given that we have fallen from about 8,900-8,800 levels a large part of the risk is breaked in. So, you might have a very limited downside from here. But till the time the certainty on what happens to the economy emerges market might hang around in balance around these levels because markets don't like uncertainty too much. So, if the data doesn't continues to be here for next one month or so market might just continue to be in a range.Sonia: So, if you don't believe that a lot of the bad news is sort of baked into the market is this a good time to be buying and if yes what are the pockets that long term investors should look to buy into now?A: The question actually for us is how long term this impact of demonetisation is going to be because pre this demonetisation the economy was starting to recover quite nicely, the data was getting better. Earnings trajectory was starting to improve. Essentially what we have essentially seen is a break to that in the short term and there are obviously lot of opinions about when does this impact start to ease. There is a camp which sort of thinks much more longer term. I personally do think that going slightly less pronounced and it will be more short term in nature, maybe two quarters impact and therefore there will be a recovery post that going into next year especially in FY18.Essentially if you are buying a sort of recovery in terms of economic activity and also the fact that because of this effort the rates in the system have come down then the first and foremost essentially will be financials because they will tend to benefit from lower rates as well as any recovery that sort of follows post one or two quarters and then secondly if the rates do get lower then some of the discretionary will start to come back I guess simply because the fact that banks will be flush with deposits and they will have to figure out ways to sort of push this back into the system and at lower rates this will probably play into some bit of discretionary - could be car companies, could be autos, etc.So, sectors actually going into next year don't change that dramatically. It is just that we had a pause for about 5-6 months and to some extent I would say you are getting stocks cheaper which had become general market were looking more expensive now is not looking as expensive as closer to 15.5 times compared to closer to 16.5-17 times earnings now we have 10 percent cheaper rates much lower and I also must say that this is the first time in the last 8 years that the earnings yield of the market is below the bond yield sort of number. So, it has not happened in the last 8 years. It happened last time when there was a global financial crisis. So, purely with respect to bonds market equity markets are looking much cheaper now.Anuj: For our market it is not really been a big bull market. We have seen only a couple of pockets do well. Consumption has done remarkably well and financing those consumption Non-Banking Financial Companies (NBFCs) and some banks have done well do you get a sense that this demonetisation then and the problem because of that in these sectors is actually a buying opportunity or could there be a bigger hit something that we are not being able to fathom right now?A: If you look at the whole demonetisation essentially theoretically it is a monetary tightening in the short term because you have essentially sucked out the earnings supply and in the medium term if part of the currency remains in the banking system, stuck in the banking system goes into savings deposit it does tend to be slightly longish term monetary tightening and at the same time if you have increasing taxes as a result of demonetisation or attack on black money surreptitiously it becomes a fiscal tightening also because at the end of the day any increase in taxes of the government at the expense of public is a fiscal tightening. So, between these two the effect will be to slow down the economy and the only way it sort of can be mitigated is through, one obviously a monetary policy action which is more aggressive than previously believed that is lower interest rates, partly it is being reflected in the 10 year bond yields and secondly if there are any follow up action on the fiscal side because the government is in a position to spend more and that is the mitigation impact that could come through.Now we don't know about that yet but my guess is that if the government does end up having more money in its kitty post this Fed effect then sometime in February we will probably see some measures to push the economy in a higher growth path which will probably happen. So, to the extent that the major slowdown in economy there will be counter measures to push this up. Therefore since I sort of think that that is the natural path for the policy to take it does seem to me that there is obviously a buying opportunity created. But you have to be patient here because the data will not be very good in at least next one or two months or three months and therefore you will continue to be more range bound in absence of good data. But the pre-conditions are being created for that bounce back to come through because of lower interest rate and what could be fiscal sort of stimulus that could come through in the Budget next year.Sonia: I wanted your thoughts on the technology space. You are still overweight on that sector and you do have a couple of stocks like HCL Tech that you guys prefer but would you not be worried about the possible painful recovery that this sector could see because of lower client spends, issues with Visa etc?A: Headwinds have definitely increase, I take your point and the short term outperformance you have seen in this year also is because of the fact that the rest of the economy took a hit and the rupee was weaker. Going forward on a more fundamental growth basis we probably will not see that much of a performance. So, that is something we will have to look at especially because there is a new administration in view which could also be sort of slightly more sort of hawkish towards outsourcing. So, not only are we seeing slower growth but we could also have some policy action which could be negative and because of the demonetisation there has been some outperformance of technology stocks simply because of the fact that the rest of the stuff were off. So, yes, going forward the case for an overweight sort of position in technologies is less strong than it was in the past 3-4 years.For full discussion, watch accompanying video...