Expect insipid nos in Q4, INR a big risk factor: Geosphere

The rally witnessed by market in the past session is one-off, which does not have the support of the fundamentals. Expressing this thought, Arvind Sanger, managing partner at Geosphere Capital Management told CNBC-TV18 the exuberance has no base as the market is facing the likelihood of poor earnings.

A weak rupee and a total lack of confidence shown by domestic investors are major risk factors facing the market. Sanger says foreign institutional investors may lose as much as 10 percent of their investments solely on the currency's weakness. He believes capital account deficit (CAD) will not show remarkable improvement in the fourth quarter either.  Speaking on sectors, Sanger says asset quality of banks is likely to worsen before one can see signs of a pick-up. "We have turned cautious on banks." He said the IT sector has help up well but commodities won't rise in the near-term. Below is the verbatim transcript of his interview to CNBC-TV18 Q: What is leading to this underperformance for emerging markets in general and India in particular over the last few weeks?

A: It is frankly some of the euphoria or expectations giving way to reality, whether it is in India or other emerging markets. China being another significant example, growth has been disappointing and the expectations that growth was bottoming and turning continuously to get pushed out in terms of the visibility on that upturn. Therefore, the markets have run up on hopes and now are facing the likelihood that earnings near-term are going to continue to drag along at the bottom. That is the biggest factor that has caused underperformance. Also not to forget fund flow, when Japan and US are looking much more exciting that again sucks some of the oxygen out of emerging markets. Those are the hot games in town and emerging markets are suffering by comparison. India certainly is in its own way having its own issues both in growth and in terms of the fact that India has got a government with a big Current Account Deficit (CAD) and fiscal deficit. Also a central bank, which is hampered from being able to do too much aggressively to help the economy, unlike US or Japan because of high inflation. Q: The outflows are the biggest worry right now in the market. We have seen a little bit of that happen last week. Are you hearing and seeing anecdotally that large amounts of money are being withdrawn from markets like India and being rerouted to trades like US or Japan?

A: I would not say that large amounts are being rerouted. However, even if one had inflows stop in India, moderate outflows, but even stoppage of inflows that is given the CAD. I know the March quarter is likely to be better than the December quarter, but it is not a huge v-shaped recovery in terms of CAD. So, I think the risk for the market is given the current absolute lack of confidence and buying and fund flows from domestic investors. Only if Foreign Institutional Investors (FII) were to stop buying or start selling in moderate, forget meaningful amount then the risk it is not that the market is going to have a big crash down, the risk is that the rupee could take it on the chin. That is another risk factor that we have to keep in mind with foreign investors. Foreign investors right now are with good reason somewhat disenchanted with emerging markets’ one interesting statistics, forget what has happened in the last three months. If one looks over the last four years post global financial crisis, or last five years including the period before the global financial crisis, the Indian market has underperformed the S&P 500 in dollar terms. So, this is both a short-term and a long-term question that it raises about India and emerging markets, as to how much of this lob that investors have paid out in terms of returns. Q: How much downside do you see? The market has lost 10 percent from its recent peak of 6000 odd down to 5500 odd. Do you see significant downside over the next few months for India?

A: The political side can result in further downside, but the government is trying to do stuff. We are getting some good news on the sugar front, which is not significant in terms of moving the Nifty. The stocks involved in the sugar industry are very small, but if we continue to get good actions that will help. However, I am assuming global risk on, I am assuming nothing goes wrong in Korea in terms of sabre-rattling by North Korea, and in the Middle East and in a meaningful way in Iran. Assuming all of that, which is our central assumption the market itself may have another 200-300 point downside. My bigger concern as a foreign investor is losing another 5-7 percent or maybe even more on the rupee. So, I see a risk from a dollar investor standpoint of 10 percent plus short-term with things that could easily move in that direction. That is my big concern as an investor. _PAGEBREAK_ Q: You track what is going on with global flows. Where is some of this shift of capital away from emerging markets India included likely to be more pronounced? Do you think it will happen with some of the ETF money which came in 2012 or even some of the allocations or higher allocations that we got from emerging market funds that also might just shift around a bit?

A: The Exchange-Traded Fund (ETF) money is somewhat less sticky in my opinion and some of the allocations could go out. I do not see huge amount of desire to withdraw money. It is just that allocations stopped. People do not put anymore fund flows into India and maybe move a moderate amount out that would be my bigger concern. ETFs is a little more opaque, but my assumption on that is that could be a little bit more easy to shift. So, those would be some of the risks from a fund flow standpoint. Q: The problem for foreign investors like you is that investments have been largely concentrated in pockets like IT and banks. Banks have already begun to crumble. How are you feeling about these two spaces and whether that can remain an investment opportunity?

A: For many emerging market investors or India specific investors, IT is a way to play global or US recovery in a market where the currency is providing a tailwind. The currency weakening is good for those companies. We have got other global ways to play it. We have not been big players on IT. I wish we had done more, because the IT sector had held up all. We have turned much more cautious on banks in the last few weeks. The problem is that it seems like the interest rate policy is not as benign that people would have hoped, given the constraints that Reserve Bank of India (RBI) faces. The bad debt and the Non-Performing Asset (NPA) issue is probably going to get worse before it gets better. Loan growth is slowing down meaningfully, therefore in banking sector there is a value here. If one takes a medium to long-term standpoint things would turnout to be okay from current valuations for some of the banks. The short-term headwinds are such that it is hard to get too table-pounding excited in the short-term about the banking sector having much of a tailwind right now. Q: How big a deal is the political landscape and developments there for investors sitting outside and looking at India? Is that a big problem or deterrent or is it still the macros and earnings as you alluded to?

A: The political side is certainly not helping as much as we had hoped it would. The Finance Minister is going to be in New York in a couple of days time and making the last of his road show pitches about what the government is doing. The government is trying to do a few things, but the constraints in the Indian political system are such that there is only so much that they are able to do. So, investors are getting a little tired of waiting for anything that is meaningful. The investors are looking at businessmen. Business confidence is not coming back. Businessmen are still feeling, whether it is the IT department, Supreme Court, government or something or the other, where we are keep getting pulled up for some issue or the other. Therefore, the business confidence to start the capex cycle to get the investment cycle going just does not seem to be appearing. From talking to business people a significant portion of that lies on the doorsteps of the political system. That is one of the reasons why investors including me are somewhat cautious on the market till we see some confidence returning in domestic businesses. Q: The other part of the market which is collapsing is commodities. Crude is down to USD 104. Cracks are appearing in many of the base metals and commodity stocks have looked awful in India. Do you expect more pain in that space?

A: I will point out that the one exception has been to some extent some of the upstream energy stocks. Many of them do not get the full price of crude oil anyway, but other than that at the end of the day commodities are a China story. Focusing on Indian companies and trying to understand what is going on in Indian fundamentals is secondary to understanding what is going on in China. One of the disappointments for many of the bulls on China was that the hope was, after the leadership change happened and Chinese New Year was behind us we would see a reinvigoration of growth. All of the data that we have seen since Chinese New Year and all news we have seen out of China including further clamp down on the housing market suggests there is not any big commodity recovery coming. One has seen that in copper as it is often called Dr Copper, which is a measure of the economic health of China. It is sitting at close to 52-week lows, oil which is somewhat more broad based global commodity and not is China dependent, but even there are the tensions between Iran and the west have lessened and the supply-demand is being helped by significant shale oil discoveries and production growth in US oil too has come off. So, these are things particularly on the metals and mining side make commodity sector in broad sense pretty unexciting on a global basis, including in the US metals and mining stocks are down 15-20 percent YTD. This is the worst performing sector. That is really largely to be blamed on the doorstep of China first and then secondly in the energy space shale related oil production growth in the US.