Nifty support 5500; market blind to macro upturn: Ambit Cap

The economy is already turning, and there could be more interest rate cuts to come, feels Saurabh Mukherjea, head of equities at Ambit Capital. He does not expect the Nifty to fall below 5500, which has been a strong support level for the past 5-6 years.

“If you take six month moving average of the IIP, for the last four or five months that moving average has been trending up and even more interestingly in the Q3 GDP data where although the overall headline print was weak at 4.5 percent, investment growth or capital formation was rising for the second consecutive quarter,” Mukherjea said in an interview to CNBC-TV18. “We had around 6 percent real growth in capital formation in the quarter to December. There are a whole host of other data points which are trending in the right direction, but because the overall mood music for the market is negative we are failing to pick that up,” he says. Mukherjea is betting that the GDP numbers for the March quarter will start reflecting the macro recovery, driven by the uptick in government spending. “Clearly, for FY14 government spending is slated to rise very sharply as per the Finance Minister’s Budget and the combination of these aggressive RBI rate cuts should also help investment growth,” Mukherjea said. Political uncertainties notwithstanding, Mukherjea believes foreign institutional investors are here to stay as downside risks are limited. He finds valuations in small and midcap stocks compelling and believes it has not escaped domestic investors' attention. Speaking about impending earnings season that begins with the IT sector, Mukherjea said it will not meet expectations. The only buy in IT sector is HCL Tech, he said. Below is the verbatim transcript of his interview to CNBC-TV18 Q: From this level of 5700 do you see more downside for the market as we made through this earnings season? A: It is difficult to make the short-term call. I take comfort from that 5500 on the Nifty has been a consistent level of support right through the last five-six years. I doubt that we will breach that in the near-term. While Cyprus is a concern what has happened over the last three or four days in Cyprus will be a source of worry in the coming week. My reading is that the economy is turning. The Reserve Bank of India (RBI) has clearly turned the rate cycle around. There are more rate cuts to come in May. The combination of an economic turn, the central bank turning rate policy around and the Foreign Institutional Investors (FII) staying loyal to India should be able to push this Indian market up gradually. 5500 is a key level of support. We have respected it for a long time. Therefore downside risks are relatively low at this juncture. Q: What do you hear about the FIIs and what they are up to going into this month? A: I have spent a fair bit of the last month in the west, meeting our clients. The sentiment vis-à-vis India remains fairly strong. All of us forget how badly China has been hit over the last 3-4 years. It is a big market for FII money. It really has not done too well. The economy does not seem to be going in any particular direction in China. That plus the huge rotation out of bonds in US. There is a huge swing out of bonds in US from bonds into equities remains the big source of support for Indian equities. My reading is that FIIs are not going to leave India very quickly. They are a little bit nervous about political uncertainty in Delhi, but by and large the core blue-blooded FIIs remain a rock for the Indian market. Q: When will the data points in India start getting supportive, where you get a sense that maybe even from a data point and news flow point of view the market has started bottoming out? A: Some of that has already begun. All of us are so lost in the negativity, what we have not noticed is that in the last three or four months the Index of Industrial Production (IIP) data has swung quite decisively into the black. If one takes six month moving average of the IIP, for the last four or five months that moving average has been trending up. Even more interestingly in the Q3 GDP data where although the overall headline print was weak at 4.5 percent, investment growth or capital formation was rising for the second consecutive quarter. We had around 6 percent real growth in capital formation in the quarter to December. There are a whole host of other data points which are trending in the right direction. However, because the overall mood music for the market is negative, we are failing to pick that up. My reading is by the May print, which would be for Q4, GDP as a whole will trend up, investment growth will continue trending up and even government spending will be slightly better in Q4 than it was in Q3. Clearly, for FY14 government spending is slated to rise very sharply as per the Finance Minister’s Budget and the combination of these aggressive RBI rate cuts should also help investment growth. So, my reading is that the turn in the GDP cycle has already begun. Q4 will be the first GDP print upwards propelled by government spending and investment growth and that will be the theme of FY14 as well. Q: If your call is that market is set for a period of recovery do you expect it to be extremely narrow in nature or do you think now the market will begin to open out a little bit purely on the valuation argument if nothing else? A: Where the valuation argument is very compelling is obviously small and midcaps. So if one takes the price-to-book of the front liners and the price-to-book of small and midcaps that discount for small and midcaps is at the 10-year high. The valuation argument for small and midcaps is obviously very compelling. Clearly their fundamentals are not going to rise in a rush. Therefore what we are looking forward to is this combination of GDP data blipping up, RBI rate cuts coming to the party, that leading to some risk appetite coming to the fore and better quality small and midcaps rallying on the back of that. It is very notable that in the last six months we have seen FII interest in small and midcaps actually pick up. That is where more than in the Domestic Institutional Investor (DII) community. We are now discussing small and midcaps more actively with clients in America and Western Europe and that valuation anomaly is getting noticed quite widely now. _PAGEBREAK_ Q: One space which has held the market out is IT and that goes into earnings first. Do you think there is a possibility of a negative surprise given the valuation expansion which has happened or do you think earnings will bear out the optimism that we are seeing in stock prices? A: What has helped the IT sector is not just a decent set of Q3 results, but also the broader data points that the American economy is recovering. We are getting fairly encouraging data from America, that the economy there is swinging in the right direction and investors are using IT as a proxy play on the US recovery. Where investors might have got a bit carried away is the extent to which IT will rise with the US economy. I do not think the results of Oracle, TIBCO and Accenture suggest that US IT demand is picking up very quickly. From that perspective we are set for a disappointing set of IT results. Not because the results per se will be dramatically bad, but expectations unfortunately have run ahead. So, we have been long standing sellers of Infosys and Wipro and we continue being so. We turned seller on Tata Consultancy Services (TCS) last week on the back of its recent rally. So, amongst the first front liners HCL Tech remains our only buy. Net-net IT has run ahead of itself ahead of Q4 results. Q: We were just talking that valuations had got hit badly in the midcap and smallcaps, what is your top list looking like in the midcap space where you were very comfortable going ahead and buying some of these names even if there is near-term downside? A: One of the things that we keep eye is our own good and clean index, which is disproportionately high quality smallcaps and midcaps. So, it had a bit of a rocky time in December, in January as the market was getting very excited. However, in the last month, good and clean has rowed back into life and has left the index behind. Names such as TTK Prestige, Eicher Motors and Sobha Developers are at the heart of that index. We are talking about market leaders in specific, in niches of the Indian economy, strong balance sheets, good cash flows, reliable corporate governance that is where we are pointing clients to names such as these. In many of these cases, valuations are also fairly reasonable. TTK Prestige has run up over the last couple of years, but even a quality name like this, which is growing earning consistently at 25-26 percent, trades at around 20 times forward earnings. So, TTK Prestige, Sobha Developers, Eicher Motors these are the sort of midcap names where the stocks have come up by sometimes as much as 20-30 percent in the last three months. We are asking investors to have a look. Our message is finding some traction especially in the FII community. Q: You keep an eye on some of the media faces, any thoughts on the names there especially Dish TV etc which have been active around the whole digitization news? A: There are two very distinct trends in media. One is a structural trend as you are rightly alluding to. The whole shift towards digitization and historically over the last year, investors have chosen to play the digital plays around that, the Den Networks, the Hathway Cable and Datacom and so on. The other trend is around pick-up in media spend over the last two-three quarters. So, it is very clear to the fast moving consumer goods (FMCG) companies have upped their advertising spends and that seems to be filtering through to the broadcasters. Whether it is a Sun TV Network or a Zee Entertainment Enterprises, they are clearly reporting beneficial ad spends and that cycle is also in swing now. One of the interesting things is these sorts of signs are classic signs of a pick up in the economic cycle when advertising spends go up in the media, the media cycle turns around. That tends to be an early indicator of an economy turning around and certainly Zee Entertainment Enterprises and Sun TV Network are quite clearly talking about it. My sense is that the next layer that will benefit is Jagran Prakashan and the Dainik Bhaskar. The vernacular print plays are next in the line to benefit from the rising media spend cycle. This is more of a cyclical issue. Though Den Networks and the Hathway Cable and Datacom play around digitization, it is more of a structural issue. Structural issue or the structural benefits might have been overdone, but the cyclical story around media, around Zee Entertainment Enterprises and Sun TV Network, clearly there is lot more life left in that cycle. Q: What would you tell the clients to do on a well-owned stock like Tata Motors, which was trading at more than Rs 320 and suddenly is available at nearly Rs 260? A: We have been buyers of Tata Motors through the ups and the downs over the last couple of years. We do worry a little bit about what is happening in China. We have quite limited visibility as to what exactly is going on in the Chinese economy. Data is quite mixed, but what is very clear is the Jaguar-LandRover (JLR) story, which is on very firm footing in Europe and in America. On the back of the strides that this company has made, we stay positive in Tata Motors. However, if given a choice, my top pick in auto today would be Maruti Suzuki India. Valuations are tasty. We know about the strength of its franchise in India. My hunch is that the Reserve Bank of India (RBI) will cut by something like 50 basis points (bps) in May. So, on the back of heavy rate cuts, something like 100 bps of rate cuts in four months, economy turning around, Maruti Suzuki India’s franchise, the yen depreciating, I think Maruti Suzuki India looks very tasty play. It is something like 11 times FY14 earnings on our estimates and that would be my top auto play going into this earning season. _PAGEBREAK_ Q: At this point, on the index what would your top three Nifty buys be? A: I will start with oil and gas. We have been supporters of Oil and Natural Gas Corporation (ONGC) for the last year. On the back of the whole reform story in oil and gas especially the potential for – if the administered price mechanism (APM) to be hiked by couple of dollars from USD 4 to USD 6. ONGC is a straightforward play on the oil and gas reform story. Moving on to auto, Maruti Suzuki India at current valuations given the strength of the franchise in the whole and the yen depreciation story, it is a quite straightforward buy. The third play I would look towards is Kotak Mahindra Bank. Most of the banks in our country are exposed to the vows of the power and infrastructure sector. Although, we are heading into a recovery with the RBI cutting rates, my fear is that by and large most of our banks will not be able to make the most of this recovery. Kotak Mahindra Bank is an exception, well capitalized – over capitalized in fact and very little exposure to power and infrastructure. It is exposed to asset management investment banking in the small and medium enterprises (SME) sector. Valuations are rich north of 2 times book but nothing like the 3-4 times where the other private sector peers are trading at. So, I would go with ONGC, Maruti Suzuki India and Kotak Mahindra Bank as plays into this current series. Q: Do you worry about that that the US market in the first quarter has taken out its previous peak, has had barely a whiff of a correction in the first three months, that there could be some turbulence which might inject a bit of risk off mood that we may not be pricing in today? A: It could well be that after a good run there is some profit taking in America. It is difficult for me to give any comprehensive views on that, but what I do see very clearly is that the big American asset management houses are in the midst of a giant rotation out of bonds into equities. That is clearly supporting US equities. It is leading to record inflows into US equities over the last three or four months and it is also helping our market. The concern is more in Europe as to what will happen in Europe and especially Cyprus. How much of a negative precedent is Cyprus for the other peripheral countries like Spain, Portugal and Italy and that is something we will watch keenly. The European Central Bank (ECB) will make a statement on Thursday and that will be quite a key catalyst to look out for.