Dalton Cap expects market to do well in H2 of the year

UR Bhat MD of Dalton Capital Advisors believes policy reforms will be the key driver for the market going forward. Snapping a four-day upsurge, the Sensex on Monday closed 31 points down to 17,398.98 on profit booking in the FMCG and auto sector amid worries over deficient monsoon.

Bhat says the market may correct if the government fails to deliver post the presidential elections. Brokers said market mood was partly dampened as global slowdown and deceleration in manufacturing pulled down India's May exports by 4.16% to USD 25.68 billion.

However, Bhat says market performance will be better if reforms are undertaken in the second half of the year.

Meanwhile, the rupee opened stronger for the fourth straight session on Tuesday buoyed by positive investor sentiments on hopes long-stalled reforms will pick up pace after recent clarifications on retrospective tax.

According to Bhat, containing the Balance of Payment (BoP) deficit will be key to arresting the rupee's fall.

Below is an edited transcript of his interview to CNBC-TV18. Watch the accompanying video for more.

Q: It has been a pretty sharp rally courtesy what has happened on global events? Would you give this more or do you think this rally has played out?

A: It depends on the hopes of some policy momentum playing out in India because what is expected is with this sort of new finance ministry team; a lot is expected in terms of policy momentum. All that hope needs to be delivered on. In Europe, there was hardly any expectation from the European heads of state meeting and what was delivered was dramatically better than expectations.

Therefore, there has been a big move there in terms of risk-on trades. That has more or less affected sentiment in India also. But finally it depends on what happens in India in terms of policy momentum. So that is something that we need to watch very closely.

Q: Where do you think this upside for the market could be capped, is this a market that looks like it could get all the way to 5,600 or not quite?

A: It all depends on policy momentum. For example, if there is oil decontrol or if there is something to suggest that there is a lot of movement on policy momentum in terms of the red tape being cut in the power sector for example, all these things can certainly take it to 5,600 but what most people know is what are the three-four things that need to be done in order to satisfy the market, in order to press ahead with growth but there needs to be some political cover for those who are required to do this.

That is what is probably lacking. Once there are some movements forward, probably, post the presidential election that is a possibility. There should be some more momentum from Europe in terms of solving the problems especially concerning Spain and whatever little they have done in terms of common supervision of the banking system in Europe, that needs some more substance in terms of the stability mechanism getting more muscle because the amount they have is not good enough for them to tackle the issues at hand and there could be something like an LTRO coming in.

Q: Would you say 5,600 looks doable with a higher base as well? How would you work in terms of markers for the market now?

A: It all depends on events that are going to unfold in India probably post the presidential election but if the hopes are belied then it could probably trace back to the lows of last month. But there has already been an 8% dollar movement last month that is something that carries a lot of hope and that needs to be delivered on.

Q: How worried are you about the newsflow that has been coming through on the monsoons? It is beginning to hit that panic status in terms of the trends, the performance and the impact. Do you think that is going to be a big make or break through July?

A: I think that would be because probably two-three weeks from now, you will know exactly that there is some amount of make-up for the shortfall that has happened in the last few weeks and the potential impact that it can have on a rural consumption and generally the gross domestic product (GDP) growth.

This is something that we need to watch very closely as it has probably escaped attention with the run that we have seen over the last one month but this will probably come back to haunt us over the next few weeks.

Q: Would you then advise churning of your portfolio from some of these expensive defensives like FMCG and move to some of the rate beneficiaries like infra or real estate?

A: If the government comes out with some movement on the policy front, the biggest beneficiary should be infrastructure because that is where most of our investments are stuck and that is where the outlook on investments seems to be very bad.

Typically, entrepreneurs are not having confidence to invest further. Say for example if they do something in the power sector, recasting the finances of the power sector especially the state public utilities, these are things that can give a huge fillip to the infrastructure sector. Therefore, it is certainly worth a trade.

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Q: How would you call the second half for the year? Is it looking more likely that the market works in a constructive frame of mind so while it doesn’t tear away, there will be higher returns to be made or are you getting the sense that there is going to be that one big event that could be looming in H2?

A: There could always be one big event that can erase the gains that we have made over the last one month or so. This development could be from the US, from Europe or even within this country. That is always a risk that we have to factor in but barring that assuming there is significant progress in following the problems that we have whether it is in Europe or even within India to tackle the slowdown in the economy whether it is in tackling the fiscal deficit, whether it is in tackling the BoP problems that we have, whether it is in tackling inflation and whether it is in tackling issues like the power structure reform, if all these things are done, I think the second half could be dramatically better than what the first half has been.

If you see last week, in Europe there was very low expectation from the heads of state meeting but they delivered a bit better. Therefore, the market is rejoicing over that whereas in India, the expectation is extremely high as far as the new team in the finance ministry is concerned. Therefore, they need to deliver. If they don’t deliver, there is always a risk that the gains will be erased but if they start even delivering in bits and pieces, the momentum can continue because hope will continue to run higher. If we do the right things and with some luck the second half could be better than the first half.

Q: Although the expectations from the earnings season are not that high at this time, what kind of an incremental negative do you expect to see from the rupee movement and the impact it would have on some of the corporate P&Ls this time?

A: The rupee movement sort of swung to one extreme and it is correcting and gaining back the lost momentum a bit on the higher side. That is largely because of the fact that there will be some excesses as it went down plus also there have been no big outflows from the FIIs and there is some sort of appetite for the debt quota that they have released. These are the sort of marginal things but if you see exports have not been doing very well.

So, it is the other peripheral factors that have helped the rupee claw back some of the lost ground but this has to be followed by good measures in terms of trying to contain the BoP issue that we have whether it is in terms of curtailing gold imports or whether it is encouraging FII and FDI flow because these are the two things that can swing the current account deficit to a better position than where we are because we have had the worst current account deficit in living memory in the last quarter.

Therefore, I think progress in terms of implementation of some of these policies is what the market is expecting and if they continue to deliver and if they sort of over-deliver on that, there could be a swing on other side.

Q: What are you expecting to hear from the ECB and the Fed because up until the EU summit, expectations were low but after the progress that was made over there, hopes are high to see more accommodative policy come through?

A: Interest rate cuts are probably on the cards by the ECB that is something that I think the market is factoring in. If it is going to be more aggressive than what the market is expecting which is 25 bps then there will be some amount of celebration in the market. Also something of an LTRO type of situation plus also more clarity on what this euro zone common banking supervision means, the necessary approvals by individual countries for that to happen, these are the things that can show some progress.

Finally in Europe what needs to be done is something that can only be done in the long haul which is regaining efficiencies and competitiveness. So some progress on that is extremely important for the market to gain confidence that we are not doing something on the periphery but attacking the core of the problem as well.

These are the things that can probably change sentiment as you go along but their interest rate change, a potential LTRO are things that can only gain some market sort of space in the short-term but in the long-term we need to address issues of competitiveness there.

Q: What would you do with defensive names like ITC? This morning there is an onerous tax burden that the stock has to take. Are you expecting more caution from some of these FMCG names?

A: The valuations are quite aggressive; there is no doubt on that. The fact that they have performed so well is largely because of people wanting to hide in sectors where there will not be much of a downside but if you are seeing some sort of movement on the policy front, it is probably better for us to shift to infrastructure sector and the likes, which are going to benefit from policy initiatives of the government or even in terms of the private sector banks or pharmaceutical companies and IT companies which are at reasonable valuations now. These are some sectors one could probably start thinking in terms of shifting.

Q: In terms of earnings performance, which sector would you be most cautious on because we will hit the earnings season next Monday?

A: The sectors that are not doing very well are well known things like textiles, infrastructure, even banking for that matter. If you see the cue on the CDR counter is anything to go by, at least the public sector banks may not be having a good time in the June quarter. These are sort of sectors where you can expect weak performance.

But the ones that continue to deliver reasonably good returns on growth numbers are things like IT and private sector banks which would probably continue to do very well. Other than that, I don’t see dramatically a good performance or any sort of outstanding expectations. I don’t expect much of that in the June quarter results.