Market pullback real, Nifty can touch 5850: Dalton Capital

The ongoing pullback in market is real and Nifty can go as high as 5850 depending on government actions, says UR Bhat, MD, Dalton Capital.

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He warns that there is no fundamental reason to buy the markets now as the current rally is part of a technical bounce. For the markets to look fundamentally strong, economy has to resurrect, CAD has to come down, exports have to pick up. It is important to get industries back which can be done only through policy measures, Bhat told CNBC-TV18.
Bhat  is unwilling to blame the public sector banks for their under-performance or growing NPAs as they are reflection of weak policy measures imposed by the government, says Bhat. Public sector banks will not recover unless structural changes are made, and under the circumstances, private banks are the only ones to look competent. He also believes that the FIIs are being patient because the long-term story of India is still intact. Below is the verbatim transcript of UR Bhat's interview on CNBC-TV18 Q: This market has seen some signs of relief in the past couple of days. Do you believe as well that this is just a pullback in an otherwise extremely down trending market?
A: I think the pullback is for real. It could go as high as something like about 5850 and also it is based on some governmental action in terms of trying to see whether they can deal with the Current Account Deficit (CAD). I think there is no great fundamental change that has taken place that can take the market dramatically up beyond 6000 or something like that. Certainly all the worries that we had earlier are still there, therefore we could really look at it as something like a technical bounce. Q: For me there is a fundamental contradiction. The incoming economic data that we get are worse, except perhaps for trade deficit which clearly has improved. Index of Industrial Production (IIP) is still in contracting mode and contracting more than it contracted in the January-March quarter, likewise not much faith that the rupee has still put its worst behind it. The market is still telling us that it is not going below 5500. Doesn't this sound contradicting?
A: Not really. The market has priced in all the contradictions that are there and thinks that 5500 is a reasonably good level provided of course Foreign Institutional Investors (FII) do not sell in a great hurry, but at this level of FII activity and with the sort of statistics that we are getting on the economy this is where the market would be plus-minus 150 points.
Fundamentally, on CAD we have administered some more palliatives. These are not things that can fundamentally change the structure of CAD. We need to really improve exports. The correction in the rupee would probably help it over the medium-term, but not immediately. That could be probably one of the reasons why we have had a slightly better trade deficit figure.
Fundamentally what we have done is we have reduced our export capability, because we have enough iron ore, enough everything, but because of administrative incompetence or because of the courts or whatever, we are importing coal, we have to import iron ore, we need steel, so we import steel.
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So we have created a situation where our export capabilities have been compromised. So I think we need to do something about this. Even on imports we have cut down on gold imports. I think that is one of the big reasons why we had a slightly better trade deficit figure, but otherwise we really need to see what we can do about oil economy. There are fundamental structural issues that we need to address.
We can always say that in next quarter CAD will be better and quite a lot of the effort seems to be on how to finance CAD, not to reduce CAD and financing CAD is essential, but nevertheless more debt is not the answer for dealing with CAD. I think we are addressing the problem in the short-term, but in the long-term someone needs to look at it and address it structurally. Q: I would think that there is more poison to come out especially when you look at bank stocks. We thought that the bad loans were peaking off in the January-March quarter, but it is now looking like a persistent problem for the next several quarters. How do you approach bank stocks? Can you really give this place of almost affection that is given to the private sector banks, after all many of them are exposed to the same corporates?
A: They are certainly smarter in terms of selecting their borrowers. There is no gainsaying that fact. The public sector banks by way of moral suasion or whatever are forced to do whatever probably they would not otherwise have done. This is something that probably nobody speaks of, but that is a fact. So that is why they are saddled with more Non-Performing Assets (NPA) than the private sector banks.
Be that as it may unless there is something that is done structurally for the economy in terms of getting industries back on the foot, there is no point in keeping on blaming the banks, because the banks are a reflection of what happens in the industry and it is not as if the banks have selected the borrowers terribly wrongly. The basic contradiction was whether the industrialists or the banks really believe in government policies and that the policies will be seen through, but if there is a change midway everybody will be affected. So I think finally the blame comes on the government only. It cannot be anywhere else. Q: So you would be a buyer on private sector banks?
A: Private sector banks probably are the only place where you can hide, not terribly excessively, but that is one sort of place where there is some amount of competence that we can see. Elsewhere, I do not know if the competence is really the issue, but owing to governmental action or inaction we have problems everywhere. Q: I want to come back to the point you were making about no fundamental reasons to buy this market now. Why are FIIs still so patient then? We have not seen any pullout from FIIs just yet. If anything there is some talk of long only funds putting in more money in the last couple of days?
A: The fact is even though we are terribly worried about it, but even then the GDP growth will be probably in the region of 5-6 percent, which is not something to be ashamed of, plus also the fact that we have issues in the short end of the market as far as the money market is concerned. It has not really translated into higher borrowing cost yet. So if RBI is able to manage this with some skill that it does not get translated into higher long-term interest rates then we can really look at this as a short-term phenomenon. The long-term story of India is still not affected.
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We have still not reached a situation where entrepreneurs in India are really not talking in terms of investment at all. They might have delayed investment, but still there is a situation where some of the investors, some of the entrepreneurs are probably planning to invest more outside India than in India, but we have not reached a situation where people think that there is no scope for investment in India. So I think the long-term story is still valid, therefore we really have not seen a huge outflow, we probably saw USD 3 billion going out, though something like about USD 15 billion has come in from January 2013. So I think there is still some hope. The ground can really give away if nothing is done in the next six months. Something needs to be done. Q: You do not see any reason to believe that this market can slip below 5000 level or so. Is it going to hold at this base of around 5500? Six month reprieve that you are giving when you will wait and watch are also pre-election months. For a government that wants to phase out fuel subsidy only so that it can be replaced with food subsidy which might perhaps be even as expensive or more expensive do you really hold out hope that they will do radically correct things?
A: Given the insistence of the finance minister that he will hold onto the fiscal deficit target, the CAD target they are all red lines he says and he has delivered in the past. So therefore it is not like any other election year where there will be lot of spending in the run up to the election. This looks likely. If that is a case, if the government acts responsibly there is certainly some hope.
I think foreigners are watching this place very, very closely. If it does not look like as if they are going to deliver on what they have been promising then all bets are off. Given the fact that the developed markets are doing very well and there is some amount of stability in Europe after a long time, even though there is German elections on 22nd and so therefore there is some worry on account of that, but the US numbers seem to be improving quite a lot. So there is a very good case for investors not to come to India, in fact withdraw money from India and invest elsewhere. I think they are still patient because the government needs to deliver and they hope that the government will deliver. Q: Is that the way you would do stock picking, look at import substitutors who will now get the protection of higher landed prices and look at export oriented companies?
A: That is the most obvious thing to do. IT has been the best example of good performance in the face of rupee depreciation. It is just a matter of time before the next price negotiation phase comes in and they eat away most of the gains, but there is an interregnum of a couple of quarters at least where they can make some good margins.
That is what is happening in the IT sector, but even otherwise the big exporters are sectors that we need to concentrate on. Import substitution because those who benchmark the prices against import products are the ones who would probably gain. They may not be able to take all the gains because then there will be problems of demand, but I think they have the work cut out for them to improve margins a bit. These are the sectors where we should really look at. Q: Would you write-off cement sector itself given the state of infrastructure? Is that a sector you would look at?
A: They certainly have some pricing power, there is no doubt about it because there is huge demand, but capacity expansion also has been quite marked, so therefore there is certainly a problem about immediate pressure on prices. All said and done, if Indian infrastructure has to really grow these people will make money there is no doubt about it. For example, if there is no sand available then consumption for cement will also come down, because they have to go together.
The problem with India is that most of the things that we need for end products, they are either banned or they are not allowed. We have a situation where iron ore mining is banned, but we need steel, where coal is not possible to be mined or otherwise there is no environmental clearance, we need power, so here also we need construction but we are not allowed to mine sand. So I think the whole structure needs to be re-examined and seen how we can get things moving. That is where market seems to be worrying. Q: What is attractive now, debt or equity? They are getting debt at bargain basement prices and there is a large India which is risk averse and which has probably burnt its fingers in debt. Is this the time to stick with debt? Will the returns be earlier than with equity or is equity at greater discount?
A: I think equity is at greater discount. It may not be the absolute bottom, but since we cannot really get at the absolute bottom good companies which have reasonably good balance sheets and which are in the right sector that is where you should start accumulating, not put all Rs 100 that you want to allocate but probably Rs 30-40 you should allocate. Q: Some green shoots are visible in Tata Steel. For a long-term investor how does this stock look?
A: These are the stocks that you should buy if you have a 3-4 year view. They will come out of all these problems in due course. There is a lot of money to be made by investors who have a 3-4 year horizon. People who have one week horizon might lose out, but I think for someone who has a 3-4 year horizon these are the sort of stocks you should be really looking at.