Expect trouble if India VIX breaches 20-mark: Sanju Verma

In an interview to CNBC-TV18, Sanju Verma, MD & CEO, Violet Arch Capital Advisors shared her readings and outlook on broader market, rupee, Index of Industrial Production (IIP) numbers etc

She also shared her views on Titan Industries, Below is the verbatim transcript of her interview on CNBC-TV18 Q: Titan is down 20 percent in two days. How would you approach it now in the light of recent news? A: Titan is one of the few midcaps, which I do not track very closely. That said, I think there should be a further correction. Most brokerages till about six months back were calling for a price target of Rs 300 plus and even after downgrades; they are calling for a price target of between Rs 230-235. My sense is they did an earnings per share (EPS) of something like Rs 8 in FY13 and there is a consensus EPS of something like Rs 9 for FY14 and Rs 11 for FY15. That will get downgraded significantly. The Rs 9 EPS for FY14 is extremely optimistic in the current scenario and current scheme of things. If one were to take fact as they were, even if I assume that in FY15 things will improve when these guys do manage to do an EPS of Rs 10-11., the stock still on FY15 estimates is trading at almost 20 times. So, why would one want to pay 25 times plus for current year earnings and close to 20 times plus for FY15 earnings, when one is not even sure to get a 10-12 percent compounded earnings growth over the next two years. Purely on the fundamental premise a further correction certainly seems more like it.  At this point in time given that our markets are not running away anywhere, I do not see any particular reason to stick your neck out and buy this one. Q: What sense are you picking up on the big liquidity argument? Yesterday's FII numbers were not great and that is injecting a lot of fear that what has played out in the debt market might now begin to play out in the equity market as well from the FIIs despite their recent resilience about not selling Indian stocks down. Are you turning a bit apprehensive? A: I am slightly cautious and perhaps apprehensive as well primarily for two reasons. One, if you look at the India VIX, which is what you should be looking at given that we certainly have been in volatile times for the last couple of trading sessions. India VIX has been making higher lows as well as higher highs. The lower end of the India VIX has been trading in the region of 13-14, and the higher end has been trading in a band of 18-20. That is a cause of concern. If the India VIX were to breach 20 on the upside, in the intermediate to short-term there could be more trouble. One must not forget that the India VIX has actually risen by 40 percent or thereabouts in just about the last one and half months or so. So, until volatility is reined in, these sharp spikes will continue to be the order of the day. Also read: RBI intervened on Tuesday to stem rupee fall: Ahluwalia Two, my concerns stem from the fact that while I do not buy the argument that the rupee will go all the way to 60. Some people have been saying that the rupee purely on the basis of the inflation differential argument should actually go all the way to 70. These are just naysayers predicting gloom and doom. However, taking into account the fundamentals as they were, I am not unduly surprised by the fact that the rupee has depreciated by 8 percent between April and now, with a large part of that 4 percent plus depreciation coming in just the last two and half to three weeks. The telltale signs were already there. Also do not forget that the rupee has not reacted to other fundamentals like falling or stable Brent crude which has been hovering in the region of USD 100-103. It has obviously not reacted to gold. While it is true that we have imported something like 142 tonnes in April this year alone which is a 138 percent jump Year-on-Year. Equally, gold prices have crashed all the way from a high of USD 1,922 an ounce in September to just about USD 1,386 on ounce this Monday. Ideally, the rupee should have actually reacted positively. Then what is it that has spooked the currency markets because equity markets have taken the cue from currency markets? - The rupee in the last three to four months has only been reacting to one parameter that is the Implied Volatility (IV). The IV of the rupee is the gauge to see how exchange rate movements will price themselves in the next couple of months and is the best forward or leading indicator. IV was sub-8 percent in as recently as April this year. That has spiked up all the way to 8.5-8.9 percent come May and in June the IV hit an all-time high of 9.22 percent. So it was always clear that this kind of volatility was there for the asking. The reason why I say that the rupee will make a turnaround, and may not go all the way down to 60-65 as some would like us to believe is because in the last couple of days the IV has actually started tweaking downwards. From a high of 9.22 percent the IV is now settling down in the region of 8.9-9 percent which means that perhaps a large part of the depreciation has played itself out. Even if I were to take the inflation differential argument between India and the US, be it the Wholesale Price Index (WPI) or the Consumer Price Index (CPI), based on inflation differentials between these two countries alone the depreciation based on WPI differential should have been 4 percent and based on CPI differential 8 percent. Rupee has already depreciated 8 percent between April and now. Fundamentally speaking, while there will be volatility I do not think the rupee will depreciate dramatically going forward. Post this depreciation; perhaps rupee assets look more attractive. I do not buy the argument that the rupee fell because every Southeast Asian currency fell. The rupee fell also because this was the best performing currency for people who were playing the rupee carry trade. The rupee has returned something like 23 percent in dollar terms between 2010 and now. So, rupee is the best performing currency after the Argentinean Peso which returned something like 68 percent to carry traders. So the carry trade has played itself out. On one hand you had US yields which shot up 27 percent in May and you had our yields, which fell all the way to a low of 7.1 percent of May 24th. It was from May 24 that that sharp dramatic slide happened, which caught everybody on the back foot. So to cut a long story short, I think now the depreciation has largely played itself out. US 10 year yields which shot up 27 percent in the month of May, have more or less settled at 2 percent plus. The hedging cost and the forward premiums on the rupee-dollar arbitrage which had also inched up all the way to 7 percent plus, that has also stabilised in the 6.5-6.7 percent range. Given all these things and taking them in their context and in the right perspective, I feel that for the moment the rupee has been reined in. However, given that there are a lot of other parameters which the markets will react to, particularly the Index of Industrial Production (IIP) numbers, which will be announced later in the day today a bit of volatility is certainly there. _PAGEBREAK_ Q: We are once again beginning to see massive cracks in some of these individual names. You would have seen Wockhardt falling 10 percent yesterday, many of these high-beta names have started cracking. Do you worry about the broader market that it might get into another big sell-off kind of phase? A: The first half of this fiscal year will be volatile, but in the second half my personal sense is that the markets will take a cue for the better. So, the broad sell-off which has by and large already happened has perhaps got some more legs to it, but after that come September-October, things should start improving. The premise for that is because I personally believe that going forward people will start focusing more on fundamentals and less on sentiment driven factors. When I say fundamentals, what gives me confidence is the fact that between FY08 to FY13, the compounded EPS growth for the Sensex set of companies has been just a dismal 7 percent, but between FY13-FY15 even by conservative estimates the compounded earnings growth should be at least 14 percent if not more assuming an EPS of something like Rs 1,350 for FY14 and Rs 1,550 or thereabouts for FY15. So, one the earnings momentum will start playing itself out. Two, this valuation argument sounds cliché to say that we are trading at 13-14 times one year forward earnings, we are trading at a discount to our all-time highs, but you cannot totally dismiss that argument. One must not forget that the last time we went up to 20,000 plus and stayed there for a while was in November 2010. At that time the Sensex on one year forward earnings was trading at something like a steep 18.5-19 times. We are certainly doing well for ourselves by trading at just about 14 times or thereabouts. The earnings trajectory has also been on the downside, but as I said that will take care of itself. What I would like to focus on and the big cue will be given today is the IIP data. My personal sense is that the IIP numbers today should be very good. I am calling for an IIP number of 3 percent and more, maybe in the region of 3.5-3.6 percent for April. While the manufacturing PMI for April was not very flattering coming in at just about 51, which was at 17-month low, the core index which has a 38 percent weightage in the IIP also was not flattering coming in at 2.3 percent for April. However, what will drive the April IIP is plainly and simply the base effect. In April 2012, the IIP for April was just a measly 0.1 percent. Capital goods degrew by 16 percent plus, intermediate goods degrew by 1.4 percent. Therefore, the base effect will play itself out and I will not be surprised if the IIP number today leads to some kind of a relief rally in the markets in a manner of speaking. I also believe that in the second half of this fiscal you will see liquidity continuing to be in abundance, but the S&P 500 which has rallied will take a breather. On a cyclically price adjusted basis the S&P 500 is trading at a ridiculous 24 times. People say that it is still in real terms 20 percent below its January 2000 highs. However, rather than looking at that number I am more concerned about the fact that it is trading at its all-time highs and earnings in the US have started to peak out. In the March quarter earnings growth was just a dismal 5 percent Year-on-Year. In other countries people are desperate for inflation, here inflation is coming down, yields are coming down and as I have always maintained falling yields is the best bet to set the next stage of a rally in the equity markets. So, if yields in India come down to below 7 percent which is very likely to happen if the terminal repo rate comes down to 6 percent or 6.5 percent, I will not be surprised if you see a 15-20 percent rally in the markets. However, that will start only come September or October this year. Till then we are in for volatile times because of a flux of various factors including volatility in the currency space.