Mkt may head to Dec lows on policy inaction: Morgan Stanley

Indian market is losing strength and the rupee too is making new record lows everyday. Many reform bills are waiting to be passed in the Parliament, while the government is busy debating over cartoons. This has left investors and experts worried that the situation may worsen if the government does not pull up its socks and act in a hurry.

Gaurav Doshi of Morgan Stanley warns that the market may head to December lows if the government inaction continues. "The more realistic scenario right now seems to be that we trade in the range of 5000 to 4500 which is near the lower end being near our December lows, you have a scenario where things in Greece remain uncertain no doubt," he said in an interview to CNBC-TV18. The brokerage has also downgraded FY13 gross domestic product (GDP) to 6.3% as it believes the balance of payment situation is going to continue to deteriorate. "More importantly we believe that lack of any curtail on the government side on the expenditure side has made us take this stand," he explained. Below is the edited transcript of Doshi’s interview with CNBC-TV18. Also watch the accompanying videos. Q: How are you characterizing this, is this a relief rally or do you think we have turned the corner at 4800 Nifty? A: Relief rally of course because we are at very oversold conditions. But having said that, the road ahead for the next one month for the market is basically two scenarios and as time and events unfold we will really see which scenario plays out. A 5,000 to me is a threshold. The market needs to pullback above this and sustain above the 5,000 mark then it would be safe to assume probability one which is the fact that the market really enters the range of 5,000 to 5,400 band. Unfortunately, the probability of this scenario seems low right now purely because of what's going on with Greece and the currency in India. But having said that the caveat here would be that if we get some sort of intervention either from the US or some sort of coordinating effort in Europe then there is a scenario that we get the markets propel into the 5000-5400 range. Let us not forget that the US elections in November make sure that the Fed has to act on QE3 by about July 4 latest. So whether we will get QE3, whether we will get a twist or whether we get some sort of European intervention, it has to play out in the next month and a half. That caveat could put our markets in the 5,000 to 5,400 band. The more realistic scenario right now seems to be that we trade in the range of 5000 to 4500 which is near the lower end being near our December lows. You have a scenario where things in Greece remain uncertain. No doubt, we have had the global leaders call for some sort of resolution to Greece via this G8 summit but the question that remains unanswered is what is the solution right? You have Holland calling for euro bonds and ECB buying sovereign debt, Cameron is calling for further QE from the bank of England, Merkel is saying I am willing to capitalize the EIBs (European Investment Bank) capital base. Monty is talking about pursuing growth and not looking at debt so much. So, it is a very mixed view and therefore what the consensus solution will be is a hard thing to imagine right now. Morgan Stanley has also increased their estimates on the rupee to about 56. Given the fact that the currency is playing havoc it could further put pressure on Indian markets. Lastly our economist has also downgraded his FY13 GDP estimates to 6.3%. So given that you have a further uncertainty in Europe the currency heads towards the 56-57 mark and the market starts anticipating a GDP print of 6.5-6.3% range. It is not hard to imagine the market trading at the lower end or near the December lows. It is a wait and watch and we have to see how these events unfolds and see which range the market chooses to settle in. Q: How’s all this translating into fund flow action? Are you hearing of more people hitting the sell trigger or has money gone a bit quiet? A: Thankfully, the chat on flows hasn’t been too much. We are not hearing anything. I don’t know whether it’s good or a bad thing, but at least the way I see it right now it’s good. The world is more concerned about what’s happening in Europe, US, crude and therefore I am not analyzing India. The way our rupee is behaving, with the complete lack of policy, there are no sort of domestic cues, earnings have also not been any major disappointment, but with no incremental triggers, there is no reason why FIIs tactically should not have sold out of India, but they haven’t. So, it’s good that we are seeing the flows that we have received stay put, but we are not hearing anything on the incremental flows side as of now. Q: You spoke about Morgan Stanley’s GDP target being cut to 6.3% for this year. Does that make you circumspect about how earnings might pan out for FY13? A: No, the main reason for cutting the GDP estimate has been the fact that we believe the balance of payment situation is going to continue to deteriorate. More importantly, we believe that lack of any curtail on the government side on the expenditure side has made us take this stand. Having said that, I would believe that earning will not be as bigger disappointment, because the market is fairly alert and aware of what potential impact will take place on earnings of companies. I would think that the market will get even more skewed and more selective if we trickle down and multiples will definitely contract. So more than earnings, we want to see multiples across sectors and even on the index contract significantly if we start putting a GDP print of about 6.3%. Q: Do you think this kind of grind in the market might continue for a couple of quarters more and basically ruling out any significant returns for this year as well? A: Couple of quarters is a hard call. This next one quarter alone is going to be so challenging, because of what plays out in Greece and how we manage our rupee and what we get in terms of domestic policy action. So I wouldn’t even look two quarters away. I think this one quarter alone if rupee, Europe and lack of policy action continue then we can grind low all the way to the December lows in this quarter itself. I don’t think we need to look beyond that. Disclosure: My firm, clients and I may have holding in the stocks or sectors discussed. _PAGEBREAK_ Q: What is your take away on core earnings performance itself? What are you guys at Morgan Stanley expecting to see by the end of the year? A: This earning season has been more surprises than hits. There have been 1-2 stocks per sector that have disappointed, but broadly expectations were so low that the market has been able to positively surprise in certain cases. But, we are not as bearish as other brokers on the street in terms of earning expectation for this year and we think this year you will have a flat to positive earnings growth. More importantly, we are looking to see is the underlying matrix of the earnings. We need to start seeing margin expansion take place, we need to start seeing working capital of companies and situation on that front improve. If the matrix continues to deteriorate then I don’t think then even current earnings were meant to be able to sustain. But I don’t think it is too late for that right now. I think right now at least from an earnings point of view we are far better placed than what market is anticipating. Q: Are you translating your rupee call into some kind of tactical call on the market? For example, are you guys going more overweight on IT etc.? A: The report talks about the fact that while we acknowledge that things are extremely oversold in the near-term they are not calling for 56-56.8 right now. But, the fact is they believe that the trend is going to be in this direction. No doubt, IT has been a sector we have been overweight on in the past and we continue to be overweight on. But unfortunately, the stocks are not kind of displaying the resilience that we would have expected with the rupee at 55-56. Having said that, we continue to believe that this sort of rupee dynamics will add some sort of a cushion to the earnings of these IT companies and that gives us some sort of comfort and therefore we continue to stay overweight. I don’t think the tactical trade is playing out or working as of right now, especially given yesterday that IT sector which was one of the weaker sectors in the market and the rupee was also at 55 levels. So it’s a strain situation tactically. Q: What's your top pick right now both from banking and the other rate sensitive space, the infrastructures? A: In banking the clear preference is the private sector banks with a high CASA deposit and extremely niche NBFCs that pretty much are catering to the personal loan and two-wheeler and utility loan segment. These are the two segments that under the current circumstances one can back with money. While we feel banking is something that one must have meaningful exposure to, we are still not convinced with the asset quality issues with the PSU banks. In the private sector space, one has to be a little selective. So the preference is for banks with high casa deposits. It is clearly these two pockets of private sector banks along with few NBFCs that have delivered earnings growth over the last 2-3 years irrespective of what the broader market is doing because of the sheer underlying trends in our economy. Those are the bets at least under the current environment that we think you should be backing. Talking about interest rate the sector is obviously consumer discretionary and capital goods would be proxies to look at when you believe that this interest rate cycle is peaking. But the question is that when will we get the next rate cut? The way the situation looks right now, rate cut could be in the later half, could be back ended and we may not see any interest rate based triggers for the next 1-2 quarters. Therefore rushing into a consumer discretionary or a cap good trade as a proxy on interest rates would not be the right strategy. If anything just chase banks right now and wait for more clarity to emerge with inflations and RBI stance to chase the broader interest rate sensitives, may be even a real estate at some point in time, but we’d need a lot more clarity for that to emerge. Q: Are you working with a range right now on currency and what have you all put this weakness down to? Are you seeing it getting reflected in terms of outflows? Do you think it is more of a lack of inflow situation? A: We were working with a number 53.8 on the rupee, which we yesterday revised to 56 and the reason is purely domestic balance of payment concerns. On another note, it is also important to note that it is not just the Indian currency, from a price point of view we have done the most but we are seeing this trend across emerging market currencies. Whether you look at the Brazilian or Indonesian currency, the trend and the behavior and the pattern has been pretty similar. I don’t think this phenomenon is restricted to just India. I think it is across emerging markets. Secondly, the bigger concern behind our thinking on the rupee has been the severe balance of payment shock. The note also talks about the fact that there is a technical target of about 62.7/USD but let me just say that this is a case that is possible only if you see a balance of payment shock. If you were to reach an extremely disastrous situation a print of 62.7/USD on the rupee is also something that technically is possible but I would say under very extreme circumstances. So worst case 62.7/USD if things turn bad and then eventually settled may be the rupee will hang around 57/USD.