Ambit warns: See 'lot more' earning downgrades, worst not behind

The ongoing stock market rally is driven by fund flows but has little support from fundamentals, Pramod Gubbi, Head of Equities at Ambit Capital, told CNBC-TV18 Tuesday.He added that the US dollar was likely to not strengthen further, something that would help keep flows intact.

But he said that he would prefer to wait for a turnaround in earnings.

"The worst is not behind us," Gubbi said, discussing the impact of demonetisation on earnings. "You could see lot more earnings downgrades coming through. The impact could be spread out over a couple of quarters."

On sectors, he said he prefers specific stocks in pharmaceutical and information technology spaces for their attractive valuations -- signalling a contrarian investing stance.Below is the verbatim transcript of Pramod Gubbi’s interview to Latha Venkatesh, Anuj Singhal, and Sonia Shenoy on CNBC-TV18.Anuj: We have had a big rally of 1,000 points, is the risk reward still favourable for Indian market? A: It has been a completely technical market of sorts largely driven by flows because fundamentals I know the results have been perceived as being better than what we have expected but expectations had been beaten down because of demonetisation. However, other than that, there has not been much going for the markets or stocks fundamentally in terms of earnings or even in terms of the outlook at least for the next two quarters odd. Yet this rally has been largely supported by pretty strong domestic flows which continue to remain strong as well as a turnaround in the foreign institutional investors (FII) flows given the topping out of the dollar somewhere around Christmas. Neither of these two look to change, so, it will be a market which is entirely dependent on flows and with little support from fundamentals. Latha: What would you advice investors and even traders, for the moment is it worth riding this for a bit more, would we go all the way perhaps to 9,000 you think and therefore there are still trading bets out there? A: I would not take that risk because the catalyst and the timing is perhaps the hardest in this job and to that extent if you are finding valuations punchy with no real catalyst in terms of turnaround for earnings, I would rather take profits off the table and wait for a better opportunity to get in. Sonia: The feedback that we are getting from a lot of corporates and market men is that the worst of demonetisation may not be behind us. Are you fearing that we could see some more earnings downgrades in the quarters to come? A: You are right in the sense that the worst is not behind us. However, the market levels are pretty much pre-demonetisation levels. So, I guess we are still not to see the bottom yet the markets have more than factored that in. So, my sense is, yes, you would see a lot more earnings downgrades coming through as some of the effects of demonetisation will be spread out, not just in the quarter that just went by, but also the quarter that we are in and perhaps extending to another quarter. So, earnings downgrades are perhaps a sure thing just as they have been over the last three years. Anuj: We have started to see some move back in pharmaceutical, would you back it right now; I know its stock specific but as a big sector? A: I think so. There has been a correction of sorts over the last two to three years given the sort of action from the regulator and some of these stocks are trading at attractive valuations. However, like you said, the sector as a whole cannot be painted with the same brush. You need to look at specific opportunities with specific exposures to attractive markets and also their own positioning within the regulatory ambit. So, that is one factor perhaps worth looking at given it is also in some ways immune to demonetisation and what the domestic economy is going through. Latha: Let me ask you to read what is even perhaps tougher to read, liquidity. It has been a constant as far as Indian flows are concerned, how would you see that trend, does that provide a solid downside support and how would you read the global liquidity picture as well? As you pointed out, dollar topped off, so, should we think that flows will remain healthy for at least this quarter? A: On the domestic flows, I think it is easier to take a long term view given what the government has been doing over the last three years and continues to do in terms of the track on black money which has its own consequential impact on gold and real estate which have been two asset classes which have attracted a lot of savings in the country over the last two decades. That process of reversal will continue; that means that the financial markets will continue to attract more flows and that remains like you said, a reasonably strong support as far as the markets are concerned. The foreign flows however are a little more trickier. I think it is very difficult to call which way the dollar is headed given the several different actions that the new President in America is taking. So, that will be a big picture to watch out for. Our base case could be that, yes, dollar may not strengthen further from here, topping out would mean that there could be further flows into emerging markets and India would participate with its own fair share.Sonia: How would you approach these consumption related sectors, sectors like autos or even something like paints, any fresh positions that you are taking over there for the long term? A: Not really. I think these are sectors which we believe from a long term perspective, but valuations and near term run up in stocks are just not comfortable in terms of an entry point. If you are a holder, perhaps may not be dire need to take profits here but to make a fresh position, I would wait for a better entry point which we are pretty confident you will get over the next two quarters. Latha: What would you stay on, you are clearly seeing risk reward in favour of risk at this juncture. Nevertheless, which are the sectors or stocks you would stay on and where would you book out?A: Hardly few exceptions, pharmaceutical perhaps is a little immune to what is happening in the domestic economy and you have had some sort of a semblance of valuation come back. Again, here I will caveat it by saying it is more of stock specific trade than a sector wide trade. Similarly, IT again, looking attractive on valuations but again it has its own headwinds not just from the visa regulations but also in terms of the structural change in the consumption pattern there. However, yet again valuations give some comfort. Other than that, the theme that we would focus on is sectors where we are seeing structural shift from the unorganised to the organised segment. Like we have maintained, demonetisation has had the biggest impact on small and medium enterprises which continues to reel under this pressure. While there has been an element of remonetisation, I don't think the way business is done in India will remain the same and to that extent there will be gainers in the organised segment. That is perhaps a theme to play. Again, commodities with selective view on particular companies, companies have had a bit of checkup past here but commodities, metals and energy could be one other sector again where you get some immunity from the domestic situation yet you are getting the tailwind of the dollar topping out and some sort of a recovery in emerging markets.Anuj: How would you look at this news, SUUTI selling 2 percent stake in ITC? A: I think in terms of impact on the fiscal, it is obviously positive and big positive. We all have been waiting for that action by the government over the last two to three years and finally it seems to be coming through if the news is true. However, in terms of impact on the stock, I don’t think there is much to read. It is technical in nature; focusing on the fundamentals I think there is a lot going for the sector. There has been a moderation in the taxation after a few years of severe rise in excise duties. All that should come through in terms of earnings and given the expectations that are embedded in the stock, it looks more positive. So, I would not read too much into the technical sale and rather focus on fundamentals which are relatively more positive.