Brexit is no 2008 but mkt to have near-term challenges: Ridham

Below is the verbatim transcript of Ridham Desai’s interview with Anuj Singhal on CNBC-TV18.

Q: Mayhem in market yesterday, at least for starters, but by the evening session, things cooled down for us, for FTSE, though the euro zone was down quite a bit and US market ended down about 4.5 percent. A lot of people asking is this similar to 2008 and are we in for a prolonged uncertainty in the market. What is your take on that?

A: There are two questions there. Is it 2008? No it is not. 2008 was a full blown global financial crisis with global banking sector in deep trouble. This is nothing compared to that, in fact, there is no crisis here. There is an event that has happened which has ramifications on the growth of certain parts in the world; what is in debate here is the growth that Europe will have and there is a possibility that Europe and the UK, both slip into recessionary situation in the next two years because of the adjustments they have to make on two counts. One is the trade agreements that flow between the two parts and the other is the labour arrangements.

Today, these two zones have free flowing trade in labour, basically porous borders; that porosity will end. By the way it ends in October 2018, so, it is not an immediate thing anyway because by the time they complete all the work around this, it will take a couple of years. So, it raises the possibility that we may have a recession in what is a pretty large part of the world economy, which can then have a consequent impact on growth elsewhere.

Now, put it into context, the world is dealing with large indebtedness. China, Japan and Europe are dealing with large indebtedness, it is an aging population, especially Europe and Japan and growth has been anemic. Now, when you put that on top of this, it raises the question about whether growth will recover in the next three or four years for the world and that, I think, is the debate that markets are dealing with.

As regards the share price correction yesterday, in most parts, the markets gave up what they had gained in the preceding few days. So the rally took place in anticipation of Bremain, they gave it up when Brexit. We have really not seen a net loss in most markets, maybe some markets, maybe some asset classes like the UK pound. To that extent, I think the markets are adjusting elevated expectations about the outcome and that is what the adjustment was yesterday.

Q: In that case, is there a risk that what we saw yesterday was just giving up of the Bremain rally and the actual impact of Brexit is something that the market will have to deal with, not just for the next week, but for a protracted period of maybe three or four months till this uncertainty is out of the way. At the end of the day, we will have to figure out what UK’s exit would mean for the euro?

A: I would say that this depends primarily on how policy response takes place. I think that if there is a sense of panic in the marketplace and corrections in asset classes last beyond a couple of days, it would not be a bad thing to anticipate that there will be a coordinated monetary response from the three big central banks and then the peripheral central banks will also participate to ensure that we don’t hit a liquidity squeeze.

Q: Would that be enough or will we require a fiscal sort of measure as well, apart from monetary measures?

A: I think fiscal measures have not been coming over the past few years. My colleague Chetan Ahya wrote a very interesting note about this, which is he says that the distinction between the growth cycle in the world today and what happened in the 30s, is that in the 30s, the monetary response was coordinated with fiscal response, which is why the world came out almost in a V-shape after 10 years of depressed growth rates.

This time around, we have not seen that fiscal response from the large economies in the world. They have been reticent maybe because their starting point of debt was too large and the starting point of the fiscal deficit was too large. What we have seen actually is a contraction in the fisc. So, that is a possibility. If I cannot really speculate on that (whether there will be fiscal stimulus) but if it happened, I think it will be very positive for equities. So, the market’s near-term reaction will be dependent on how policymakers react.

In the medium term, I think certain business will hurt because there is a likelihood that the next two to three years will see slow growth in euro zone and therefore businesses that depend on that -- exporters to Europe for example -- may hurt.

By the way, the producers inside the UK may have already got their bonanza yesterday because if pound remains this weak, then basically you got an upfront payment for the slowdown in growth that will happen, which is probably why the UK stock markets were not hurt as much as the Europe. All this is nicely explained in hindsight. If you had asked me on Thursday I may not have been able to tell you all this.

Q: Are you saying -- and this is not a stock recommendation -- that for example Tata Motors, which fell 10 percent, was just more of a panic reaction and some of these companies which are getting revenues from the UK actually stand to benefit and any fall actually is a buying opportunity?

A: I am not going into specific names but let us pause for a moment. Companies that have exports into Euro zone may have to see their earnings adjust a bit with a two to three year view. Companies that have production facilities in say the UK may not hurt as much because of the currency market’s reaction.

There are two different things here which is that the two- to three-year view Morgan Stanley view is that there is a rising spectre of a recession in Europe and the UK and therefore if you are selling to those markets, if you are servicing consumers or corporations in those markets with your products out of India, you may see a slowdown in demand, which is why you may have to cut back.

So, pronounced impact is on IT services because a lot of IT services companies in India actually receive a sizeable portion of their revenues from Europe and there may be a cutback in orders there if Europe slips into slower growth and recession.

Q: Just to come back to my original question because this is something that we debated all through yesterday. Why is it so different to 2008, 2008 we had just one bank collapsing and we had financial markets in a bear market, a lot of large indices gave up 50-60 percent. Here we are talking about the largest country actually moving out of the euro zone, the question mark on the survival of the euro itself as a currency and that brings along a lot of uncertainty and about fund flows, which really is the most important factor in the medium-term for stock markets. What makes you so sanguine that this is nothing close to 2008?

A: We should not describe it as a sanguine view. I think there is a difference with 2008. The spectre of the euro zone breaking up is a real one and we have to deal with it if it happens but it is not yet happened and for sure if this leads to several other countries leaving the euro, then there will be a lot of disruption in the stock markets.

However, the difference between this and 2008 is that then you had a universally overleveraged banking sector that had run up massive losses and it was a collapse in the financial system of America.

There is no collapse here. It is not a collapse of the financial system that is happening. It is very different in the scale and size. You say one bank but actually a lot of banks had failed by the time we hit October 2008 and then there was a massive bailout package that had to be engineered in order to redeem the US financial sector and a lot of things have changed since then in terms of regulations. That is not what we are dealing with here today.

We are certainly dealing with uncertainty, let us not have any doubt about it, we are dealing with uncertainty, I think there are medium-term implications here, there is a risk that other countries depart the Europe and it is something that the markets have to deal with and there are specific stocks and sectors that will get hurt.

In fact even India’s own macros to the extent we have some amount of exports to Europe, I think growth in those areas will slow. So, it is quite possible that India’s gross domestic product (GDP) growth may be a little lower than what we may have envisaged because of the events that unfold in Europe. So, I think it certainly has some impact, it should not be viewed as there is no impact but it is not as catastrophic as 2008.

Also, one more point is that we want to evaluate the impact on the markets, not just the macro and the big difference between 2008 and today is the starting point of valuations.

2008 happened when the global stock markets were on a five year bull market and valuations were elevated everywhere. Just for comparison, India was trading at 32 times earnings; we are now at 16-17 times earnings.

So, it makes a difference where your starting point of valuations are and that exuberance is not there in the market. In fact if anything, take away the last two or three weeks of stock market rally in Europe because the Bremain confidence had gone up, actually these markets have been languishing prior to that. So, there is no optimism baked into the share prices outside India.

With regard India, I think we still have a few things to deal with in the near term. I would say that the rains are still developing news. Yes, we have seen a start; it is a bit of a delayed start but it is still a developing news flow. It is not absolutely clear that we are going to get a great rainy season and it is not about just the quantity; with regards to the rain it is always spacial and temporal distributions. So, where the rain comes and when it comes and this is a crucial period.

I think stock prices in India are getting a little optimistic about the earnings season because of what happened in the previous earnings season where we saw a notable uptick. So, expectations are a bit higher now and we have to deal with also the events which will happen in Europe.

So, I would say that it is possible that we go through a period of consolidation. I say that with great care because my short-term calling on the market is woeful but I think 8,300 on the Nifty which we saw a few days ago will not come back so easily. I think it will take a little while to go there and we may go a little lower before we come back; it is possible.

Q: You normally don’t make such index calls in the near-term

A: No, I don’t. I am just giving you as an illustration that the near-term upside is going to be harder to get in this market.

Q: At index level because of valuations as well or is it because of the headwinds that you spoke about?

A: We have to get clear of these headwinds and who knows by end of July these headwinds are clear and the market could be up a lot and I will be having egg on my face; that is a certain possibility that is there and I can see that as well -- that scenario also can be seen. I think people should not be really concerned about this.

We are in the middle of a bull market and bull markets will always have their 5-10 percent correction all the time. All those corrections happen to be opportunities. Those who can time this and those who are good at it, great for them but those who are not good at timing should not worry about timing it and should just buy stocks because I think stocks in India are going to CAGR nicely over the next five years.

We are in the beginning of a new earnings cycle, there will be doubts that will creep in because there will be one quarter that may not be as good but I think we are in the beginning of a cycle. I am quite bullish on the way the government has handled the economy. I think it is quite spectacular in the way things are turning around in India.

It is happening slower than what we may have anticipated two years ago because of the headwinds from the world, those headwinds are not going away and Brexit has just added an extra headwind, so, it just increases our challenge that means we have a slightly more sedate and prolonged bull market; not a V-shaped bull market but a kind of a U-shaped bull market. However, it is nevertheless still a bull market. So, you want to be in stocks.

I keep looking at how much households in India own stocks. The last calculation is USD 300 billion, they have USD 1.8 trillion in gold. They are all hedged against a Brexit. So, they are all hedged, they were all in the money on Friday. The country as an aggregate was in the money on Friday because they own six times or five times more gold than they own stocks.

Q: We can deal with Brexit but we can’t deal with mexit -- exit of monsoon -- that is something that I read.

A: The reason why the rains are more crucial this time -- and I don’t want to over emphasise that -- is because again if you look at market behaviour during the rains, apart from the trading moves that you get, the market actually does not consider the rains to be that important because the rains have lost their significance on the economy. The reason why the rains become a little bit more important this time is because of two years of drought.

The reservoir levels are running really shallow and I don’t think we can tolerate another drought without causing huge human hardship. Now, when human hardship happens, the risk is of policy errors creeping in and the last thing the market wants is a policy error at home because we have got our policy well sorted. That is the risk of the monsoon. It is not anything else and if I were to point that one single risk, it is the risk.

Q: So you spoke about looking at things right now and the current scenario 8,300 being a near term top, but you know in bull market it is always more important to find out where the bottom is, upside will take care of when the rally happens. Are you fairly sanguine that we will not go below say 7,500-7,600 because the worry is that, we may have made a bottom somewhere around 7,000, but is there a risk that we actually go and revisit that.

A: Maybe, I think 7,500-7,600 would be a very attractive level to buy stocks if 8,300 is a level that you are looking at with a six months view. That would you give you a 10 percent upside, so 20 percent annualised return, in my mind it looks like a great level to reengage.

Q: But that won’t be your base case scenario that market falls 10 percent.

A: No, I don’t think so. I don’t think the market is 10 percent downside, 10 percent will work out to 700 points, that’s a lot more than 7,600, that’s 7,300. It 300 more point, so it’s a 600 point. I am not sure whether we will fall that much.

Q: Five percent.

A: Maybe, maybe, like yesterday. I mean how can you prevent a certain 5 percent fall in stocks is possible, but the point I was making is outside the index, there a few stocks that look overvalued and a few stocks look undervalued and that’s the more interesting aspect.

The index seems to be in a range, it get oversold in February, there was a big index call to be made and luckily we made it. I don’t think there is a big index call today. Even now I am saying 8,300 is not a very big call -- there is [not much] conviction from my side.

Q: Maybe it is not material right now because we are all looking at broader market right now instead of the narrow marker.

A: I think it is a stock specific market. My conviction on index level is not high. You can see that I am hesitating in giving you levels on either side so not a very high conviction call it is more at the stock level and there are certainly a lot of stocks that look undervalued, there are lot of interesting spaces.

I see that in retail banking. I see that in consumer discretionary. I see that in industrials. I see that in utilities. There are lot of interesting stocks out there which are undervalued. There are the few places that still look rich, maybe avoided. I think consumer staples look rich so it is avoidable.

I am not so sure about materials because it is a global things so I rather avoid them, because then I making a global call, but I think domestic cyclical looks very interesting at this stage and are likely to surprise in terms of earnings with reasonable valuations behind them, they are the ones you want to bet.

Q: Domestic cyclical is a really big basket, anything in particular.

A: It includes consumer discretionary so the autos and retail. It includes cement so domestic materials. I would say it includes the retail banks, including some microfinance, non-banking these places have got momentum behind them.

Q: All of them have rallied a lot, lot of NBFCs have doubled, auto stocks a lot of them have done well and cement stocks of course the rally started with cement stocks, so lot of these stocks have done well, but still room for rally from here?

A: The fact that they have done well or not done well is less relevant. What is relevant is where the valuations are and I think they are reasonable in the context of what earnings growth can come. I think we may end up underestimating the operating leverage that these companies have accumulated over the last five years in a down cycle. That operating leverage will lead to an earnings surprise and then you look back you may actually find that the stocks were trading attractive, once that earnings potential unfolds. Again I am talking from a two to three years perspective not from a six month perspective.

Q: Just to come back to that Brexit question because that still is a big worry for the market or big overhang. Fund flows do you see significant impact on dollar inflows or FII inflows into Indian market because yes the domestic money is there and the domestic money had taken care of FII outflows over the last one year, whenever we have protracted period of outflows, but at some point that does get impacted, if we have consistent FII outflows. Do you get a sense that we are in for a period of consistent FII outflows?

A: So my worry is greater than there are both domestic and foreign institution buying the market. Those are more crucial inflection points in judging the market. FII flows I think may get affected, but India I think on a relative basis is still quite a standout, which is why we are overweight in our emerging market portfolio on India and rate India as one of the best markets to own definitely in an emerging context.

If FII flows are to turn negative, you will see a lot more outflows in emerging markets, so I don’t get that sense that we are about to see a major outflow of FII money, but again as I say it all depends on how the whole Brexit thing evolves over the next few weeks, how policymakers respond. If they respond in a coordinated fashion then we may not see yesterday’s level again. If we don’t then we may test them and may even breakdown and then they may react, so who knows. Policymakers worldwide seem to have one eye on the markets and they are losing market levels to decide what to do.

Q: It is not a good thing?

A: Well, that’s not my problem. Therefore it protects your downside, so it doesn’t pay to me too bearish, so if you have policymakers that are going to act at a certain level, then it means that you got a rangebound market really, globally, because they act other way when the markets go beyond a level and they act in favour of the market when it falls to a certain level, so it kind of protects that. If they give up that approach then maybe you could see more upside or downside. From a global perspective India I think will do it own thing.

Q: What is Morgan Stanley’s house view on whether this Brexit issue changes, what the US Fed is going to do because the gaining view is that now a Fed rate hike is out of the way, let say completely. Would you share that view?

A: We anyway had a view that the Fed will only hike one more time, so in a way we were out of consensus, I think that developing view will evolve depending on how financial conditions in America tighten and the market yesterday started pricing in zero rate hikes and even maybe a rate cut, but that's what the market does all the time. Swings from one extreme to another extreme.

The US Fed will be very focused on its own data. Brexit is a risk in terms of liquidity, they announced yesterday that they will backstop any liquidity problem, they are very clear about it that does not necessarily mean that they changed the rate view because it also depends on how US job market evolves and how US growth evolves.

Q: What about China because in January-February, we had a big correction in our market, a lot of markets because of the China factor. Because of what is happening worldwide with currency now, with the pound, with the yen, do you get a sense that China becomes a bit of a wildcard here in terms of their currency moves or what happens to China’s equity markets in terms of that impact on risk to emerging markets?

A: Our view is that Chinese growth may slow in the coming months and how that affects the market -- we saw that last time around, it had a pretty deep impact on stock markets because it is all about what markets are pricing in. So, we think that China’s mini growth cycle has ended and will probably slow in the next few months. 

So, our view is that global growth is not accelerating in any major way and that as I said during our conversations are headwinds for India and that keeps playing on Indian stocks from time-to-time. So, we are anchored to what is happening globally, a lot more than what is happening domestically for that very reason.

Q: Any thoughts on what Raghuram Rajan’s exit would mean for the market because that has also been one worry. For now the market ignored that and moved on but you can’t really gauge that in one day or two days move.

A: The market has very clearly from whatever price action it has, it has probably said that we are interested in who the next leadership of RBI is and what the policy is. I think continuity is a good assumption and there is no reason to assume that the RBI will change its framework. It is a pretty robust institution. 

Q: I ask you this question because you have a lot of global clients, the big worry was does this change India’s perception on how institutions are treated in India or debasing of institutions. Is that a worry? 

A: I have not heard that from clients actually. I think they appreciate that there are political appointments and you don’t need to necessarily take a political appointment as a signal of debasing of institution. I think that connection is not so clear, it is not so clear to me and you can make your own conclusions but I think what the market seeks is a policy framework that is supportive for growth, that is supportive to India’s macro stability and that is what it is interested in. So, I think that maybe evident as soon as the new RBI Governor comes in. 

Q: We spoke about retail banks, we spoke about NBFC and spoke about a lot of discretionary consumption. What about two of India’s biggest sectors – IT and pharmaceutical. Now, there is a currency angle as well of course involved and there is this Brexit angle, any broad call that you have on these two sectors? 

A: We are neutral on IT. I think the environment is not so positive. You want to be very stock specific, certain companies are doing well, others are not. The sector I think is not making much headway.

On pharmaceutical, we have been underweight. I have to say that now the levels are getting more interesting but there is growth elsewhere and that is the big difference between today and five years ago when the bull market in pharma started, there wasn’t growth anywhere else. However, now I think there is growth elsewhere with better valuations. So, I am right now comfortable being underweight pharmaceutical. I am right now comfortable being underweight pharmaceutical. I am keeping an eye on the valuations.

Q: They have come down to below median valuations.

A: Yes, but they could go down even further. We don’t know because there is growth as well. So the excitement is elsewhere.

Also, with regards to NBFC, I think you have to be careful about some NBFCs because they have become very expensive. You rightly pointed it out, I dismissed your point earlier with regards to share price performance but not with regards to valuations. So, I don’t think NBFCs universally are stocks to look at.

I always am worried when a bank does 30-40 percent CAGR in growth, five years on the trot. There is always some accumulated NPAs that are there. So, you have to be careful and diligent about which banks you back and you have to be assured that their practices are good and they are not accumulating NPAs. 

That said, I think we are in the start of a major boom in retail loans. So, that is a very big call for five years. In the early 2000s, corporate loans to GDP were 25 percent, by the end of the decade it has become 50 percent. Corporate banks CAGR was 30 percent.

I think today retail loans to GDP are 13 percent; I would not be surprised if at the end of the next seven to eight years that number doubles. So, banks with retail focus will CAGR at 20-30 percent depending on their size. It may or may not be priced in all the stocks, so, some stocks may have priced it in. I feel on a general basis it is still not priced in.

Q: Hindsight is 2020 of course but let us use a bit of foresight. Is Brexit a great buying opportunity? With hindsight we will know but right now if the market corrects 5 percent because of Brexit, 5 additional percent, is it a buying opportunity?

A: February was a better buying opportunity. I don’t think right now we are at levels in the stock market where you can say that things are in panic. There is no panic.

Q: But if we get a panic that will be buying opportunity? 

A: Of course but that is conjecture and if we get one. It will be great but we have not got a panic really. Stocks sold off a bit, in fact a lot of stocks were in the green yesterday, so, they didn’t even fall and we have had a nice rally since February. So, February was a much better buying opportunity, there was no Brexit then, there was just nothing, there was just a global growth scare and stocks sold off like the world was coming to an end. It seemed to be a far more interesting opportunity. Today we have not got that type of an opportunity but who knows -- if it comes, then you want to capitalise on it.