'Capital flight from EMs unlikely; India structurally good'

However, from a long-term perspective, Bala says the structure for India is still positive. Also, he adds that with the Chinese market becoming frothy, ‘money out of China is good for India’.

Below is the edited transcript of Jai Bala & Sanju Verma’s interview with Sonia Shenoy & Reema Tendulkar on CNBC-TV18.

Sonia: What is the sense you are getting about the market itself? Are we in for some more rough times and do you think 8,000 could be protected or is it just a matter of time before that gets taken out on the downside?

Verma: Speaking of the markets, there are two very important variables that need to be accounted for – one on the international front and another on the domestic front. Variable on the international front that has been spooking emerging markets including India.

The general consensus view is that with the rise in bond yields in Germany and in the US, risk aversion is back and that basically means that there will be a flight of capital from emerging markets.

Nobody seems to have realised that this time around the rise in bond yields has less to do with any rise in inflationary expectations or growth coming back because growth is still in the doldrums in the US.

The general consensus is that even the 0.2 percent gross domestic product (GDP) growth, for the first quarter of calendar year in the US, is likely to be revised downwards to a contraction. You are welcomed to basically empty malls and emptier showrooms. The sell offs in global bonds and the rise in yields basically has less to do with the rise in the risk premium pertaining to inflation.

It has more to do with the risk premium pertaining to deflation having come down. So, I think as Bill Gross of Janus put it very succinctly – this sell off in global bonds and the subsequent rise in the yield is nothing more than a momentum reversals because perennially till kingdom come for the last 2-3 years we were investing in bonds as a safe heaven so the law of averages had to catch up at some point.

There is not going to be a flight of capital from emerging markets because situation globally particular in the US is pretty bleak. A couple of months back I had said that I don’t foresee any interest rate increases in the US. My sense in speaking to some of the global fund managers there who manage large chunks of money is that before there is a rate hike there could actually be small rate cuts given that even the second quarter GDP number in the US is not likely to better than the 0.8 percent.

For everyone who is being routing about the fact that unemployment in the US is at 5.4 percent they seem to have forgotten that retail sales is the single biggest indicator that the Fed takes into account and December 2014 to March 2015 retail sales were down between 0.6-0.9 and April it was static. So nothing much is happening on that front so there will be no rate increase and to that extent emerging markets are safe.

Sonia: Do you concur with that view, technically that emerging market equities will continue to be relatively perhaps a better game than some of the other markets and within that what is your own view on how India will perform?

Bala: The sentiment towards Indian markets that we track in a global macro is one of the lowest. So, that is actually positive from a contrarian perspective. There have been many markets that have been falling since March, but the sentiment towards India is one of the lowest.

So what that tells us is that, we had put in a possibility that 7,997 was a very significant low but there was a 10 percent probability that that low could go. In the event that it goes, given the sentiment is low towards India, the probability that it goes much lower is very low.

So, it is not going to go much below, it is probably going to hold above 7,800. But from a larger timeframe perspective, the structure for India is still positive and when you are talking about emerging markets, China is looking very frothy.

We call this, in technical terms, as a wave five of a five. So, when that happens, it goes through a significant reversal. So, it could even work with the thesis that money out of China is good for India. But the structure for India is positive and there are a lot of structural negatives in the emerging markets which are looking fearable for India.

Ekta: One of the significant things this week was that the Bank Nifty broke 18,000 very decisively. In fact, broke its 200-day moving average as well. It closed at 17,500. how significant a level was that for incremental weakness on the Bank Nifty, according to you?

Bala: That was an important support. But as long as the May low holds, the probability of the markets getting higher and surprising everyone is still there. But as long as the important factor for Bank Nifty holding up is SBI not closing below Rs 255. It barely closed above that this week.

So, basically, we are looking at very important supports for Bank Nifty as well as the Nifty. It is holding above the May lows; as long as those hold, the probability that, we saw a very significant low in May is still on. But, the odds are still receding. Be a bit cautious in the market.

Ekta: One of the big sectors that were in focus this week was the entire FMCG space. How have you read the news on Nestle as well as ITC where there was that news about the loose cigarette ban in the state of Maharashtra possibly coming through?

Verma: Given that most of these FMCG players have 30-40 percent of their sales coming from rural areas, I will not specifically comment on Nestle or ITC. Between the two I like ITC.

While the results for the fourth quarter were nothing much to write home about, the interesting point is that despite a 14 to 15 percent fall in volumes, the revenue growth was still static.

I had anticipated the revenue growth to actually inch several notches down which did not happen but personally speaking there is so much to choose from within the FMCG space that you really don’t have to get into controversial stocks like ITC or Nestle.

If I have to look at the pecking order, it would certainly be some thing like a Dabur, an HUL, a Marico and an Asian Paints perhaps in that order.

One very interesting point which needs to be brought home is that in the fourth quarter the volume growth for some of the biggies surprised on the positive. Be it an HUL, which had a volume growth of six percent or Dabur, which had a volume growth of eight percent. What increasingly tells you is that demand is slowly but surely coming back and the reason why the top-line growth was muted.

Despite of volume growth of six percent, you only saw a sales growth of 9 percent from HUL and a ten percent sales growth from Dabur. That is because companies chose to be discreet and smart. They passed on the input cost deceleration on to the customers and did not get greed in terms of raising prices, which was also reflected.

The input cost fall was reflected in margins expanding by between 80 bps to 120 bps for all key players within the space be it HUL, be it Asian Paints, be it Dabur with the sole exception of Marico which saw a small contraction in margin.

So, my point is that FMCG does look interesting and for all those who are screaming their lungs off that rural demand is just not picking up, people seem to have missed the point that if you take the April inflation print and read in between the lines, rural inflation actually came in at 5.37 percent more than the urban inflation at 4.36 percent, something which was amplified by Marico’s numbers where the rural growth was 24 percent year-on-year (YoY) whereas the urban growth for some of their products was just about 18 percent.

So, rural growth is coming back into the system but it will take a while before it becomes more visible and more lumpy. So, FMCG is something that I am surely betting on because when you buy an HUL, you don’t want to look at the 30 times or 40 times it is trading at but the fact that the return on equity and return on working capital is at 100 percent or more.

So, you look at different parameters or more for different stock and in terms of efficiency ratio, FMCG stocks definitely rule the roost.

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Sonia: You were mentioning that from a risk-reward point of view the downside for this market looks limited now, so if we do manage to see a concrete rebound between two of these pockets- bank and technology, where do you see the highest amount of returns now?

Bala: Banks are an ideal bet. I am actually not that positive on IT space. That doesn’t mean I am negative there. Basically what I am seeing is that the cycle from 2012 lows to 2013 lows. Most of the stocks seems to have completed a complete cycle. Once that happens, we could see a sizeable correction come through for rise from 2013 lows to the highs of 2015.

So, that is the reason why I am a bit neutral on IT, but banks they still have a one more leg up. From a medium-term perspective, three to six months perspective, banks are heading towards 22,000-23,000 on the Bank Nifty, so that presents a tremendous low risk and high reward potential.

So, that is the reason why I am positive there. If you look at something like an Axis Bank, you can look at something like Rs 750 over the three to six months time-frame and even if SBI were to break the Rs 255 level that I spoke.

The down sides are about eight to ten percent but once that is done, the short-term correction would be done and the longer-term trend will take over.

So, with relation to IT and banks, I am positive on banks more than IT.

Ekta: I wanted to come to you with regards to Sun Pharmaceuticals. That one reacted to its numbers this Monday, it is down 12 percent on a week to day basis. How would you approach Sun Pharma from a technical stand point?

Bala: If you look at most of the stocks in the healthcare space, none of them have had a significant correction since 2012. So, basically what is happening is a long-term correction.

So, basically without getting into individual levels of Sun Pharma, there could be a bit more downside. Basically, healthcare is the only sector which never went below the 200-day moving average since 2012.

So, that being the case, what is happening for the stock is path for the course. So, it might look deep from a short-term perspective. But it could still have little more correction to come through.

But the long-term cycle is still intact. You are looking at fresh highs for Sun Pharma, but let the stock complete its long-term correction. Once that is done, we look at picking the stock up for the next up move.

Sonia: So, the long-term cycle is intact for Sun Pharma, that is the technical word coming in. But fundamentally, what would your own view be because we have seen stocks like Sun Pharma, Lupin, etc. consolidate for a bit. Is this a good time to be increasing your exposure to these companies?

Verma: I am not a big fan of Sun Pharma at this point in time. While I do agree that in the long run there is a lot of money to be made there, the fact of the matter is that no significant earnings per share (EPS) increases will be seen before FY17, maybe FY18.

I am not perturbed by the fact that despite a 50 percent jump in sales in the fourth quarter, the profit after tax (PAT) crashed by 40 percent, it was obvious that the Ranbaxy integration costs would take their toll.

But, what really spooked me was the fact that the operating margin came in well below consensus at just about 14 and a half percent and even if you account for the fact that research and development (R&D) spend went up to about 9 percent of sales and you add that back, the operating margin was just about 22 or 23 percent which is still a far cry from the 44 percent that they logged in for the same quarter in FY14.

So, that is a huge fall and my personal sense is that Sun Pharma has had a brilliant run, ditto with Lupin, though of course, then FY17, if you are talking of an EPS of Rs 73, then Lupin certainly looks far more attractive with respect to valuations than Sun Pharma.

That said, at this point in time, the pecking order that I am looking at in pharma would be Cadila, followed by Wockhardt and perhaps Cipla. The reason I like Cadila is that if you look at the fourth quarter numbers, they were excellent, it was picture perfect with an 18 percent jump in sales, a 40 percent jump in PAT. The profit before tax was actually extremely sharp with a 60 percent plus jump.

And mind you, this despite the fact that the company has been firing on only one cylinder. Their Latin-American business has yet to see traction. Their joint venture sales have been muted. The India business grew by just about 9 percent. But the US business grew by 44 percent year-on-year. And even if the stock moves up to Rs 2,200 or so, it would still be trading at just a little over 20 times FY17, so there is a valuation comfort there.

But more than that, the fact remains this is a USD six billion company and if they do manage to acquire Claris Lifesciences which has presence in 70 emerging markets, the geographical diversification, that will certainly work wonders for them going forward. And while the management has chosen to play safe on that front, I am looking at some positive announcements on that front. And Claris will be a very small acquisition for them, but with big benefits, because do not forget that Claris has just about a market capital of USD 210 million odd.

So, Cadila and followed by Wockhardt which has seen a steep correction all the way from Rs 1,900 to sub Rs 1,400. So, I am not factoring it at this point in time, any positive EPS accretion from their Waluj or Chikalthana plants.

But even if the Aurangabad plant adds something like Rs 70 million to their sales in FY17, you are talking of an EPS of something like Rs 85. But if Waluj and Chikalthana add to the US sales, then the incremental number in the US sales could be anywhere between Rs 120-250 million, which means you are talking then of an EPS of not 85, but Rs 125. So, then the run up to Rs 1,700 or Rs 1,800 or back to Rs 1,900 is certainly there for the asking.

And of course Cipla, which again, is a story that has been evolving, it has had its fair share of issues with respect to Food and Drug Administration (FDA) import alerts. But it is still one of the better valued stocks within the space, so that is the pecking order for pharma.

Sonia: What is your own view on how to approach some of these stocks? Not just Larsen and Toubro (LnT), and what do you expect from that, but also, something like a Tata Motors that lost almost 10 percent this week? How would you map that chart?

Bala: The auto sector is very crucial for the overall health of the market, my understanding from the chats is that there is still one more leg up for the auto sector. But as you recall from our last taking stock interaction, I had pointed out that I am more favourable towards Bajaj Auto than any other stock within this space. Bajaj Auto is set to take out the all-time high at Rs 2,700 plus. So, I would prefer a Bajaj Auto to Tata Motors.

Coming to other stocks, in the highly leveraged space, you would recall, when we were bullish on the markets and calling for fresh highs to come through, we said we were very negative on DLF and expected that to take out the 100 level. It was trading at about Rs 140 odd in those times.

And even now, we saw this week it hit a low of Rs 103. It could still have much more downsides to come through. But, from a trading perspective, a risk reward potential is quite low, so you would rather wait for a pull back closer to something like Rs 120-125 to come through and then try to act on it. But, we are negative on the highly leveraged space like infra stocks and real estate stocks. So, we are positive on auto. As I said earlier, it is very important for the larger health of the market.

Ekta: Any specific stocks that you could leave us with in terms of picks from the broader markets even maybe from the front-liners that besides the auto space, any specific stocks?

Bala: There are two sectors which I spoke about in the BSE FMCG space in the early part of May. I was positive on it and I even picked up something like Bombay Burmah Trading Company which had no coverage from the fundamental side. And that has moved from Rs 400-550.

And I am still positive on the FMCG space. From a front-line stocks, Asian Paints is looking very attractive, but it needs to bottom somewhere close to Rs 740-720.

Once it does that, we are looking at something like Rs 900 plus for the stock. But it is very important for us to understand that a trading setup is made up of three components, one is the setup, next is the reversal and trigger, and then you pull the trigger.

So, you wait for the stock to bottom around Rs 720-740, if it does not do that, do not do anything about it. Likewise, even Colgate, Palmolive is positive. It is attractive at Rs 2,200.

Outside the FMCG space, last we spoke about Coal India, it has moved up quite a bit and we still have much more upsides to come through. I think it has been in a very sideways range for several months now. It is trying to breakout of that. We are looking at something like Rs 440 for Coal India.