Cash ban earnings impact may not have played out fully: BofA-ML

Apart from strong domestic fund flows, the TINA factor (there is no alternative) in investments is driving the market higher, according to Sanjay Mookim, Director, India Equity Strategy at Bank of America Merrill Lynch.The next leg of market up move will need support from earnings, he says, adding that it is advisable to be a bit cautious on that front as the demonetisation impact has likely not been fully factored in and may call for some more earnings downgrades."Demonetisation has been forgotten. But we still need to see how much of the sales in December were genuine retail sales," he says. He believes there is residual stress in public sector banking. "With public banks remaining short of capital and NPL problem not completely resolved, private sector banks will likely continue to gain market share," he says. Mookim expects two rates cuts by the Reserve Bank of India this year, with one coming in the policy meeting on February 8.Below is the verbatim transcript of Sanjay Mookim’s interview to Latha Venkatesh, Anuj Singhal, and Sonia Shenoy on CNBC-TV18.Anuj: Do you recall when was the last time we had Rs 13,000-14,000 crore of FII selling and market going up 10 percent; that has really been the interesting aspect of the market over the last couple of months and from here on do you expect this trend of domestic liquidity pushing up stock prices further? A: I don’t, to be honest, but the phenomena as you have described it is because domestic liquidity has been very strong. We were worried that any sort of capital gains imposed on equity might deter that a little bit, but since that has not happened, the alternative investment opportunities in India at the moment are not very rosy. So, real estate is in a bit of a funk, gold is not doing anything and bond yields especially post tax on debt you don’t make any money at all. So, incrementally the flow is likely to end up in the equities as well which is the phenomena you are seeing in midcaps in carrying on from the previous discussions is more and more domestic liquidity tends to be attracted to smaller companies where people believe they have an edge, where they could generate some sort of an alpha perhaps and that is why midcap valuations will probably continue to rise up until you see a very strong primary pipeline built. We are hoping that we have enough issuances this year which caps out midcap valuations, but, yes on a theme, more and more money should keep coming into equities from India. Latha: I want to speak to you about the Bank Nifty and the PSU bank index. Both of them are leading the rally today in particular, 1 percent higher on the Nifty Bank, largely private sector bank index and the Nifty PSU bank index is up 1.2 percent after fairly sturdy gains last week as well. Is this the space that one should hanker after or do you see gains here, the economic survey painted a fairly grim picture of the NPL position? A: We have to remain cognizant that that is true for many large banks, especially the public sector ones the bad asset problem is not over. We may have been over the hump in a way because we have accelerated a lot of recognition, but certainly there is a lot of stress still residual in the system. More importantly the long term trend of public sector seeding market share to private sector is very likely to continue.Public sector is going to be short of capital not just to meet their NPA issue, but to deliver on the Basel III norms and only then find capital to grow the bank as it were and it becomes a relatively easier for private sector banks over the next three-five years to continue to accrete to market share especially for deposit let us say with the expanding branch network. So, I honestly don’t think that the NPL problem is completely resolved, maybe the market is looking at some short term benefits from the lower bond yields that gives you one time strength in the quarter. However, our advice to investors really has been to stay with the private sector banks where growth opportunities come through. Just a last point on that, if you were to forecast earnings for the market for the next two years odd, a large chunk of the growth will actually come from banks because of a) growth being relatively secure on the retail lending side, but more importantly provisioning cost starting to ease off because of the high base last year. So, banks, there is I think a lack of choice, many other sectors aren’t doing very well plus there is earnings growth visibility at least arithmetically which keeps you attracted to the sector. Sonia: What do you see as the big trigger for the market which could support the next leg of growth? A: To be honest it has to be earnings and that is where we are turning a little bit more circumspect because in my opinion what is happening over the last several months is that expectations are chasing reality. In the middle of November or early December, the reality was very bad because of demonetisation and the expectations were extrapolating that and the outlook at least in the market participants was very horrible. Right now, expectations are that everything has turned out fine, the demonetisation word is completely forgotten about, the results have been good so far and I suspect that that is not completely true as well. We still need to see how much of the sales that we have seen in the December quarter are genuine retail sales and how much of it is inventory buildup in channels. My worry is that at least in some part of the market, the March/June quarter may still see some residual impact of demonetisation come through. Therefore when the whole market is swung to haven forgotten the D-word completely, it may be an overshoot on the other side. I think downgrades are still due. We had called for the market being 29,000 at the bottom of demonetisation; it has gotten there in really hurry; I don’t think I am upgrading earnings either because the demonetisation has lasted shorter than we expected or because the Budget has delivered something that changes our opinion. Earnings being where it is, I think the market has gotten up too soon. Latha:  What are you hearing from your foreign counterparts, your international peers, are you getting a sense that India may play catch up because if you looked at it from November 8, we perhaps are still underperformers. So, as the emerging market (EM) trade reflates, would India play catch up and therefore get a little more money? A: I am not so sure. If you see the period of underperformance, you can break it into two parts, it is the November 8 to December 23 when we have underperformed. However, the bounce from December 23 when all EMs started going up, there is no underperformance. We have actually been bang in-line in the uptrend. So, there is this specific one period of underperformance.In conversations, I don’t see that coming up at all. So, the underperformance being a reason for attractiveness, no, people aren’t looking at it that way. Everybody needs to worry about where earnings are coming from and where valuations are and especially if you are thinking about this cyclically, then some of the commodity led countries in EM are perhaps better places to be still.Anuj: What is the call from here on because the index has also moved up but it is very close to as you said the fair value, it has been a bottom-up stock pickers market. Do you expect this kind of trend to continue for the rest of year where a lot of midcaps will do well regardless of valuations? A: It could honestly, I have no answer, no way to predict how long that will last. Arithmetically like I said, the relief to the domestic savings glut is if you start seeing primary issuances in size. We have started to see some especially if the real estate investment trust (REIT) and infrastructure investment trust (InvIT) starts happening, then there will be enough supply of equity to meet the demand of equity and which is when the valuation should stop re-rating. How can I time it? I don’t know, but to your previous question, will it be a stock-picker market? We did some analysis of this a little while ago and uptrend is always a stock pickers market. In a bull market, only alpha is generated through picking stocks. In a downtrend, when the market is not doing anything or it is going down, sector allocations tends to add more alpha than stock picking. However in an uptrend, it is always bottom-up stock picking that works. Sonia: On the RBI policy this week, what are your thoughts, in a sense even if there is a cut that comes in, do you think it would matter at all considering the big lending rate cuts that we got earlier in the year and how do you see the cycle progress through 2017?A:  We are looking for two rate cuts; one in this policy meeting. However, your second point I would agree with that you have already got huge transmission from the demonetisation, bond yields have already fallen and rates have already fallen, maybe the RBI policy this time does not lead to an incremental reduction in rates per se. The other point I will highlight is that no central bank has free choice, the big problem in India is that India savings rate has been falling very sharply. It is down from 36 percent to 29 percent and part of it could be because our real interest rates have been negative. So, the policy as it has been modified recently, intends to keep real interest rates positive. Inflation expectations are still not very low. Even our house forecasts are for them to be 5.5 percent by the end of December. If the intention is to keep real interest rate positive, then there isn't too much room I would believe for central banks to be very aggressive on cuts which is why I think that this is a year where after two years you may get equities outperform bonds where last two years all you had to do was to buy duration.