Deep correction near term unlikely; buy on dips: Madhu Kela

Below is the transcript of Madhu Kela’s interview with Udayan Mukherjee on CNBC-TV18.

Q: What is your view on markets?

A: We have had a dream run in equities in the last 12-18 months. Even the indices, forget in the rupee terms, but even in the dollar terms, they are up anywhere between 80 percent and 120 percent between Nifty, smallcaps and midcaps. So, whenever you have such tremendous run in equities, obviously, you have to take a step back and think whether the party is there for longer-term.

So, if you have a medium term perspective, which is like 3-5 years, there is still a long way to go for this bull market. However, in a very near-term, consolidation could be a decent way to describe this market because we have had such a big rise in individual companies also. So market should digest this rise and before we go to the next level, I am sure it has to get supported with ground reality improving and visibility of a much faster earnings growth in the markets, so that we can take the next leg forward.

Q: How would you describe this consolidation? The markets may choose to do one of two things. It may just go into a range for many months, maybe an 8,500-9,000 kind of range or do you think that the market has the prospect of a deeper pullback getting to even 8,000 or sub-8,000 Nifty levels?

A: Let us not put the numbers. I would say the market is more likely to consolidate because for a few days or a few weeks the numbers can be of anything. But, I would rule out a much deeper correction beyond 8,000 because let us say that you are in a bull market, one of the characteristics of a bull market is that it always will climb the wall of worry and there is no doubt in my mind that we are in a longer-term bull market.

Second characteristic of a real large bull market is that it does not give you a much deeper correction, which in other words means it does not give a free entry to a lot of people who are left out. So, time-wise correction to me looks a much bigger probability than the price-wise correction.

Let us also accept the fact that the leaders of this bull market whether they are pharmaceutical, whether it is technology or even FMCG companies or auto companies even in this correction they are not correcting and they form a significant portion of the Nifty weightage today.

I don’t see a situation where companies like technology are not very expensive. So, I do not see a situation wherein they can give a very big correction. I feel time-wise we will need to spend some time and that could get extended to 4-6 months in this broader range of the market before we take the next leap.

Q: So, many triggers have played out and you can think of two or three reasons like valuations, earnings, maybe even global reasons why the markets might face some hurdles in the near-term. But can you think of three-four things in the next six months which can lead to a big rally in the market?

A: There are two big triggers. One is the earnings rerating, which is there in the card. Obviously, the ground reality in the last six months has been very muted. But I expect, maybe two quarters down the line, there will be a much bigger earnings jump which will be visible to the market if you take a two-three year perspective. So, once that starts to kick-in and you have one good quarter of surprise results, then markets will start to factor in.

The other big trigger is the flow of domestic money. I have been interacting with a lot of people. People have not yet participated. The domestic people, the retail people have not yet participated whole-heartedly.

Also, the other asset classes, there is such a big challenge, real estate has been stagnant for last two-three years. People are finding it very difficult to exit their real estate investments. Then you have gold, which is crashed out, basically in the last two years there has been no return. Fixed income yields are falling, so there was some money to be made in the fixed income side; that money will be there for the next 6-9 months more and, the businesses itself are in challenge. So where do you go for returns?

Also, equity, on a contrary to everyone’s expectations one to one and a half years down the line has done quite well. The continuous trigger for the market -- every decline you will see big flow of domestic money and that is why I rule out a possibility of a much deeper correction because it will get supported.

Even globally, the entire situation of the rate hike by US to some extent may have got discounted because this is one event, which we have been talking for a long time. My experience of last 20 years is that something which remains in a discussion in the market for a long time, maybe the first one or two hikes, may have got discounted by the markets.

Even globally, today we are still in a sweet spot. Let us assume that even if US raises rates, there are a lot of other central banks which are still easing out, whether it is Japan or Europe or other markets, they are still easing out. So, I cannot envisage a scenario that even in the near-term, which is in the next 12 months, globally things can give way to a big correction to this market.

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Q: Is there an uncertainty in your mind that maybe four quarters back earnings would have picked up by now, two more quarters will pass but earnings would still not have ticked up? What is the level of patience for this market where it keeps waiting for earnings to catch up with valuations and at what point do you think there could be cracks led by disappointment?

A: This is one point I agree completely because market has been hoping that earnings would pick up and this is the biggest risk we are facing in the market. This is because if you see the bipolarity in our markets, whatever is performing, wherever there is quality, they are disproportionately valued.

To the extent of saying some pockets of quality look overvalued to me and wherever there is no performance, market is just not interested to look at any value, any bigger themes.  The earnings have been very disappointing in the other pocket of the market however the pocket which has been performing whether the price to earnings ratio (P/E) multiples are 30-40-50-60, there has been support of earning not to the extent the valuations have run up.

I would completely agree with you that if we do not get a clear visibility of earning revival even in the next two quarters, they are not decisive signs that earnings have bottomed out and things have started to improve. At that time market will take a very serious view of the earnings. I would still say that government has done a tremendous job, let’s give it to them. From where they have taken it over to do a coal ordinance and to do an entire coal auction in matter of six months, something which did not happen in 60 years, all this will start to show results maybe one or two quarters down the line.

Now, what I am watching in an immediate term which I said last time in my Budget interaction also—it is the Budget session and not the Budget.

We have to see whether the government politically can pull through all this reformist ordinances which have been pending barring one or two which will always be pending but if they can pull that off then all this will come in handy in pushing the earnings growth maybe two-three quarters down the line.

Q: You spoke about high quality stocks with high valuation. As a professional investor, what is your approach to these sets of stocks? For example, pharmaceuticals; great companies, very high valuations right now in many cases. Is there enough margin for safety to go out and still accumulate these stocks or do you feel nervous?

A: You have to have a portfolio approach because we do not know. I have learned one thing in my life: highs are higher than what we think and lows are lower than what we think. But, it is not for me to decide what is the highest valuation and when I should exit. Till the time these companies are still delivering 20-25 percent plus earnings growth and the broader environment is still in their favour, we are running a portfolio approach rather than running a skewed approach.

However, we keep evaluating on a very constant basis. There are one or two pockets of companies that are becoming expensive even from a three year perspective; it is very hard to make money even if I assume 20-25 percent growth. And we will be diluting our stakes in those pockets. We will be selling off and getting into something which is still reasonably valued.

In pharma sector still there are companies that are trading 18-20 times from one year, one and a half year forward perspective. That is not expensive, but there is the other pockets in the same sector where you find companies are trading at 35-40 P/E multiples.

We have to be careful about individual companies in these sectors which are in my view, have extended in terms of valuation. So, it is a bottom-up approach in these sectors rather than top-down.

Q: Let me ask you about contrarian investing now because the focus as you rightly said has been so much on quality that there are sectors in the market which are quite unloved. People just don’t want to go there, most of what we like to call high beta – whether it is real estate, whether it is commodities, whether it is large parts of power. Of these three sectors which ones do not belong to the favoured sectors in the market and which one would you plum for?

A: As a basket, I would evaluate full thing again on a bottom up basis. Last time also when we interacted, we divided these companies into two parts. One of the companies where the balance sheet has gone to an extent which doesn’t look that it can be repaired regardless of what the valuations are we don’t want to touch

However, within these sectors there would be some companies – like what happened in technology; in 1998-2000 there were 400 technology companies that got listed but 10 years down the line there are still 10-15 good technology companies that have survived and 380 of them have vanished.

I am envisaging a similar situation in this entire – you can club them as either rate sensitive sectors. So, there will be a few winners in these sectors and we are extremely focused on identifying those winners.

We are looking at operating leverage. Right now the operating leverage may come because of the fall in commodity prices, the operating leverage may come because of the fall in interest rate, the operating leverage may come because sales will rise much faster than what the market is envisaging.

I am convinced that in this entire bucket whether you talk of tourism, hotels, whether you talk of real estate, whether you talk of even construction companies, there will be few winners over the next 3-5 years and one has to really focus. This is where I think some kind of disproportionate money will be made in these stocks.

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Q: What about public sector banks, would you buy them now?

A: It will be very selective but may be I would love to watch public sector banks for further two quarters before we really pinpoint that this is a big bang buy.

We are very clear that it is not the whole sector which will be bought, there will be may be one or two or three banks which we would like to identify and hold on. If the whole story of India is to play out from a medium term perspective there will be few winners from this space but I would still watch them for a quarter or two.

Q: Where do you see the maximum risk of valuation compression in the next six months?

A: There are individual companies which have run beyond their near term justification of even three years earning growth rate. So, they belong to all the so called hyped sectors.

I am no one to say that 50 PE multiple is expensive or 70 PE multiple is expensive. In the technology boom we have seen that the last leg of euphoria in the market can take these companies to even 100 PE multiple or 150 PE multiple.

We just have to be conscious that they do not form a disproportionately large portion of your portfolio and that is what we are focused on. So, every time a company which is expensive becomes more expensive our approach is to trim down a little bit and make sure that as a basket they still are forming a reasonable portion of our portfolio and not a unreasonable portion of our portfolio.

Q: You spoke about domestic flows, do you get the sense in your interactions that people are finally convinced that they need to be in this asset class after last year’s experience and have they matured enough to buy some dips in the market, they won’t get rattled or thrown by it? A: There is no doubt in my mind. People are convinced that they need to participate in equities. When I interact with a lot of independent financial advisors (IFAs) across the bank sections, there is lot of bank interest in equity.

The problem is that out of Rs 100 people have put what they wanted to put, may be Rs 10 or 20 and they have been waiting for a sizeable dip to come in the market.

What is confusing them is a ground reality because when they talk to people like us they hear a story of India, what is going to happen in the next three to five years, I am talking six-nine months back and when they go and talk to an industrialist who is there on the ground, he tells them that nothing is happening on the ground but stock prices are telling a very contrarian story and so, they are in a dilemma as to whom to believe.

Do I believe a person who has experience in the market or someone who is doing real business and that is what has cost them to not to participate but I am sure may be in the next two quarters the earning growth starts to improve a bit and market gives them a chance whether it is in time-wise or price-wise.

There is a huge amount of money that is waiting from the domestic markets to come into equities and the other parallel asset classes whether it is real estate, whether it is fixed income, whether it is gold, whether it is any other asset class still cannot compare the equity returns if you have a three to five year perspective.

As a matter of caution equities cannot be viewed with a six month or a one year return perspective but if any one has three to five year perspective he will still make superior return in equity as compared with any other asset class.

Q: Gold has been a bit of a dog, do you have a view on gold yourself? Do you sense general disenchantment with that asset class amongst retail or domestic investors?

A: I had a clear view. We spoke many times in your channel at different interactions. As an asset class it has done whatever it had to do. Gold prices went up 10 times and it went up in an era wherein there was a concern whether some of the biggest nations in the world will fall and that is what was supporting gold to be an international currency.

I do not anticipate that fear to come in, but if at all that fear comes in, then only you are going to have a chance in gold to make money. Otherwise for a real long period we may have seen the top in gold.

Q: How big returns can be from listed insurance players because of the recent changes? Do you think it is an area of big opportunity or do you sense that the market has discounted quite a bit of it in the price already?

A: I do not think the market has discounted because this is one sector which has not done well in the last three-five years. Insurance companies have seen negative growth rate, have seen a muted growth rate and in a way it has consolidated.

We do not see a lot of new entrants in this sector which we did between 2002 and 2006. Whatever regulatory changes are being talked about, including what we recently heard in the press; the opening up of the bank insurance channel will bode extremely positive for this sector and, if independent companies are getting listed with a proper track record at renewal valuation, this is one sector where still a lot of money will be made. Again, at the cost of repeating, that this is one sector which has not seen a lot of growth.

Therefore, I do not expect insurance companies to do the offering at astonished valuation. So, there will be downside protected from a medium-term growth perspective and there will be opportunity to make money.