Expect a sharp global correction by Diwali; worst over for pharma: Udayan Mukherjee

Q: Last week you had the Fed hiking interest rates and the market is expecting two more rate hikes for the rest of the year. Besides, the ECB has also indicated that it could put an end to quantitative easing by the end of this year. So how do you see these developments impacting Indian equities?

A: These are the most important ponderables for the market right now. Earlier we have spoken about elections and election cycles and earnings, but over the next 6-7 months the most important factor determining Indian market performance and global markets is this world of shrinking liquidity. You have seen signs of it already, the fact that emerging market currencies have started doing quite badly and emerging market equities are not doing great. India has outperformed over the last one week because of the sharp fall in crude oil prices which is very good for us and that is why we have done relatively better.

But overall, the turf for emerging markets looks very tricky for the next 6-7 months and I think we should all tread with caution out there. Particularly markets like ours where we have seen consistent outflows from foreign investors, both from the equity and from the bond market and therefore, a country which is running a fairly significant current account deficit today and the question of how to fund it in a world of shrinking liquidity, both from Europe and the US, is a very important question for both our currency and for our stock market.

So I think, if I had to stick my neck out, I would say that given that stock markets have bounced back quite significantly globally and in India close to the previous highs. I think some time in the next 5-6 months, between now and the end of the year, if you want to narrow it, between now and Diwali, there is a significant risk of a fairly pronounced global correction of between 10 and 15 percent. That is not a small correction. It may not happen immediately like next week or next fortnight, but I think in the next 4-5 months, the chance of a fairly sharp global correction, particularly in emerging markets is fairly high.

Q: We are seeing some renewed weakness in the rupee. What is your outlook on the currency in the short-term?

A: It is the pain point right now. The rupee is at 68 per dollar and it is not just the rupee-dollar, it is about pretty much any emerging market currency which is struggling because emerging markets now realise how difficult the turf will be for the next 2-4 quarters given that liquidity is tightening. When liquidity tightens and the dollar strengthens, emerging markets struggle. We have seen it so many times in the past and this time it is complicated by the fact that US and China have had a couple of very ugly exchanges of the last few days on the trade front.

So, a trade war might be simmering, liquidity is shrinking and in the midst of all this, emerging markets might struggle. You are seeing some fallout happening in the commodity market already and I think emerging markets will have it fairly rough over the next few quarters. So, keep watching this space, do not get side-tracked into looking at IIP, local inflation, local politics, because I think the overall, overarching driver for performance or at least for the next two quarters will be the global piece.

Q: TCS announced a buyback last week. Do you expect more IT companies to come out with similar announcements?

A: It is possible, but I think TCS' policy of giving back free cash to shareholders is stated very explicitly and it is sticking to that line which it has always maintained that whenever we have a lot of cash, which we cannot deploy, it goes back to the shareholders. And I think it is good for shareholders to have that kind of clarity in the free-cash policy of a company. TCS is a class act and in the past, the serious money in TCS has been made by shareholders who have held it for a long time, not traded the stock.

People who have held TCS for the last 10-15 years have actually multiplied their money several times. There have been patches of 2-3 years in between where the stock has not delivered, that happens with every company, every sector, but people who have held on have actually done very well. So it is a good management, it is a good company, it has transparent and good policies and now, its recent statements and actions seem to suggest that it is beginning to feel more confident about growth going forward.

Is it the same across the board for all IT companies? Perhaps not. As results start rolling out, you will probably find that Wipro is still struggling, Infosys is still flat, TCS is doing well, NIIT Tech is doing well, maybe Hexaware is doing well. So you will have to choose your cherries from the IT sector and TCS is on top of the heap despite fairly stiff valuations. But I think it is an evergreen jewel and long-term investors should not think of selling it or even tendering stock in the offer.

Q: Pharmaceutical shares, broadly have had a good run in June so far. Do you think the view on the sector itself is changing?

A: It is probably changing and I think pharma stocks probably have hit their valuation and their price bottom. It took its cue from IT because IT got out of the woods first. But now there is a lot of focus from investors on the export oriented sectors, partly to do with the currency also. So a combination of these things, focus on export sectors, the fact that pharma has underperformed for such a long time, the fact that some of the newest FDA news in companies like Sun, Reddy and Cadila has not been bad, the fact that technically, there are some new NFOs coming in from mutual funds on the pharma sector. It is all coming together to sort of ensure that a bottom is in place.

Now we have already had a good rally of 15 percent plus in most pharmaceutical names. At some point, there could be a pull back, but I would be very surprised if pharma companies went back and made new lows or broke their lows from which the rally started. If I had to guess, I would say the worst is over for the sector.

Q: How would you look to play interest rate sensitive stocks at this point?

A: I would be very cautious. In fact, that is part of the reason why midcaps and smallcaps are not doing well because these companies typically tend to struggle more in rising interest rate environments even if the rate cycle is a shallow one which most of us expected it to be this time around. But many other sectors like NBFCs, housing finance companies, infrastructure sector, real estate, I think many of these sectors will probably struggle in a rising interest rate environment. So, I would not be in a rush to own those. Maybe there is just one more rate hike unless inflation goes completely on the boil, particularly since crude is showing signs of cooling down. But, I would say be careful and cautious about these sectors.

Q: We have seen a spate of auditor resignations. Do you see this trend persisting or is the worst over?

A: No, it is a dangerous trend and I think next quarter's earnings will also be followed by some more auditor resignations. It is also driving a line of quality in the market. Right now, given the multitude of risks surrounding us, global and local, people want to be in quality, people want to be in defensive names. And already, we have seen a significant correction in midcaps and smallcaps and this frequent and surprising auditor resignations is basically driving home further the point that you should be a bit careful about anything where the quality is not assured. So, I do not think we have seen the last of the auditor resignations and that remains a risk for the midcap and smallcap space.

There is another risk which is that as and when you get a pullback from this correction in mid and smallcaps, people who have not exited midcaps and smallcaps from their portfolio or reduced their weightage there, might actually look to sell on those rallies and even redeem some of their holdings in the PMS schemes which hold a lot of these midcaps and smallcaps. For the next 6-9 months, most investors, even positional traders are coming around to the view that it is best to stick to the defensive names and to quality rather than being in high beta, high risk midcap and smallcap names.

Q: Which is your favourite team in this World Cup?

A: My favourite is always the South American teams, Brazil. But they could not win last night so it remains a bit of a worry. So my heart is with Brazil, but my head says that it will probably be one of the European teams this time around. And it could even be a dark horse. I mean Belgium has got a fantastic team. Spain did well in the first match. We have not seen England play yet. Germany lost. So it could be a surprise from Europe which might make it past the post. Though I would, as always, be rooting from Brazil.