Expect GDP & earnings to trend down for next 2 qtrs: BNP Paribas

Raychaudhuri is positive on IT stocks and suggested that investors should avoid metals stocks.Below is the verbatim transcript of Manishi Raychaudhuri’s interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.Anuj: Indian market has had a double whammy, you have the dollar strength and of course the demonetisation breaking the consumption story back here. How are you dealing with both the issues now, do you think the market can deal with both the issues? A: In case of India, it is the local issues that have proved bigger because if you look at the kind of stocks that have underperformed the most, they are in consumer discretionary, they are some of the non banking finance companies (NBFCs). So, while the entire world and particularly the emerging markets have been reeling from the so called Trump effect, in case of India, the impact has clearly been exaggerated because of the local issues which have rather coincidently come at exactly the same time. So, eventually, India would be able to cope with it, to borrow your phrase, but in the interim, at least in the near term, we are likely to see some underperformance. We have already seen some significant underperformance by India in the wake of this problem and we think that in the near term, maybe over next one to one and a half months, this underperformance could continue. We are also seeing the currency, the rupee weaken significantly as a consequence of what happened domestically even though if we look at it from a broader framework, from the point of view of current account and the adequacy of the reserves that India has, the Indian currency should not have done so badly. So, I think in case of India it is a case of kind of a perfect storm that has hit the market in the near term. Latha: What is your sense however as to what is the fundamental damage of the demonetisation? Are you working with lower valuations, are you working with lower earnings growth? A: It is clear that in the near term, clearly in this quarter and possibly there would be some spillover in the January to March quarter as well, gross domestic product (GDP) growth and corporate earnings growth would be dragged down. From the interactions that we have had with the companies, particularly in the areas of consumer staples, consumer discretionary and so on, one problem that they are facing is in terms of the supply chain which has partly got disrupted because of the transportation problem that the transporters have been facing. It is almost impossible to exactly quantify what the impact could be in terms of GDP or corporate earnings, but what it looks like is that in FY17 we may end up with a similar single digit earnings growth like we had been seeing over past three years. In fact, I was hoping for that particular trend to be broken in this year, in FY17 particularly because of better performance in the second half of the fiscal year. However, now it looks like we will have to wait another two quarters for that recovery to come through. This has been clearly an unanticipated event which nobody could have predicted. As a consequence, all the market targets, etc, like we had been talking about 29,000 for the Sensex, they have actually been rendered meaningless in the short term. However, it is something that we have to cope with. I think the longer term consequence is obviously likely to be better because a larger portion of the economy is now gradually coming into the formal sector. However, in the near term, I think the impact on corporate earnings, on GDP growth, is something that we have to bear with. Sonia: Are you advising buying anything now amidst all this turmoil? A: There are some stocks which have reached interesting levels. Even though the market maybe down somewhere around 7-8 percent from the recent peak, there are some stocks that have declined about 20-25 percent and in some cases even more. So, we think that in some of those, particularly let us say in the consumer discretionary areas, in some select few non banking financial companies, such opportunities maybe arising right now. However, having said that, investors would have to be selective and it is not very clear how long this impact is going to last. As I said, it may spillover slightly into the January to March quarter as well. However, for long term investors who are focused on one year, three year or five years, I think there are some interesting stocks that have opened up in terms of better valuations. Anuj: Would you buy any NBFC now; that was the big theme which was going on before this whole demonetisation took place and stocks have now corrected 25-30 percent? A: I would not obviously comment on individual stocks, but I think there are a select few opportunities within the NBFC space. As you rightly pointed out, there are stocks that have corrected about 25-30 percent. Now, having said this, there were a few NBFCs which were trading at very expensive valuations prior to this event and they have corrected the most. So, in this universe, investors would have to look at two things, number one, the NBFCs which are unlikely to face the brunt of the cash crunch and secondly, the ones which are not fairly egregiously expensive or the ones which have not simply corrected from being very expensive to slightly expensive. So, I think these are the two filters that one has to apply in this sector and applying these filters it is possible to select attractive stocks over the longer term. Latha: Let me come to the consumption stocks themselves. Bluest of blue-chips like Asian Paints and Eicher Motors have corrected a goodish bit; would you start buying Eicher Motors right away or is there a fundamental issue that you have taken off ill-gotten gains from the economy, you have given almost a threat of life to people who are evading taxes, so, companies like these, consumer companies, may not quite reach their previous immediately? A: Maybe not immediately, because as you pointed out, one impact of this so called black economy being reducing in size is that some of these consumer discretionary items which were being bought purely on cash and the income not being declared by the relevant companies, that portion of the transaction would obviously be lost going forward. However, we think that the longer term impact of a larger portion of the economy getting captured in the formal sector can only be positive. I can understand what you are about to ask so I can guess that you are about to ask me that what portion do we think -- now honestly, it is not an easy guess. There are several estimates of the so called portion of the black economy that have been floating around. We have seen estimates ranging from 20 percent of Indian GDP to somewhere around 80 percent and honest answer is we don’t know. The flow of black money and so called conversion to white is no intricate, I think it is almost meaningless to try to get an exact sense of that. Latha: There is a very good likelihood of yields and interest rates and generally the cost of money going down rather sharply. We have already seen some big cuts in bulk deposit rates, they will be followed by retail deposit and then by lending rates as well. So, is it a good time to buy commodity stocks like for instance even a Maruti, why only Eicher?A: I wouldn’t name any stocks but at the same time I think in this consumer discretionary space, particularly in the auto space, if you look at passenger cars, two wheelers, or even tractors, agricultural tractors, a majority of sales of these were clearly on a combination of cheques and other electronic forms of payment. So, I would think that after this massive correction that we have seen in the consumer discretionary space, they are actually providing a good entry opportunity for most investors. The point about interest rates that you made just now, I think that is very correct. The increase in liquidity has clearly had its impact in terms of deposit rates. At some point of time it could get translated into lending rates as well, so, this complaint about non-transmission of monetary policy that we had been hearing for quite a few months now, it is sort of brutally coming through. So, banks are actually reducing their lending and deposit rates and I think this impact would obviously be positive for the consumer discretionary sector.Sonia: Are you interested in either of these spaces, metals or IT now? A: IT, yes and metals, no. Look at what is happening across the world because in these two spaces, they are essentially globally linked. If you are likely to see an appreciation of the US dollar as a consequence of much faster rate hikes by the Fed than we anticipated earlier, it could have a debilitating effect on commodity prices because we must remember that the US dollar and the commodity prices, particularly the hard commodity prices, are inversely linked. Even though it would also mean higher demand from the United States on account of infrastructure construction and so on, majority of these hard commodity demand arises in China, close to about 55-60 percent for coal, iron ore, etc and the over capacity situation still persists over there. So, the hard commodities are a space that we would not be very positive on at this point of time. IT is a slightly different issue. We have no doubt seen order cancelations here, we have seen companies coming up with profit warnings, but at the same time, if we do have a recovery in demand and GDP growth in the United States and a simultaneous US dollar appreciation going forward, both of these are pretty significant tailwinds for Asian exporters including the service exporters from India. I think that is something that investors must be aware of at this point. Anuj: What about fund flows, are we anywhere near the foreign institutional investor (FII) capitulation or do you think that is too early to call because that is really been the most important factor?A: We have actually been seeing this retrenchment from the FII side from around mid October. This actually started prior to the presidential election in the United States and it has obviously been continuing. India has borne the brunt of it as a consequence of this local and global issues combining together. US dollar appreciation, if it lasts for too long, that has never been good news for emerging market flows. We have seen that during 1996 to 2002, we have seen that during 2014 to early 2016 and we are clearly seeing a repetition of that. Now, having said this, we think that within emerging markets, there are a few countries which have large current account deficits or which have concerns regarding capital outflows, they would possibly bear the brunt of it. They would possibly be the biggest losers as a consequence of this FII withdrawal. Some of those countries are Turkey, South Africa, and maybe some of the North Asian countries as well. On the other hand, India does not really suffer from too much of these concerns. So, we think that after this phase is over, some of the flows that we have lost, could come back. We are also seeing significant degree of support from the domestic investors, both retail and institutional, in India. So, after this period of turbulence is over, we should see some outperformance from this market.