FII liquidity driving mkts; fall can be dramatic: Experts

The higher the market goes, the more dramatic will be the fall believes KR Bharat of Advent Advisors. However, he expects market to make new highs backed by liquidity.

Manish Sonthalia of Motilal Oswal AMC also agrees that abundant liquidity has helped market to rally. "If the economy grows at 4-4.5 percent and corporate profits in FY14 and FY15 grow between 8 and 10 percent, and if you are able to find stocks that can grow anywhere between 16 and 20 percent, you will beat the index hands down," adds Sonthalia. The buoyancy seen in the Indian market is purely due to abundant liquidity on back of tapering delay by Federal Reserve, but is not backed by strong fundamentals both locally and globally, adds Bharat. Bharat is cautiously optimistic on the markets and believes that the moment liquidity takes a turn, market will correct. He sees correction coming in by first quarter of the new calendar year. Sonthalia says, in the current scenario the sectors to watch out for are consumption, export themes, telecom and select financials, IT. While Sonthalia says avoid ITC because the volume declines seen in Q2 will not help it sustain at current levels, Bharat believes ITC is likely to outperform going forward on back of rural growth. Meanwhile, Bharat is upbeat on Larsen and Toubro (L&T) and BHEL but is cautious on banks. On the RBI policy front, Bharat believes the focus will be on inflation and if there is repo-rate hike, the markets could be disappointed and sell off for 2-3 days, but the power of liquidity is so strong that the market will overcome the disappointment quickly, and the push towards making new highs, says Bharat. Below is the verbatim transcript of their interview on CNBC-TV18 Q: This week the market gave some signs of cooling off and infact selling off a tad bit as well. Would you start to get cautious on the market or do you think the going is good? Bharat: Notwithstanding the fact that the markets have been going up and with all this talk about new highs, I have continued to be cautious. The reason for my caution stems from the fact that the fundamentals both globally and more importantly, in India have not changed. The factors that are keeping this market buoyant and will continue to keep this market buoyant for the next couple of months at least are an abundance of liquidity in the system and the fact that tapering has been postponed and could be postponed still further because of the US government shutdown recently. Therefore the party will continue for next couple of months. However that doesn’t mean that we forget the fact that from an economic fundamental point of view very little has changed around the globe and certainly very little has changed in India. So, I would continue to be cautious. If for the next couple of months the market continues to do well then it should be used an opportunity to trade, to may be book some profits before the turn of the year, because I do believe that tapering will start some time in the new calendar year. Q: What is your view, do you also concur that this has now become a traders market and you can perhaps still get on to this bus but with a shorter horizon? If yes what would be the stocks to look at? Sonthalia: Liquidity is abundant. You have a pre-Narendra Modi rally. If election results are favourable, in the state election that is coming up, we will see an expansion of the rally. Liquidity can expand your prices to earning multiples; there is nobody who can control that. If the economy grows at 4-4.5 percent and corporate profits in FY14 and FY15 grows at anywhere between 8-10 percent, if we are able to find stocks that can grow anywhere between 16-20 percent you will beat the index hands down. Right now the sectors to watch out for would be consumption, export themes, telecom, and select financials. So, I am positioning myself to play it out that way. Q: What is the call now? Do you think history is going to repeat itself, we are going to hit an all time high, retail is going to get sucked in and then all of a sudden we will have a big crack? Is there risk that something like that could play out all over again? Bharat: The usual caveat is that it is virtually impossible to predict our equity markets. So, the play now is the liquidity play but one has to be cautious that the inflation problem is not restricted to India alone, China too is facing its own inflation problems and there is a strong chance that they may up rates as well which could lead to a sort of fall in prices of commodities across the board. So, all indications are that until tapering starts or until there is a specific announcement from the US that tapering will start on a particular date, the abundance in liquidity will see markets go up. However, the reality is that if there is a turn in this liquidity which I do see happening post the tapering then that will sort of see a reasonably significant correction in markets. That correction will probably last until the economic fundamentals takeover once again. This market will get pushed towards newer and newer highs. The higher it goes the more dramatic is the correction that I see happening in Q1 of the new calendar year. Q: When the earnings season started the worry was that this is going to be a washout quarter. However it looks like there have been more positive surprises than negative surprises. Do you think that is going to lead to may be a change in sentiment and may be this rally can be a bit sustainable? Sonthalia: The first half of the results season has always come with companies reporting better set of numbers. It is the companies reporting numbers in the second half of the earnings season is what worries us. The public sector banks we have just started the earning numbers start to come through. Then you have capital goods, infra companies, the metal and the real estate sector. So far the going has been good. Most of the companies have reported either inline or slightly positive numbers than what was expected before the start of the earnings season. So, although that is giving some cushion to the downfall in the markets, it is a bit too early to take a call on the entire earnings season. However expectations are quite muted and second half of this fiscal should be better than the first half. Q: The next big event to watch for is the Reserve Bank of India (RBI) policy next week. Although it may not be the right thing to do but there is some section of the market that believes that perhaps the RBI may hold itself on rates and not raise rates purely to keep with the sentiment that is currently in the market. That is not what our poll is suggesting but what do you think, do you think that the RBI governor may use this as a opportunity to hold on to rates or do you think rate hikes will continue? Bharat: All the evidence that we have seen so far points to the fact that the RBI governor is not an emotional or a sentimental man. His clear focus is on inflation control and he is firmly focused on monetary policy. If you look at the situation today, inflation is not coming under control, and so his focus will remain that. The second thing to take note of is the fact that he has actually said and so has the finance minister that the RBI is in the process of building a treasure chest of dollars to ensure that when tapering starts we don’t get affected to the extent that people fear that we may get affected. If you take these two in conjunction what that means is the RBI is buying dollars and oil companies have been told not to buy their requirement of dollars in one shot but phase it out. When RBI buys dollars in the market, they are releasing rupees. So, while inflation control on the one hand is important on the other hand you are buying dollars releasing more liquidity into the system and there is a bit of a dichotomy there. Under these circumstances I would bet that the focus in going to be on inflation control. I don’t think sentiment is going to play any part in the decision that is taken by the RBI. Q: So, if the RBI hikes the repo rate by 25 basis points and brings down the MSF rate - do you think the market will be disappointed or will that be factored in? Bharat: I think the market will be disappointed because every time before the RBI governor makes his statement there are hugely optimistic (for market) expectations built around the event and so if the repo-rate hike scenario takes place the market will be disappointed, there will be a sell off and that sell off will probably last two or three days. However, the abundance of liquidity coupled with the optimism that is currently enveloping markets will take markets back up again. The power of liquidity is so strong that the market will overcome this disappointment fairly quickly, and the push towards making new highs will start again however temporary that may be and contrary to the economic fundamentals. Q: What is your take on IT? Is it likely outperform? Sonthalia: It is a good opportunity that stocks are correcting but I think IT is here to stay and in terms of returns generated this is one sector which will give good returns as we move into the next one year. The setting is very right; discretionary spend is on the up move, you have currency gains. Some of the companies are reinvesting those gains into building up efficiencies. There is expansion of multiples. The 14-15 percent NASSCOM guidance could be upped as we move into the next one year. Price to earning multiples are not very exorbitant, may be they are priced to perfection for the near term but if you have a one year view then I think there is still money to be made in IT stocks. Q: How would you approach ITC now? Bharat: There is an issue, and there will be an issue when an economy which was growing at 8-9 percent five years ago, is now around 3.8 or a 4 percent, so there is a significant slowdown. You just have to sort of look around you in terms of what is happening to prices and therefore what is happening to the consumption story. So, there is an impact across the board. I don’t believe that, that slowdown and the impact is going to affect the larger companies as much as it will affect some of the smaller companies. The rural story is still not as bad as perhaps the urban story. While there may be a bit of disappointment with the ITC numbers, I think over time a stock like ITC will outperform for a couple of reasons. One is the rural story that it encapsulates and second is its products. A lot of its products are reasonably recession proof and therefore notwithstanding some dips it will by and large given the fact that it has quality management it will outperform. Sonthalia: For ITC, what was expected to be an 18 percent growth has now come down to 14-15 percent growth. We have seen decline in volumes for this quarter. So the decline in volumes is to the extent of 5-6 percent is not good for a company like ITC.  I don’t think with this sort of a volume decline you will see the stock price sustain at current levels. So, according to me it is worthwhile to avoid this currently.