Indian shares are likely to follow a sideways trend in the near term in the absence of a real recovery in earnings, which will likely turn only in the second half of the next fiscal (FY17), says Gautam Chhaochharia, Head of India Research at UBS Securities.In an interview with CNBC-TV18, Chhaochharia said the market was unlikely to test recent highs or lows in the near term as disinflationary pressures would keep a lid on earnings even as there will likely not be a fiscal or monetary expansion.He also played down the impact that GST may have on the stock market's fortunes in the near term, saying tangible benefits from the proposed tax -- whose rollout data too is as yet unclear -- will likely flow only over a two-three year period. Below is the verbatim transcript of Gautam Chhaochharia's interview with Latha Venkatesh & Reema Tendulkar.
Latha: What is the overall view on the Nifty? Do you think it gets well supported at 7,500. Does it get there at all fairly soon because of the negative vibes we are getting from the global spaces?
A: We are not so worried about big downtick as such for the market, globally as well as for India, but you never know, if global emerging markets face a downward pressure, India will also hurt but in absolute terms we are not looking at Indian markets correcting sharply.
Reema: What is the probability that you would assign to the goods and services tax (GST) bill getting passed in the winter session and if it does then do you see the market breaking out on the upside and if it doesn't then would it hurt the market?
A: We have seen progress in terms of political realignment towards getting everyone on board towards GST. Our stance has been that the government even now has the numbers to pass GST in Rajya Sabha but it is a question of Rajya Sabha functioning and the government is trying to make sure that even Congress is on board.
Our stance also remains that GST is unlikely to be a market catalyst and will not determine the trajectory of the market. It will lead to sentiment for a day or two but it will not lead market to drive higher in itself. The market will be driven more by micro and macro data points rather than reforms or other headlines.
Latha: Therefore, in anticipation of the GST getting passed, are you already recommending any buy?
A: Our stance has been that around GST, the benefits for macro and micro is a longer term phenomena, it is a two-three year phenomena rather than a one year phenomena, in fact the first year could see a lot more turbulence in terms of tax revenues and impact on sectors than what market pricing in or looking at. Over the longer term the biggest delta from GST implementation in our view comes not from sectors where tax rates are effectively higher or lower because those will likely be competitive way and the benefits or impact will be short-term but will come in sectors where the unorganised sector becomes uncompetitive as they are brought into tax net. Those impacts will be much long lasting in the form of higher margins or higher market share or possibly mix of both._PAGEBREAK_
Latha: Which are those sectors where that advantage might come. In any case you are only expecting it over two or three years?
A: Yes, so the benefits will be flowed over two-three years because it takes time to bring in the unorganised into tax net and to show up in competition etc. So they are primarily in more small or midcap space in the building materials, ceramic tiles, packaged food etc.
Reema: Your thoughts on ITC after it's almost come to levels near Rs 300-310 thereabout and what should a longer term investor do?
A: I cannot comment on individual stocks but we are saying that one shouldn't jump to conclusion based on the chief economic advisor (CEA) recommendations on GST - (1) it is not clear as to what it encompasses whether it includes the sin rate, includes both central and state government or only the value-added tax (VAT) and (2) this is one of the reports; ultimately the decision will be taken by GST council and the CEA report is one of the reports. We have had seen many other reports over last couple of years.
Latha: You are making an interesting and slightly contrarian argument that it is not reforms whether it is State Electricity Board (SEB) reforms or foreign direct investment (FDI) or land bill that affects stock prices but more really earnings. If that is the macro call, slightly contrarian, what is the call on earnings? Does it takeoff second half, does it takeoff first half of next year or not even then?
A: Our view is that earnings recovery will be mild and gradual and we should see some recovery panning out in the second half of next year because even in the next three-four quarters you will see the pressure of disinflation capping nominal growth being a reality for markets and we still haven't seen any signs of any fiscal or monetary expansion as such to drive demand up in any meaningful way. So the earnings still have downward pressure.
However, the reason we have been seeing since early in the year that post budget the initial phase of honeymoon around the government reform headlines etc will matter less and focus will be back to macro and micro data points because you have to remember all the positives of these reform measures are anyway build into street forecast for earnings and macro. We all are positive on India medium-term and longer term and that positive stance is premised on a lot of these reforms going through while a lot of these reforms do not affect next 6-12 months earnings.
Reema: If the market trend is determined by earnings and earnings recovery is not going to take place for another one year, will the market upside be capped and if yes, do you see the market heading to levels of our previous highs of 9,000-9,100 in the next six-nine months?
A: It will be tough because it will be sluggish, the recovery will be sluggish. We still do not see any catalyst for recovery in earnings to be very sharp primarily because of the nominal angle, the disinflationary pressures. We have already seen some margin improvement because of commodity prices.
However, unless we see government or policymakers taking expansionary stance on the fiscal and monetary, we do not see an uptick happening in a hurry. So the recovery will be sluggish. It will be a recovery, earnings will still grow and grow faster than where we are right now but it will still be sluggish.
Latha: What would be the leaders of the rally such as it is. Which sectors would you bet on?
A: The sectoral call will become less and less relevant in our view because over the last six months we have seen the dispersion coming down; in fact even investors are more closely hugging benchmarks than earlier. It will be much more stock specific but in terms of our own recommendations, we are still sticking to overweight financials, oil and gas, pharmaceuticals, telecom and media and underweight on two-wheelers, industrials, infrastructure, power, capital goods and IT services.
Latha: Yesterday one of our guests made a point that while this year, in 2015 midcaps have outperformed the heavy indices. Now midcaps probably are reaching uncomfortable valuations and perhaps next year midcaps may not be the flavour of the year. What is your call?
A: I wouldn't disagree with that. We have midcaps in neutral stance as our overall portfolio basis. We won't be pushing midcaps aggressively as an asset class but midcaps in India is a lot more about individual stocks rather than as an asset class and we all know that midcaps have done very well this year also because of the interest from retail investors in local mutual funds, some bigger buyers of midcaps. So the answer to that question is more whether flows will continue on that or not next year.
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