Market upmove accompanied by fundamental improvement: Nomura

The recent volatility in equity markets globally was driven largely by a sucking out of and reversal in liquidity but economic fundamentals continue to improve at a slow but steady pace, says Prabhath Awasthi of Nomura."Parts of the economy has picked up strongly. If you look at data for electricity, cement, cars [they are pointing to improvement in the economic cycle]," Awasthi, India MD and Head of Equities at Nomura, told CNBC-TV18 in an interview.Conceding that while fiscal year 2016 was 'terrible', Awasthi said he expects earnings to increase 12-15 percent in FY17 -- possibly with a further upside risk -- on the back of low base, upturn in the commodity cycle and receding of pain in the banking system.Going forward, he said "every quarter will be a better quarter and markets will be healthier."Below is the transcript of Prabhat Awasthi’s interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.Latha: This rally is shockingly strong. What is the sense you are getting largely liquidity driven? Are fundamentals now getting the short shrift?A: The question is that which view you take on fundamentals. Our view on fundamentals is slightly more positive so I guess you don’t really seen this anomaly but in the short-term what we have seen when the markets have went down and now that they are going up mostly it has been liquidity driven. The risks on globally emerging markets in general have rallied, commodities have rallied so, we are sort of seeing that trend come through. So, both the downturn early on and now the uptrend to some extent is because of the risk off and the risk normalisation. Having, said that as I said fundamentally, we think that things are not gotten worse. If you look at the data in India it is not really looking as bad as, it is been getting. So, fundamentals have been improving. Earnings will follow, so we will see FY17 will probably be better than FY16.Latha: In that case what is your estimate of earnings growth? Where may we end FY16 and what are you all forecasting for FY17 in terms of earnings?A: FY16 is largely over; I think market has now started looking past FY16 and FY17. FY16 was quite a terrible year for earnings as you know. There were multiple pressure points in FY16 which have largely played out, so the biggest problem, pain points for earnings was commodities. The benefit of commodities is well distributed so what happens is that commodity price declines tend to lead to a downgrade in earnings. Not only that the kind of declines we saw led to also a stress points for banking system which obviously was a very clear in the last results of the banking sector. From all perspective therefore I think one, the fact that commodity prices are either stabilised or moved up from the bottoms. Secondly, the fact that given that, you probably will see some improvements from earnings perspective and base perspectives.Secondly, the fact that banking system was also flushing out the past mistakes rather than seeing incremental pressure so I don’t think the nervousness on banking sector was more on account of the fact that the stresses were getting recognised very fast and there was a concern on capital. The fact that these stresses were always there, was something that was always appreciated by the market. However, the ferocity of the write downs too the market was surprise - that has been absorbed. So, going forward I think if you look at the data, you are looking at better sales of commercial vehicle (CV), better demand for electricity, cars, two –wheelers, cements so overall broad economy is recovering. I would think that anywhere between 12-15 percent this is what we have sort of said in our strategy piece which we publish for 2016 is what where we have pecked the overall earnings growth of the markets. So, 12-15 percent with the possible upside if things get a bit better globally is possible._PAGEBREAK_Sonia: I wanted to ask you about the qualitative trend of this market. You did give us some of the positive factors but do you believe that the emerging market equity bear trend that we had for the last six to eight months as that come to an end and if yes what could the upside target for our markets be in the next say 6-12 months?A: The assessment is never optimistic or pessimistic; it is my assessment that we should get 12-15 percent. If I was optimistic I would say 20 percent growth in earnings. It could happen actually if things really do get better. Realistic assessment is for a 12-15 percent growth. Now whether we are completely out of the woods, difficult to say but what has happened if you look at last few months or few weeks even that you have essentially seen US Fed cooling off and the expectation on US Fed hikes have cooled. I think that is one of the reasons why emerging markets have sort of rallied. That view has been reinforced again by the Fed again in the last sound bites that you heard from US. So, that I think has given a relief. Can that reverse? It could reverse but logically speaking I think that where quick change in views of the sort that we are seeing I think may not happen. Secondly, the global economy still remains slow, so the monetary stance will probably remain accommodative globally. So, far as India is concerned, the positivity could emerge from the fact that if for example what happens if what Reserve Bank of India (RBI) does – for example if they cut more than expected 25 basis points is what expected, so if they cut more or if you start seeing a strong recovery in earnings in second half. This is also quite possible because you look at the data 30-40 percent growth in commercial vehicles, so some of the data points don’t look like 6-7 percent economy at all, they look stronger some of the data points are weak. What we are essentially seeing is an economy where the investment cycle is at the cusp of picking up but a very gradual process. However, there are parts of the economy which have picked up much more strongly. So, if you were to look at optimistic estimates of market you have a 15 percent growth in earnings, you get bump up in multiples by 5-10 percent and then that is your optimistic case that you go back up by about 25 percent. Sonia: What do you think the sectoral approach should be from now on? I heard you mention that Q4 will see decent pick up in earnings. Where do you expect to see the first signs of green shoots or a pick up this time?

A: I said second half of fiscal 17 should see much more decent pickup. However, what we have seen in Q3, which was a very poor quarter, will probably be better in terms of overall earnings in Q4 but the base effects of commodities are still very poor. So while they will get better, the real impact of base effects will be visible in the second half of FY17, but I do think that every quarter from here will essentially be a better quarter and the earnings downgrade cycle that we witnessed whole of last year will probably be coming to an end. So from that perspective market will be healthy because you probably will not see any more downgrades we have seen in the last one year.

Sectorally we have been saying that from our strategic perspective we have been saying in our reports that financial especially private sector banks are the best place to be to play an economic recovery followed by sectors like -- we have like oil and gas especially the downstream oil and gas plays, not the upstream ones. We like cement sector as a whole and we have been bullish on that to play an economy of a sort that we expect. We have been positive on autos especially four-wheelers but we added two-wheelers to that. So we have been positive on auto sector for domestic recovery. We have been positive tech to safeguard against rupee blow-up because of dollar strength etc. In defensives, we have been more positive on tech and we have been underweight on pharma and FMCG stocks.

Latha: With respect to the midcaps versus largecaps, we did see extraordinary midcap outperformance a few months ago. Now would it be stolen again by the large?

A: In the long-term the earnings is what drives performance. What we saw in the last leg of the rally for midcaps was purely a multiple expansion which was not necessarily backed by earnings. This is a massive multiple expansion and there was a time when midcaps became much more expensive than largecaps. So in the longer term the return will essentially be driven by earnings. I would guess that if there is an economic recovery which is taking place then midcaps in general will have more leverage on earnings but it will be very gradual process. The kind we saw last time around was largely driven by flows; domestic flows flowing into midcap funds and therefore chasing asset class where the supply was more limited. I do not think that we can continue to believe that that such a scenario will play out. So I would think that from multiple perspectives it's even stevens but if you take two-three year view and say that we are living in an economy which is slowly recovering then the likelihood of midcaps outperforming in general is there but the kind of outperformance we saw, the kind of runaway rally we saw, I don't think repeats and even if it repeats, it will come to an end like it happened last time around.