Markets in 'goldilocks' zone but risks high: Udayan

The US market offers a curious picture, with the S&P 500 being perched near all-time highs even as bond yields are at an all-time low.CNBC-TV18 Consulting Editor Udayan Mukherjee says the market is in a 'goldilocks' kind of scenario -- market parlance for things being just right."There is tailwind behind this market. The recent US jobs data was strong and so is the overall economy. But the Fed can't raise rates because of the Brexit uncertainty," he told CNBC-TV18 in an interview."So right now, bad news doesn't matter. The market is focusing on liquidity and central bank action," he said. "The market rally is based on fallacious thinking. But the near-term momentum is very strong."He added that locally, stock prices were more vulnerable to bad news than good news from the upcoming earnings season. "The market has priced in 16-20 percent growth. So the room for disappointment will be low." In the interview, he also talked about why he thinks the L&T Infotech IPO was not 'exciting', outlined his view on midcaps and explained why he wouldn't buy back-from-the-brink JP Associates even with a 'gun to my head'.Below is the transcript of Udayan Mukherjee’s interview to Anuj Singhal and Sonia Shenoy on CNBC-TV18.Anuj: Strange scenario, we have the US bond yield at lows and we have the US equity markets approaching new lifetime highs. Friday was spectacular in terms of the non-farm payroll data. I am sure you would have looked at that. Your sense on how the global markets are moving right now?A: The global markets have gone into a goldilocks kind of mode right now, which is to say that the economic data in the US is improving, the jobs data, as you said was very good. That means that there is some kind of tailwind behind the market out there. Yet, logically, that should mean that the US Fed would raise interest rates, but because of the Brexit confusion, the US Fed will not move. So, the stock market there is almost saying we have got the best of both worlds. We have got some good economic numbers, but the Fed cannot move because of Brexit, so why should we not party.So, the market is in a strange kind of thinking mode right now where it says bad economic news does not matter as long as the Fed is not able to hike interest rates in the foreseeable future, and therefore we should focus only on one thing, which is liquidity and more Central Bank action which is likely coming and therefore there is no reason for the market to feel blue at all.So, it is all guns blazing out there. I do not know how long this will last. It seems to me like a fallacious kind of thinking that stock markets are in right now, but you cannot question the near-term wisdom of the market, which is to focus on liquidity and therefore grind stock prices higher.Intuitively, something seems amiss to me with this kind of reasoning, but in the near-term the momentum is very strong and an all-time high on the Standard and Poor (S&P) is not an insignificant matter from a trader’s point of view.Sonia: Forget about the market feeling blue, it is 50 shades of green that we are seeing on the screen this morning. But, we enter into the most important trigger for our own markets which is earnings. We kick-start with IndusInd  today. There is Infosys and Reliance on Friday. How do you approach this phase?A: Earnings were good last quarter and that is at least part of the reason why the market is at 8,400 today. As you have spoken many times in the past, we need to see further validation that earnings have bottomed out and earnings are on their way up.The only thing right now is how much of it is already getting priced in into the market because valuations have also moved on quite a bit and everybody on the street is talking about a number between 16 and 20 percent for earnings growth already. When people start talking about a number, then the market has already begun to price it in. It is not waiting to see that number, but it is getting slowly priced in.So, now, with validation, you will probably see market prices move up a little bit, but given that stock prices particularly in the sectors like cement, etc. some of the non-banking finance companies (NBFC) where expectations are high, their stock prices have run well ahead of those earnings numbers.So, my sense is that there is more to lose than to gain from earnings right now at least for the next couple of quarters because much of it might have already got priced in and the room for disappointment is quite low. I hope there will not be disappointment over the next couple of quarters, because then it might become a difficult thing for the market to digest, given that such a lot has been priced in already. I am keeping my fingers crossed. Hopefully, it will be alright.Anuj: Two of the erstwhile leading sectors have seen divergent moves. We have seen pharmaceuticals bottoming out and that has made quite a bit of an upmove. IT, on the other hand is struggling with all the news flow, whether it was Brexit and now some noise on the US Visa issues. What is your sense on the risk reward in both these sectors?A: IT, I am struggling to think how it will outperform over the next few months, there are too many challenges out there at this point in time. If the starting point of valuations for Infosys and Tata Consultancy Services (TCS) was maybe 15-16, you could still have made a case to go out and buy those companies, because they would have been trading at historic average historic valuations. The problem is these stocks are not terribly cheap given their own historical track record of valuations and now, the headwinds seem to be piling up. I am not talking only about Visa bill, which has been introduced, that will probably not see the light of day. But, there seems to be genuine resistance to the idea of outsourcing. We are running into US elections, which is also quite close to call. The market after seeing the Brexit vote will not be complacent about that, I imagine. Therefore, outperformance for IT, pending the election outcome from the US, might be a fairly static kind of an affair.Earnings too, might not gallop away, all of us know about some of the inherent challenges that this sector is facing. So, valuation expansion for IT over the next six months, at least till the US election results might be a bit of a challenging one. I imagine that a lot of funds have started positioning themselves for that and therefore, IT is not performing, which is not to say that the bottom will fall out of the sector. These are very resilient companies and resilient stocks as well. So, for example, Infosys might for the time being, settle into Rs 1,100-1,250, Rs 1,100-1,300 kind of a price band and not do too much beyond that at least over the next six months or so.Sonia: So, can I infer from your views on IT that you are not recommending subscribing to the Larsen and Toubro (L&T) Infotech initial public offering (IPO) because compared to the industry as a whole, L&T Infotech has been growing at a much slower pace.A: I am not in the business of recommending stocks, but I can tell you what I feel about it. It is not an exciting IPO. IPOs, which come with new themes, new ideas, new sectors, those excite the market’s imagination. IT, there are 100 stocks that you can choose from and then, a stock with a middling size, not with a very attractive niche in any case. If this was a product company or something which was doing something niche in the digital space, you could still have said that this is a different kind of an IT company, I want to look at it. This is a vanilla IT company and not even in the top-five, not even a billion dollar topline, focusing largely on the commodities space, primarily on the application development space so what is there to get excited about barring maybe a notch of valuations or two.On valuations, sure it is cheaper than some of its near peers like Mindtree or Tech Mahindra. But, you can get HCL Tech, which is so many times its size at probably just one notch higher on the price-earnings ratio (P/E) chart, 13 odd times. So, to go down and take a risk with that untried and untested quantity, that too, on a commoditised business which is not growing super fast or higher than industry averages. Just to capitalise on that one P/E multiple, I think it is not worth the trouble.So, you can play it and if the P/E multiple goes up to 13 on the day of the listing, you can sell it and just get that 7-10 percent pop, if that. You can do that game, but my sense is that this is not one of those exciting IPOs. There are better stocks in the IT space with not so much of a valuation premium to pick from. So, I will not seriously, be very gung-ho about it._PAGEBREAK_Anuj: Talking about midcaps the space that has dominated mind space over the last few days is the high beta ones lead by JP Associates. It has doubled from the recent lows, up 35 percent this month. Is it a space where traders are overstaying their welcome or do you see more gains?A: Midcaps will do well in a market like this because there is a lot of positive sentiment and momentum in the market right now. Next week we will probably have GST and that has been built up. I don't know what the immediate impact will be for GST but I remember those days a few years back where all that the market could talk about was FDI in a sector or another sector. So, we are in that state right now where the whole thing has come around to focussing on GST and that is such a make or break for the market and next week we will see it go through at least in principle at least.So, there is a lot of feel good in the market and typically given that large cap valuations have gone up such a lot midcaps will do well at a time like this. You are not seeing any major selling from FIIs or domestic institutions or domestic institutions not buying either and therefore domestic traders seem to think that they can have a feel there with many of these midcap companies. High beta as you said, high debt companies have done well over the last week or 10 days.I have never been a big fan of JP Associates. I know they have done some work with cleaning up their balance sheet, selling of assets and repaying some debts but I was looking at the numbers, the group debt is still around Rs 44,000 crore and they are selling some of their most profitable businesses just to stay afloat. I don't think their remaining or residual businesses can generate interest covers for Rs 44,000 crore of repayment which means that they will be forced to sell more assets.So, when you have a group or a company where the earnings from businesses cannot cover interest costs the equity value of that business should be zero. That doesn't mean that JP Associates will trade at zero price right now but in my mind that is something like Kingfisher kind of stock where it was trading at Rs 5-6. The market will accord some value to your stock but given what I described is the dynamics of its balance sheet the equity value should be close to zero and not Rs 2,800 crore as the market is giving it.I am not going to be buying JP Associates if I had a gun to my head. This group has shown enough number of times that they cannot operate their business with an eye on their balance sheet. They have made too many mistakes. It is something which is best avoided. Whether a trader can trade it up from 12-14 in the near term given this market mood that is a different question, I am not qualified to answer that. As a businessman it doesn\\'t deserve to trade at more than Rs 5.Anuj: That really stands out. We could argue about the index, but the fact is that the bottom up stock pickers have made so much money all through the last 3-4 years.A: I do not know how to say this but, yes people have made money, but people have also not made money. We only remember the winners, we do not remember the losers. And you look in any portfolio, take the portfolio of the guy you admire the most and see how many stocks have made money and how many stocks have not made money and you will find that the ratio is not more than 1:1. You look at Rakesh Jhujhunwala’s portfolio. Take it out, and see how many stocks have created a lot of wealth for him and how many stocks have not created wealth for him. And you will find that the ratio is probably 1:1 which does not mean that he has not made money. He has made a lot of money because he has accumulated the ones which have created a lot of wealth for him and probably gone slow on the ones which have not, but it underscores the point that this midcap selection business is actually better or seeing more glowingly in hindsight, when you have those numbers out and say this has gone up 100 percent, this has gone up 150 percent. But the fact of choosing it and actually making those gains is not that easy. So, I am not in that camp which says that bottom up you would have made a lot of money because you can take out a list of 80 stocks which have actually gone up a lot. You could, as easily, if you want it to be gloomy, take out a list of 80 stocks which have not done very well at all.Sonia: At a time when the Sensex is up 400 points, nobody wants to talk about the worrying signs, but it is always better for investors to remain vigilante. At this point in time, there are some worrying signs in the economy whether it is the slowing down of the commercial vehicles (CV) sector sales. Centre for Monitoring Indian Economy (CMIE) told us a while back that there is no pickup in private capital expenditure (Capex) at all. How much credence will you give these data points?A: Data point is a strange thing. Depending on how you want to feel, you can pick out a data point and say I am going to feel bullish about it or I am going to feel bearish about it. So, there are, as you said, worrying data points, the last Institute for Supply Management (ISM) Services data is barely expansionary at 50.3 and that is the largest segment of your economy. As you pointed out, the last kind of data that came out from the commercial vehicle space is not encouraging, replacement demand is weak and freight rates are actually quite soft. Now, if you were bullish, you would say that it is a temporary blip and you do not want to fret about it. Let us party about the market. My point is not that the Indian economy is not improving or that earnings are not improving. My point more is that in India, you have got things which are improving and I am optimistic about what the earnings picture and the economic picture is looking like. Right now, the rally which is playing out locally has got a lot of sentiment, momentum and euphoria about it because I do not see great buying from domestic institutions or foreign institutions over the last couple of weeks. So, this looks like a retail trader driver kind of a rally, nothing wrong with that. I am not saying that they do not matter, but it seems like weaker hands might be driving this leg of the rally by participating at this point in time. Globally, I am not optimistic. That has been quite clear the last few times we have spoken and there, there are very divergent kind of things which are playing out. One is that economies are not improving, but asset prices, like stock prices are improving and that is clearly a function of central banks pumping in liquidity. So, there is a complete disconnect out there in global markets. That might last for a while, but it may not last forever which is the Brexit kind of news that you are seeing is driven by the same dichotomy that I am talking about which is that central bank action has not been able to affect the lives of most people. It has affected the lives of stock market participants which is important to us, which is why we are talking about the Standard and Poor (S&P) high, but that is not the mood across most economies in the world today. And at some point, the two will meet. Now, whether it will meet in three weeks or three months or three years, that is very difficult to predict. So, right now, global markets are in the grip of the kind of momentum where doomsayers and Cassandras will be wrong and you will find that more of the bullish comment will hold sway at least over the next few weeks.