Morgan Stanley has upgraded its June 2015 target for the Sensex to 28800 after today's rally, says managing director, Ridham Desai. However, that’s his conservative estimate. Desai expects the Sensex to rally as high as 33900, but with some conditions: if the government continues to work on it fiscal consolidation path and the Fed doesn’t take any disruptive policy action. If these two conditions are met, then Desai says, the Sensex has about 40 percent chance of seeing this level by June 2015.
A 360-degree turnaround in sentiment regarding India, apart from institutional flows has led to this market rally. And a lot of it has to be credited to the government, believes Desai.
“People abroad have faith in the potency and execution of the new govt. They are sending the right signals. The Goldilock-like scenario that is unfolding, both on the macros as well as the micros, will change for sure, but we are fairly comfortable for the next three years atleast,” says Desai.On sectoral plays Desai prefers staying away from retail and industrials, but is confident on Indian IT companies and private banks. He sees demand in consumption basket, especially autos and food sector growing over time.
Below is the edited transcript of the interview to CNBC-TV18.Q: 1000 points in barely 2-3 months, a 100 points in 24 hours, what do you make of the speed with which we are moving up at this point?
A: There is a global rally in equities, it is not just India. We are underestimating how much of this is global. There is a very big India story that a lot of people have a lot of faith in.
I have met a lot of investors across the world in the month of July and nobody was bearish on India. So, people have amazing faith in the potency and the execution capabilities of this new government. So far so good, it seems like they are sending the right signals out there.
Investors’ faith is rising and we have this push from the world. It seems like a Goldilocks- scenario. It will change. It is not going to go up 100 points a day forever. However, I feel fairly comfortable with a 3-4 year view. You actually want to just shut this off for the next 3 years and let your money ride this market.
Q: One disappointment that we hear when we speak to some investors is that this government’s failure to articulate major reforms. Is that something that worries you or do you think what they have done is part for the course?
A: This has come from a lot of people. It comes largely from journalists; not in India but outside India. So my rhetoric is- what are these reforms? I want to know the list because back home, it feels a little different. It feels like we are changing things which could not have been changed and which we do not believe could have been changed. Just easing our procedures, disintermediating the bureaucracy, disintermediating ministries and these are changes which are far-reaching. In my view they are big reforms.
Q: So, you are saying that state of policy reforms were already there in the books, administrative reforms oiled the systems in a nice way?
A: Yes, India has got the tailwind of demographics like no other country in the world and don’t underestimate the power of having good demographics. I can give you an example of where it doesn’t work, like the Middle East. But it can work in India because we also have democratic institution. What we need is more robust institutional framework and we need better execution.
So the work for the government over the next five years is to ensure that it leaves a trail of institutional framework which by the way is what the Prime Minister achieved as Chief Minister of Gujarat over a ten year time frame. So now Gujarat is running on its own. It doesn’t require political intervention at every step and hopefully if he can leave that behind for India we will have a very glorious two-three decades but these are hopefully not last famous words.
Q: When people look at the diesel under-recovery from the outside in, I am sure in July when you were meeting investors these are the things they are looking at, whether it is the UPA government and P Chidambaram who put it into play or Narendra Modi's government who might take it forward?
A: If you see the last two months, the government has crashed expenditure. The trailing 12 month deficit in March was running at 5 percent. By the end of July it is running at 4.2 percent.
Q: What is the quality of that?
A: It doesn’t matter. Quality means there is no postponement of expenditure. In March expenditure rolled over into April and May. So, there was a big jump up. All that has now been absorbed and in July we are running a trailing 12-month number of 4.2 percent. The 4.1 percent target that was set in the June Budget which looked very unrealistic, which drew criticism from all quarters now looks achievable. The government has not yet divested a single crore of shares. It has not collected telecom revenues, these are without those revenues. So, they have managed expenditure extremely well.
So, when you talk about diesel subsidy, obviously it is contributing to this but this government means business.
It is not only about the government, we are also in a cyclical turn. That is also something that is playing in the markets. So, you have a structural potential via the governments mandate, you have a global rally which I don’t think we should underestimate and we have a cyclical turn, so it is Goldilocks like situation. A confluence of a lot of favourable factors, some of this will change in the next few months.
Q: What is more susceptible to change, let’s assume for a minute that the structural changes in the economy will progress, at varying speeds but will progress given the nature of this government and the faith in it, will the global factors remain as conducive. This is a question we put to everyone and nobody has an answer, so they sort of find a way to evade it or they say, who knows, we will see in March-April next year or June-July next year?
A: Who knows is the right answer but let me just try and speculate what can happen. It is a unique situation where we are getting into 2015. India opened its doors to foreign investors in 1993. Since 1993 to 2014 we have been in sync with US rate cycle. So when US was raising rates we were raising rates, when they were cutting rates we were cutting rates, for example 2003-2008.
For the first time in India’s history since it opened its doors to foreign investors in 22 years we may be doing the opposite, which is America may be raising rates and we will be hitting the peak of our rate cycle. This pro-cyclical tightening brings uncertainty to our doorstep and I really don’t know how this will play out in the marketplace but it is going to be an event that we have not got any experience of. So it will bring volatility to our markets.
Q: Can we be fair and say this is not necessarily the Modi wave playing out, it may be the stock market in terms of the gains that we have seen but what we have seen happening in the economy is probably a Chidambaram and Raghuram Rajan effect given the measures that they took last year?
A: Let me not disagree with you but add a point to make it a full point which is that let us not underestimate the repair on balance sheets that has happened only because Modi is the PM. The amount of debt capital that could be raised, the amount of equity that could be raised, just the amount of capitalisation that can happen and as a consequence businesses can actually turnaround, is only happening because the sentiment is better.
Q: Some time back you said Sensex target of 26300 for June 2015?
A: No that is actually revised, it is 28800.
Q: Would you stick with that 28800 or what you spoke about the Fed, the measures that the Fed could take would that change it?
A: The way we approach this is that we have a bull, bear and base case so this is the base case. The bull case is 33900 and it is premised on the government taking more forceful action by June 2015. So I am attaching a 40 percent probability to the bull case and that is all near even probability. But it is premised on the government taking action and the Fed not disrupting things. So if the Fed remains benign and the government takes action, we will see a much bigger upside to the index.
For your viewers, do not focus on 12-month price targets. We are in the midst of a multi-year of Bull Run and there is no point in trying to trade this thing. Institutional investors struggle, they are experts, they still struggle. Retail investors not even attempt that, just play this, put your money. The best way to do it is invest savings on a monthly basis. Households in India are dramatically underinvested.
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Q: When you say if the government does the right things, what are the right things that they should be doing?
A: In the list of the four-five things, one is to continue focusing on fiscal consolidation with the emphasis on quality which is cut back on consumption expenditure.
The second is wind down NREGA or at least make it more productive and these are the two very important things.
Third is kick start an infrastructure cycle, it has not yet started by the way and for that it is imperative that these divestments happen because that is the source of money.
The forth is tax reform particularly GST and the government is very optimistic that it will get the ball moving next April and if that happens it will be a pleasant surprise for everybody including in the market. I don’t think anybody is factoring in GST in April and so, that will be a big surprise.
The fifth thing is to continue with this admin reforms to ensure that processes get eased out and approval processes get better and people can do business easier. So these are the five things. It is not expecting a lot actually, we are not putting insurance and defence on this. I am not too fussed about insurance FDI, I think those are not as crucial to the economy. They are signaling desire to change things which is fine, they have limited impact.
Q: Your model portfolio for the next three years – these are stocks you should be invested in today and then chuck the key away as you pointed out and not look at for the next three years. What would the top five stocks be?
A: You should buy consumption, how much ever I do not like it, with a six-month view or a 12-month view. It is inevitable that consumption will do well.
Q: Consumption is expensive also?
A: Do not judge stocks on the basis of PE ratios. They should be judged on their ability to generate cash. How predictable that cash flow is and how much that is going to grow. A PE ratio will distort the nature of valuation. We recently wrote a piece of research which was titled Cheap Value Versus Deep Value. Therefore, cheap valuations are stocks which traded six-seven times earnings but they are not necessarily deep value.
Value is tough which will generate cash flow when discounted, you expect a return, produces a number that is above the current share price and that could apply to a stock that’s 40 times earnings and may not apply to a stock that’s 7 times earnings. I do not think consumption is much expensive. There is a lot of value there, amongst the consumption-oriented stocks, the stuff that I like the most is packaged food.
Q: Packaged food or fast-food. I am looking at the top 20 stocks under Morgan Stanley coverage and they are all rated overweight – Jubilant Foodworks features there. So I am assuming this is an instance that plays into the philosophy that you have just explained?
A: You want to buy food – that’s one theme. I am not so bullish about buying retail for example, because I think there is going to be a change in the way Indians will behave – I think we will skip the whole retail thing.
Q: Are you positioning yourself for e-commerce?
A: The all support services for e-commerce comes with a risk because somebody is now talking Drones, so then what do you do with logistics. What do you do with the courier service firms if somebody is going to deliver stuff on drones then they all come with risk but yes, as a concept, as a theme it is something that you should find stocks – so that’s one theme – consumption, in fact in that I would add autos. Therefore, food is one and second is autos.
I think India is very heavily under-penetrated as the road network improves, as urbanisation happens there will be greater demand for autos. So cars, two-wheelers, I like the whole bit.
Second, buy financial services. India is heavily under-penetrated. The fact is that financial services will penetrate rapidly, rural finances, micro business finances.
Q: How do you play this? Do you play this through private sector banks, non-banking financial companies (NBFCs), public sector banks or are you looking at other forms of finance delivery that will play out over time to come?
A: I lay a lot of emphasis on the people who run the businesses, so whenever you are buying a business, you should buy the people not necessarily the business because if people are good the business will turnout to be good.
Q: That is such a difficult selection parameter for us to understand which stocks you are pointing to?
A: Therefore, private makes more sense over public in the banking sector. I think that distinction is very clear-cut in the banking sector. You want to buy few good people and there are lots of bankers in this country; there is no dearth of good bankers.
I think private sector banks, non-banking finance companies as well should do okay. Therefore, financial services sector is the second place where you want to put money. I am a bit more reticent about industrials. The stocks traded up a lot post elections; they became a bit too rich on valuations.
Q: Why are you looking at valuation in this case?
A: Valuation in the sense they were not giving me enough value. They were pricing it too much about the capex and you can wait a little longer. Capex will take a bit more time to come back.
Q: Won’t they become more expensive a little longer from now because everybody will be subscribing to that philosophy?
A: They have become cheaper in the last two months, so you will get better opportunity to buy them. I have the luxury to wait and I am hedged because I own financial services. Don’t go too overweight on any particular theme. If you buy industrials and financial services then you have too much of capex in your portfolio, you need a bit of consumption as well, so I would avoid industrials.
I love technology. I think Indian companies are set for a multi-year run on US demand and it is underestimated by the market place right now. Stocks are not rich. Most of these companies or most of these stocks are trading at very reasonable valuations and their earnings are being under estimated, so I would be overweight technology.
Q: Are there enough largecaps to bet on? Would you need to go into midcaps?
A: You can go across the cap curve. There are microcaps to largecaps. We do not cover the microcaps but everything in that space looks interesting.
Q: Would you say the same thing if US GDP data for the third quarter and the fourth quarter came in at between 1 and 2 percent? The reason why I am asking is every time we talk about IT stocks and this conversation that goes on, either it is a rupee play or it is a US growth play. It is very rarely play that distinguishes between what one company does in technology versus what another company does in technology, so I am just curious. So you play this sector?
A: Then explain the difference in the performance of Infosys and Tata Consultancy Services (TCS) for the last five years.
Q: It is also the management and the growth thing.
A: There you are.
Q: But Infosys is on everybody’s buy list even though the company’s new management?
A: If you are right then the correlation across stocks in the technology sector will be very high because you are saying it is a top down story.
Q: This is how people usually recommend playing this sector, so if you see currency movement they will say this is favourable for IT, which is a good place to get into or if you see US GDP. The question I was putting to you is that the right way to look at it. How do you distinguish between companies in this whole process?
A: You can make the same point about food, which is that there is going to be demand for package food or retail food in the country and therefore, buy all food stocks it does not work that way. There is a good macro setting and then you have to apply macro parameters to pick the stock.
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Q: So if US GDP growth came in at sub-one percent over the next two quarters, would you still make these cases?
A: We have just published a report which is a joint report by a strategist and economist in the US talking about this being the longest business cycle, possibly the longest business cycle in the US in a long time. It could happen one quarter here or there.
The GDP data in America tends to be very volatile because of the seasonal effects but the underlying growth momentum is picking up, and therefore, we think that tech companies should do well.
One more reason why they will do well is that US is coming back as a manufacturing base and therefore, they will demand more services, they do not have the size of workforce to take care of the services demand that will emerge out of a new manufacturing thrust. Again Indian companies and this is not just software services but even the BPO companies will actually do quite well.
Q: What about pharmaceuticals?
A: Pharma is selective. It is a good environment with all these pattern expiries and lots of drugs in America that will be launched by Indian companies but you have to be selective. I do not think it is across the board. So selectively you should own some pharmaceuticals in your portfolio.
If you are an institutional investor and if you are overweight consumer discretionary and if you are overweight financial services then you would probably get underweight pharmaceutical and consumer staples because you need to fund that. In a personal portfolio, in a retail investor portfolio it does not matter because you are not benchmarking against the index so should own some pharmaceutical stocks.
Q: The one sector we have not discussed is metals. We are in a bit of flux right now with what is going on the coal order but none the less?
A: There is a fair bit of value in metals, something will arise out of the coal order but there will be few companies that are not going to get affected and shares of those companies are trading at reasonable valuations, so I would actually be overweight on that sector and also energy because energy will surprise us on the upside in terms of profits.
Q: Across the board energy?
A: Largely public sector, in fact that is one area where I would love to own public sector companies. Generally, I am not a big fan of owning public sector stocks but that view has changed.
Q: Across energy?
A: Not the utilities but the energy stocks which is both upstream and downstream. Since Narendra Modi has taken over as the PM, there is a bit more optimism regarding PSU companies. There is an urge to reform them and to generate greater return, people will make money. You want to stick couple of PSU names into your portfolio and the best sector is energy and the next one is material.
Q: Just to try and give illustration of what Morgan Stanley is overweight on and that includes companies like Bharti Airtel, Crompton Greaves, Havells India, HPCL and Oberoi Realty.
A: Real estate is good; the thing that we missed here is real estate. It is part of the financial sector but given how India's housing demand is likely to unfold over the next few years companies that deliver houses should do well. The midcap real estate stocks are decent companies. They do not have much leverage on them. The larger companies have leverage, so maybe not but the smaller companies look quite decent.
Q: What you do for more near-term games? I know you are talking three years but not all our viewers look uniformly three years term or three year horizon?
A: What is near-term when you say that
Q: I mean three to six months.
A: You really want me to tell you that.
Q: I know you have made the long-term bull case but I also want you to talk about not specific but medium and near-term market because in August while earning seasons was on, we did see a minor dip in the market, everybody was calling a correction at that point. It was a very feeble correction if one might point out because we went 100-200 points down and the recoveries were quite dramatic 500-600 points on the upside. What is that tells you about how resistant this market is now?
A: Indeed it is, because there is a confluence of three factors, so it has great support. The moment will end when nobody tells you correction is coming, so it is a bit heuristic in that sense. We do a lot of charts which plot sentiment; they still suggest some upside in the near-term. We do near-term stuff. The moment will come when the market will look overdone when it will look like the panwala is telling us to buy stocks and then a nice correction will come.
Q: On what stage of a bull market are we because we had the 2003-2008 bull market in which there were at least 10 instances of market correcting at least 10 percent and in certain cases correcting 20-30 percent and giving great buying opportunity to investors? So far we haven’t had any. Do you think at some point there would be a 15-20 percent correction which would be a great buying opportunity? Do you sense something like that coming anytime soon?
A: In 2003-04 we started at 28000 index, it was on April 25, 2003, that was the bottom of the index. By January 2004 which is eight months, we had more than doubled, we had gone past 6000. So if September was the mark this time, we were at 5300 and so, if you apply the same logic then, but then after that the market fell 30 percent because we had a big emerging market correction, the Fed raise rates and we had an election result by which the market got disappointed.
In the subsequent seven-eight months the market actually went down more than 30 percent and everybody gave up on the market saying it’s done, we are done, we are finished, this bull market is over. And then from that level of 4344, in August-September of 2004, from there we climbed up and that was a big run. So even if you miss the first leg you get a sharp correction, you come back, you still make a lot of money. So we are in a nascent stage, these are early days actually.
But the multiple comparison is very different because in 2004 even though we had doubled, the market multiple was about the same as it was before this rally started. So the multiple this time around is a lot higher and the profits were as depressed as they were then. So the story was all about profits coming back which is what I think can happen right now. But the multiple comforts are not the same as it was in 2003.
Q: We are expecting a lot of government paper to come to the market, what will that mean in terms of absorbing some of the liquidity that is sloshing around and will we see that depress some FII appetite for otherwise secondary market stocks? Secondly, besides equities, given your bullish view on the economy, are there any other asset classes that you would be investing in?
A: On the first question yes I think that will create some headwind and supply tends to get bunched up and also expect the private sector to raise money. We are getting past that threshold on valuations where it becomes attractive for companies to sell their own stock and therefore, there will be supply and that may become the point where the market corrects and it may coincide with the view change on the Fed. So it may come together.
A bit of supply builds up and the Fed changes view and we get a sharp correction. It comes as a triple whammy; it usually does so that you get a sharp correction and that will happen. I would not rule out supply being quite large in the next 12 months in excess of USD 20-25 billion.
Retail investors will pump maybe around USD 20 billion in the next 18 months and so, they are going to be big buyers of equities.
Q: On what basis are you saying this?
A: If you plot the share of equity savings in GDP or the share of equity savings to gold savings versus trading returns versus real rates, the charts are already telling me that there will be big bump up in equity savings. So financial savings are coming back which is why you want to invest in financial services stocks.
Last year financial savings were less than 7.5 percent of GDP which is close to 22-year low, it is very close to the number we had hit during our balance of payment crisis in 1991 and this number was 12.5 percent five years ago. Five percent of GDP is USD 100 billion, it is a lot of money. That shift is already happening and we will see a shift. So the policy of the last three-four years was to promote negative real rates and therefore, discourage financial savings which is why we ran a current account deficit. So that is already changing which is why it is important that the RBI sustains its framework.
Q: You recommend any asset class besides equity?
A: Long bonds, they look very attractive, the yield is at about 8.5 percent, it is very attractive, should do well in the next two years.
Q: If we are doing defence, or if we are doing railways but not yet doing infrastructure because there are some sensibilities involved you are signalling mechanisms are already working reasonably well?
A: In fact I would say railways is far more crucial than insurance and I will say around this is the real rate framework of the central bank. Rajan should get due credit. The emphasis that the central bank has put on real rates and the de-anchoring that they are doing on inflation is so crucial to this cyclical recovery that is happening and they will probably continue doing that as they have and that would be great for the economy. If they keep real rates positive more money will flow into equities and as money comes into equities the economy gets better because it is all reflexive.
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