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Last Updated : Jan 03, 2017 02:48 PM IST | Source: CNBC-TV18

No bull market without earnings recovery in 2017: Udayan

CNBC-TV18‘s Udayan Mukherjee believes that market could rally in near-term also on back of a good Budget and global strength, but could sulk later once the Goods & Services Tax (GST) Bill is implemented.

The consensus view on the market is that the first 3-4 months of the new year are likely to be tough and then some recovery will happen, believes CNBC-TV18’s Udayan Mukherjee.

However, Mukherjee adds that market could rally in the near-term on back of a good Budget and global strength, but could sulk later once the Goods & Services Tax (GST) Bill is implemented.

The current year will be a volatile one for the market. 2016 was a pedestrian year for largecaps and midcaps.

Mukherjee said that core problem of the market continues to be earnings, which will have to be closely watched. If earnings recovery happens in current year, the upward trajectory is possible for the market.

The upcoming UP elections will add to the volatility in the market.

On banks stocks, Mukherjee said that chance of Bank Index leading the market looks stretched. “You will get better opportunities to buy bank stocks as you wade through the year,” he added.

Below is the verbatim transcript of Udayan Mukherjee's interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.

Latha: How will 2017 look for stock markets or at least in Q1?

A: 2017 is starting off on the predictable note of analysts saying once again that regardless of what happened this year, next year we will certainly get -- though we were wrong the last three years -- 15-20 percent earnings growth and by the end of the year, the Sensex will be up 15 percent. Having been wrong three times on the trot, maybe fourth year people will get lucky but one thing it has taught us is not to make these predictions at the start of the year because these one year predictions more often than not go wrong with earnings and with market predictions.

I think there is a fair amount of consensus which is leading to one view which is that the first three-four months will be tough then the markets will recover and by the end of the year will be much better off.

Since everybody is talking about this scenario, the chances are that this will not happen. I don't think markets are that easy to map and this view has the weight of consensus right now that we have to wade through three-four months of pain and the moment you get pass that and the April numbers, we are off to the races once again.

So something more surprising might happen, I don’t know what it is but I would put a very low probability to this scenario, which is being discussed right now. The markets could rally now, who knows, on the basis of hope, the Budget, global strength and then they could sulk later in the year or once goods and services tax (GST) implementation comes in and ramifications of that on the earnings trajectory, some talk between US and China, there are so many things which can happen during the course of the year.

So I would say, it would be a volatile year. How do we end the year? Going by this year's experience, it will take a very brave man to stick his neck out and put out a percentage return idea for 2017.

Anuj: 2016 wasn't that bad if you look at the midcap index or if you look at portfolios for example, the midcap index itself was up 8 percent. Lot of stocks did well to be fair and first day of 2017 also started like that, do you get a sense that it remains just like it has been for last two years, just getting your stocks right and that will reward you?

A: Let me give you some facts because more than conjuncture about what has done well and what has not done well -- you take out the top 10 highest assets under management (AUM) midcap funds. Let us not make our own list of 10 midcaps or 20 midcaps which did well because that is an exercise in hindsight tabulation. Who are the smart midcap managers in India? Presumably, the managers of the top10 largest AUM midcap funds. I would exhort you to go and look at that list. If you look at the big ones which are in the AUM of Rs 1,000-3,000 crore, which is large enough for midcap assets, you look at some names which are in the top 10 like ICICI Prudential midcap, Reliance midcap, SBI Magnum midcap, Birla Sun Life midcap, UTI midcap, Franklin midcap -- the returns are ranged between 4 percent and 7 percent maybe Franklin is 8 percent. So 4 to 8 percent this after a last week rally of the year in 2016 -- if you take out the last week rally in midcaps, I think returns for the last 12 months probably ranged between 3 percent and 5 percent for the country's largest midcap funds. There are two exceptions, I think the HDFC midcap fund and DSP Blackrock midcap funds, which are large and there the returns are between 10 percent and 12 percent.

You tell me, is this an exceptional midcap return spectrum from the country's largest midcap fund from expert fund managers -- I am not even talking about amateurs. So at the end of the year, you could make a basket of stocks and say midcaps did very well. It has not been a bad year but you look at the equity investor who invested in midcaps through mutual funds in 2016 and they got returns of between 4 percent and 7 percent. I don’t think that is an acceptable return from midcaps or a great return from midcaps given the risk that they come with. So it has been a pedestrian year for largecaps and for midcaps. The best you could say is that some midcaps did better than the largecap universe but you will have to leave it at that.

Latha: There is a whole lot of demonetisation months data that we have now started getting. The two-wheeler sales are dismal, tractors very good, trucks have come in bad in the sense they are down about 9-10 percent but the markets were expecting 20 percent, so they didn’t sulk much. What have you made of this entire picture and the impact on earnings?

A: It is a bit all over the place and it is a exercise in evolution even for the managements. I wouldn’t take management commentary negative or positive too seriously either because I don’t think they even know what is going to happen next month or month after that. This is so unprecedented that you cannot make a linear forecast of what happened in November then in December and therefore in January and February.

So the optimistic view is that things will only get better. The pessimistic view is that things will drag on for a while but I think these are all darts in the dark. I don’t think anybody including the managements know what will hit them in January, whether it will improve dramatically or turnout to be worse than December. So we are all trying to find our way into what the data will be like, some of the data is not good like the PMI contraction, the two-wheeler numbers, some of the data has not been that bad but let us see what January has in-store.

So this will take two-three months to play out and therefore to pass judgement at this stage will be a little difficult. Let us see, there will be some positive surprises in the numbers this Q2 where the market might have priced in a very dismal picture and the results don’t turn out to be that bad and there would be some results, which are horrible but then don’t think that that is the end of the good and the bad in the January quarter reporting because maybe some of the impacts cannot be foreseeing for the January to March quarter because this phenomenon might have more lingering and lasting impact than we think. So to think that everything has played out in November and December, I think would be an error.

So the markets might remain volatile with the numbers and the commentary but this saga will take a while to play out. So I don’t think the dust will settle quite in the month of January that easily but right now the data is mixed, some are good, some not so good. Let us see how it flows from here, we have to keep tracking the monthly data.

Sonia: What have you made of the kind of steep rate cuts that we have seen from banks lately? Banks are starting to lose their leadership, do you think that would continue?

A: I have not been very optimistic since demonetisation about banks because the turf is a little tricky for them and I am not surprised that the stock prices or the Bank Nifty is not exhibiting any great leadership or strength at this point in time.

My fear is that from a technical standpoint once the foreigners come back after their Christmas holidays -- as they are coming back now -- they will sit and take stock of what is going on in India and I think some of their core holdings are in the financial space. I hope that they do not have a situation where they start trimming some of their overweight holdings in the financial space in the light of what is happening with the rate cuts and what impact it has on some of their large housing finance exposure etc but I think banks have a difficult job right now. All of us know what the credit growth figures are like, they are not going to improve dramatically anytime soon, they are showing some signs of desperation because of the kind of credit growth that they are seeing. The asset quality profile looks tricky to me, will see how things go over the next couple of quarters, even the Reserve Bank of India (RBI) is not painting a very rosy picture of what the asset quality picture could be like even in 2017.

So if you have a situation where you are not getting the core engine of the growth firing which is credit growth and you have tricky asset quality profile and now you have the prospect of margins at least not improving, even if they don’t drop significantly, at best they will be flat so you will not get any buffer from the net interest margin (NIM) front either, I don’t see how these stocks can turn in very great numbers for 2017.

So my sense is that you could get periodic rallies but for the Bank Nifty to lead the market from hereon, looks like a bit of a stretch to me. I stick with my original hypothesis that you probably will get better opportunities to buy bank stocks as you wade through the year.

Anuj: How big of a risk is politics now because we now enter into the most important state, Uttar Pradesh (UP) and we have heard some populous noises. It has been measured so far, but then we never know as we head closer to the UP elections.

A: It will cause volatility. The markets are always very sensitive to politics, more so right now with what has happened with demonetisation and every verdict will be seen as some kind of verdict from the population about how it has gone down with them. So, markets tend to over-analyse politics and this time, it will be the case as well. Now, since there are so many moving parts of the puzzle this year -- there is Trump, there is demonetisation, there is GST coming, there is politics -- so many of these factors cannot be analysed accurately to distil down to a market view. I would say keep your eye on one ball because that is the one which is disappointing the market the most and consistently over the last couple of years, which is why the Nifty has not been able to go anywhere and that is earnings.

So, you track earnings in January and see what hit we have taken with demonetisation. You track it again in April and on that base, try and come to a reasonable conclusion on whether we will see on a very low base earnings recovery finally in 2018.

If the answer to that is yes and the market often goes wrong with that assumption -- and has in the recent past -- then the market has a good chance of recovering in 2017 calendar because the core problem of the market, all the noise around it notwithstanding, is still earnings and demonetisation has hit the market because it is hitting earnings for two quarters at least. And in fiscal 2018, we need to know, whether that lingering impact continues or earnings can recover. If earnings can recover, we have a good chance of resuming the upward trajectory after three years, otherwise we will have to wait. The rest around it is frankly -- at least from a local point of view -- noise.

Sonia: I wanted you to come in on the housing finance companies and the kind of pressure that these stocks are seeing. How do you approach them because some of these guys have been the best performers last year? Do you see that trend reverse this year?

A: Tactically, they are running into rough weather now. From a longer term perspective, it is difficult to bet against housing finance in India because the space is so good that eventually people will make long-term investors will have to stick to housing finance as a space. But in the near-term, there are significant headwinds which are cropping up. Of course, you guys have all discussed how this State Bank of India (SBI) rate move could lead to some kind of net interest margin (NIM) compression for housing finance companies and that will happen.

My bigger concern, other than the NIM compression, is that banks have such few avenues to deploy credit in right now that their eyes will automatically focus on the low hanging fruit which is housing finance. Many housing finance companies are still growing their AUM at the rate of 15-20 percent per year, which is mouth-watering for any bank today because they are just not able to deploy funds and they just got a lot more to deploy. So, I see that the competitive intensity particularly from the public sector banks and even from the private sector banks, which are retail focused, are going up significantly in the housing finance space.

So, not only is it a question of rates coming under pressure and therefore NIMs, but I think the existing pure housing finance plays might actually find it difficult to grow their AUMs as significantly as previous years because of the onset of much more significant competition. So, it is a bit of a topline headwind plus the margin headwind and therefore, you could see price-earnings ratio (P/E) contraction happening in some of the more expensive names out in this space. I am not talking of the one that you were talking about just now, because that has at least valuations on its side. But there are many in the space, which trade in the ballpark of 3-5 times book and I see those multiples probably at the risk of contraction in the housing finance space.

Latha: You said that it could well be that the market’s consensus is not what happens and reality is that markets are able to hold up. Where can leadership come? Just about every sector seems to have a problem. If at all the markets rise, where can leadership come?

A: That is a good question. I have been thinking about that as well. But, it is a tough one at this point to point out. I am not suggesting the resumption of any major uptrend right now because the dice is loaded against the market at this point of time. You can see that. There is no energy in earnings and they probably will get marked down. The economic turf is not great. Flows from foreign institutional investors (FII), which set the price on the margin, they are disappointing. The rupee is not strong and there is every reason for volatility but not for a clean uptrend at this point in time.

So, the best that one can hope for -- if 7,900 is to hold out on the Nifty -- is basically some kind of a counter-trend move in the market. Those things can also be powerful. Now, it can happen for a variety of emotional reasons like some tax cut comes in the Budget and everybody thinks that is the palliative for all our problems and the markets make a massive run. So, maybe this 8,200-8,300 level, which I think is the near-term top for the market, this 7,900 is the near-term floor, if for some reason we can break past that 8,200-8,300 congestion zone, there might be a feeling in the market that we have a short-term bottom in place at 7,900 and this rally might extend. It is not my base case assumption, but strange things do happen in the market.

And if that were to happen, I think the stocks which might lead it are the stocks which broke the market’s back in the first place. Something new will not emerge. Maybe consumption will come back into play, maybe pharmaceuticals come back into play, maybe even non-banking finance companies (NBFC) recovered because they have been thrashed up too much. A combination of these beaten sectors can lead a fairly powerful technical pull-back move which might suggest for some time that the worst is over.

But I would submit that aside of that, we are still wading through such a difficult economic turf that barring a counter-trend powerful rally, you should not expect too much of a recovery in the market in the next few weeks. Because it is pitted with a lot of events, strange moves can happen, but I do think that we have to wade through very heavy water, which is the point I was making to you a few weeks back where people who were in a breathless rush to say that everything has been discounted, the market has put a bottom in place. I was suggesting that day to you that sometimes, it is not that easy for markets to factor in everything in five or six days and put a bottom in place. We have to do some heavy lifting over the next few weeks before we can talk about a proper resumption of this uptrend.

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First Published on Jan 3, 2017 10:37 am
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