Rally may not sustain; cyclicals have to support: Nomura

There may be some signs of the economy recovering, but Prabhat Awasthi of Nomura Financial is skeptical of a structural improvement.

Eight core sectors grew 8 percent in September, raising hopes that an economic turnaround may be underway. Awasthi tempers the optimism by saying that these are numbers for sectors where the market is aware of the capacity additions happening. “I do not think we have seen a structural pick up in the growth in the economy,” he said in an interview to CNBC-TV18. He says that the current rally is unsustainable, because it has been largely driven by defensive shares which have now become expensive and offer limited upside from these levels. And unless the other sectors start catching, the uptrend cannot sustain, he says. “For a fresh rally to start and sustain you need domestic cyclicals to catch up, things like banks, capital goods etc. A sustainable rally would mean that growth needs to essentially start heading back up which is definitely not something that I would call for structurally at this point of time,” Awasthi said. Also read: Sensex at new high; investors ready for Samvat 2070 warily Below is the verbatimt transcript of his interview on CNBC-TV18 Q: Did the core sector numbers impress you? Are you getting a sense that we are somewhat turning around? A: The numbers are good, but these are the production numbers for sectors where you know that there are capacity additions happening, for example in electricity. So there will be some sort of floor in the next five-six months to growth numbers because of two things. One is monsoon which has been very good and the rural sector would do well and secondly because there has been some revival in exports. Barring that I do not think we have seen a structural pick up in the growth in the economy. I would be very sceptical about our structural pick up and economic growth. Q: Would you be sceptical about this market as well from hereon or do you think that these moves are sustainable? A: You have to put it in the context of what has happened - why the market went down and why it has gone up and what has moved that market. First, the market fell initially because of taper and it recouped when the taper was absent, that is point number one. A large part of the move you can explain from that. Second, if you look at the year-to-date (YTD) performance of the market, a very large part, almost entire move in the market is explainable by movement in technology, pharmaceuticals and consumer stocks; consumer stocks to a lesser extent, especially because they have been weak of late, but technology stocks have continued to perform. So in a 7-8 percent market move YTD you have essentially seen 80 percent move up by technology, and a similar move by pharma stocks. However, the old economy stocks YTD have not done anything. Although from the bottom they have bounced back, but YTD performance for even public sector banks which have moved up a lot is still nothing to write home about, it is negative in several cases. So, what you have essentially seen on a full-year basis is a defensive rally but obviously, from the bottom there has been catch up. Now, the question is - what moves the market up from here? Essentially, the valuations of the defensives or the exporters are looking fuller compared to what they were. Although not absolutely crazy valuations, they are not extremely expensive but the valuations have definitely moved up across pharma, technology and consumer obviously is expensive. Therefore for a fresh rally to start and sustain you need domestic cyclicals to catch up, things like banks, capital goods etc and I am a bit sceptical about whether this part of the leg can see a sustainable rise. The rise we have seen in the recent past is more of a relief rally from taper, from the said currency, from the current account data but that is a one-time catch up that will happen. But for a rally to sustain would mean that growth needs to essentially start heading back up, which is definitely not something that I would call for structurally at this point of time. Q: Would you take any positive from the fact that at least in one big bank the amount of fresh bad loans generated has fallen. Even the gross Non-Performing Loan (NPL) percentage for Bank of India (BOI) was lower than it was in the previous quarter. For the rest of them the pace of creation of slippages appears to have slowed. Is there any positive in that? A: The point is that if you we going to live from data point to data point then it will be impossible to call the market. First of all we should think about this as what are the underlying factors which are driving the Non-Performing Asset (NPA) cycles up. Underlying factors are a very slow economy. There were stresses in several sectors, like power, then there was stress in certain sectors because of the policy issues - in road-infrastructure sector, for example because of the fact that people had overbid, their projects are not completed, so those kind of issues. I think the growth in the economy has not structurally turned, so those kind of stresses will remain in place. However, one can argue that spaces like power might have seen definitely a policy action which will reduce the possibility of NPAs forming, the kind that existed one year back might have been taken off.  But I would still think that the NPA cycle worsening or NPAs continuing to form at a high level by no means is over, primarily because of the fact that as I said I do not see an economy, which is going on a higher growth path. If you look at the import numbers demand seems to be contracting that would argue for fairly week earnings numbers maybe not this quarter but going forward. I am not sure whether a call about a structural move in NPA cycle getting better can be made at this point of time.