Carnage on D-Street continued for the second consecutive day Monday pushing the S&P BSE Sensex by over 1200 points in opening trade. But, experts feel the correction was long overdue, and the index could well head towards 32,000 by end of 2018.
“We have been worried about rally not just in India but globally which is largely driven by the cost of capital. I want to also highlight that Nifty might well erase gains made so far in the year but if we look at other markets in Asia such as China or Hong Kong are still up for the year,” Sanjay Mookim of BofAML said in an interview with CNBC-TV18.
“The pace of the decline is astounding, but we are so bullish that, in fact, we are bearish. We are bullish on the economy, we are bullish on the fact that inflation will rise, and we are also bullish on earnings growth of companies in India and elsewhere,” he said.
So much bullishness can be a cause for bearishness in asset prices because the cost of capital will go up and the environment of easy liquidity will have to be withdrawn. Even in India, we will see good quarters in terms of earnings growth, said Mookim.
We expect earnings growth in FY19 to be better than H2FY18. If we look back on the rally, the market was going up but not because we anticipated economic recovery but because of the lower cost of capital or reduced opportunity cost.
During market correction such as this, lower PE stocks will work better, relatively. In other words, they would fall less as compared to other High PE stocks. My target for December-end on Sensex is 32,000, said Mookim.
When the market is falling, low PE stocks or defensive stocks such as utilities, IT, material sectors that tend to do well. Commenting on midcaps, Mookim said this is not the time to buy midcaps.
Investors should avoid bottom fishing at current levels especially in midcaps. Staying with defensive means investors should stay with largecaps even now.
On value picking, Mookim said this correction is happening on the back of rise in the cost of capital globally. I wouldn’t be tempted to bottom fish growth stocks right now.
Below is the verbatim transcript of the interview.
Anuj: I can sense a bit of a smile inside you because that has been the view from Bank of America Merrill Lynch that things have run-up too fast and too soon and in your strategy reports you have been pointing out about Sensex targets which at that point were much lower than the prevailing prices. But your thoughts on the big brutal move that we are seeing right now?
A: We have been as a house worried about the fact that much of the rally globally has been a cost of capital driven upside and our worry is that the icarus trade would end sometime as you get closer to the sun your wax starts to melt which is what is probably starting to happen. The risk is that it starts to feed upon itself, I mean you all read about the notes on quant selling yesterday in US and as volatility rises that kind of reinforces the selling pressure. Hopefully, we will not get into that sort of a problem where the markets downside starts to feed upon itself.
But I would all like to highlight is that look up until yesterday the Nifty was still up for the year which is January, so in fact we have not seen on the Index at least a very big correction. Only after today will the Nifty be down for the year and markets in Asia in Hong Kong or China still up for the year even after today’s correction. So, yes, the pace of decline is astounding, but we have not yet eaten up the returns that we have seen in 2017.
Latha: This market correction is coming at a time when fundamentals are improving with each passing data point, whether it is in the US, but I will concentrate more on India. We had a fairly decent PMI services. Motilal Oswal put out a note saying that 68 percent of the companies in their coverage have beaten or are in line with their earnings estimate. So, is this value picking time already or will you wait?
A: Our stance has been globally that we are so bullish that we are actually bearish. We are bullish on the economy, we are bullish on the fact that inflation will rise, we are bullish on earnings growth for a companies in India and elsewhere in the world and that has cost us to be bearish on asset prices because it meant that the cost of capital will go up.
The environment of easy liquidity will have to be withdrawn as the numbers in the US work came through which they have at the moment. Even in India I argue that yes, you will see good quarters in December and in March. A lot of it is frankly base effect, but I expect the earnings growth momentum in FY19 to actually to be better than FY18. There is a lot of reasons why the turmoil that we have seen over the last two years will not be repeated.
But the problem is that the market when it was going up was not going up because we anticipated the economic recovery. It was going up because of a lower cost of capital. Multiples for stocks were doubling in a year literally not because the market was factoring in a three year upcycle, but because of a reduced opportunity cost. That cycle can turn down even as the economy recovers. So, I would still be careful on equity indices, equity prices and take a bit of a wait and watch approach.
To your other question, during market corrections it is the value stock, it is the low PE stocks that will work better relatively. So, they will fall less in the market.
Sonia: What is your target for the Sensex by the end of 2018 and have you tweaked it because of the moving parts that we have seen especially with respect to the global markets over the last few days?
A: No, we haven’t changed it, we have a fair value of the 32,000 and frankly I don’t want to refer it to as a target. It is what we think the earnings into PE should be by the end of this year. 32,000 would probably still leave you with a little bit of downside from where we are today. But, yes I mean again to highlight what is happening is a reversal of the cost of capital tide, so it could play out for longer as well.
Anuj: 30,000 of course you have been talking about it, we are still 10 percent higher than that, but portfolio approach money is flowing in and there is a good chance that after a brief lull it may again start to go back to equities, so what would be the portfolio approach from here?
A: Just to correct you 32,000 is what we have been saying. It is too simple to say, when the market is falling in absolute term it is the defensive stocks, it is the stocks which are low PE that will outperform and those would be the traditionally the IT, the materials, the energy sort of names which would come into that basket. I would also highlight utilities, the power utilities where you have relatively safe earnings outlook with relatively low earnings multiple as well, these are the ones that will tend to outperform a falling market. So, if you are relative investor that is what you do. If you are an absolute investor you either short or you stay away from this volatility.
Latha: Where are you looking for value? You spoke about some stocks where the PE will be low, but if you can indicate it more in terms of sectors will you go for capital goods because at some point expansion will start? Will you continue to go for consumption because that is the only proven theme?
A: Two things I would say is one is that this is not the time to be in midcaps. So, you shouldn’t try and bottom fish stuff which is extremely volatile at the moment and where liquidity can disappear overnight. So, defensive attitude would mean that you stay large cappish even now.
On value picking, I wouldn't say that a correction is an opportunity to buy growth because again this correction is happening on a cost of capital increased globally and if cost of capital increases growth stocks in turn will suffer the most. So, I wouldn’t be tempted to bottom fish the growth stocks just yet, I need to wait to see how long this global turmoil continuous, how high the VIX rises really and once I am clear then I may get back in to my growth positioning. But, if you are taking the view that this volatility will continue for a while it is the low PE stocks it is the value like I said the IT names, the utilities that might actually give you relative performance in the short-term.
Sonia: One sector or space that you have liked for a while is all the rural oriented stocks and we had a relatively good Budget, higher minimum support price (MSP) etc. you think the largecaps in this space will still continue to do well, the two-wheeler names, the tractor names etc.?
A: The rural India has had a lot of support from government policies not just in this Budget but even prior to that National Rural Employment Guarantee Act (NREGA) spends have doubled. A lot of farm insurance is actually being implemented on the ground. The weakness has been due to agri prices and hopefully some of the MSP increases the government has promised will help address that. So, we are from an economic perspective hoping that rural India will look better and therefor the rural exposed stocks which would be the two-wheelers, tractors, cement, staples should incrementally benefit. That is where the earnings numbers would come through.
So, yes, I don't think that there is any reason for me to change that underlying fundamental view on earnings outlook for those companies if the stocks were available cheaper in this rout that would be an opportunity to get back in.
Anuj: A bit on the macro as well? Do you think the government's math could now look ambitious both in terms of the numbers of long term capital gains tax and divestment arithmetic that they are planning right now?
A: To start with I don't think that the assumptions on revenue were too aggressive to begin with. So, if you look at the forecast for tax collection both direct and the GST they seemed to be fairly in line with nominal GDP growth. So, if they do see some slippage on long term capital gain tax collections for example there may have some room to make it up in other forms of tax collection.
Divestment frankly the 800 billion number could look very high if you only left it to the secondary market. But if you were to execute transactions on the lines on ONGC- HPCL deal and media reports have been talking about other alternatives you may be able to get close to 800 billion number finally. So, yes the mood of the market will matter, but the slippage on the revenue side should not be too high for the government.
Latha: Does this market get a floor because earnings are picking up?
A: I will go back to what I have been saying for a year that the dynamics of the Indian market and Indian earnings are secondary to the global tide and India has not been decoupled for emerging markets or global assets for a year and a half now. While the Indian earnings environment will look better, Indian earnings are actually underperforming the numbers which we have seen in North Asia for example, those coming out of China or Korea have been better than what we see in India.
And of course domestic liquidity does not seem to have had a specific impact on large caps as well. Indian large caps have underperformed the Index stocks in the region. So, again despite the improvements in earnings which I expect I don’t think that the India will decouple or stand out from a falling global equity price. If the Dow and the S&P everywhere continues India will fall in sympathy as well, unfortunately.
Latha: Why is there a reason that it should continue? Will there not be an argument at some point that the market is falling for good reasons, it is falling because of a demand pull in the economy and therefore like we saw in the 2003-2004-2005, interest rates were rising at the modest space or accommodation was being removed at a modest pace, but the markets continue to climb because economy was doing well that is why the moderation or the accommodation was being removed. So, at some point the growth argument should reassert shouldn't it?
A: Yes, you are right, exactly and that is exactly what we have been telling our clients that we are so bullish that we are bearish. We are very bullish on growth outlook. We are bullish on earnings finally starting to recover globally. But we do think a reset is required for the equity valuation, much of the returns we have seen over the last few years has been the increase in cost of capital. Once you see the reset then the earnings growth will drive markets up, hopefully.
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