See Nifty in 7600-8500 range; stagger buying midcaps: Udayan

He doesn’t see banks returning to profits over 6-9 months.

He will be looking at high-quality banking franchises, if they come off well.

He recommends stagger purchases of midcaps, which have come off 30-40 percent. “I stress the point about buying then slowly.”Below is the verbatim transcript of Udayan Mukherjee’s interview to Anuj Singhal, Latha Venkatesh & Sonia Shenoy.

Anuj: It is the first time we are chatting since the Trump day. We did break that low after that and did go to the Brexit day low and have bounced back. How have you read into all the market moves and what should be the strategy from here on?

A: These are uncertain times. So, I would not jump to any conclusions right now, bullish or bearish. Things are changing every day, some set of policy moves are happening and then 48 hours later something else is happening and while the market is trying to price in the gravity of moves that have been unleashed over the last couple of weeks, I don't think even market participants know for sure which way finally this cookie will crumble. They have some expectations. The initial part was reacting in complete and abject fear. Right now there is a little bit more hope that maybe the market has discounted the worst and maybe in one or two quarters things will get better and therefore you are seeing a bit of a pull back, but that could change quite easily again given certain realisations that maybe things are not moving in the right direction.

So, right now it is a zone of uncertainty. On that day I remember telling you that the Nifty probably would now be in a range of 7,600 on the way down and 8,500 on the way up and there is nothing which has happened to change that view. You could get pullbacks, a lot of people might have got short after the event and there could be short covering bouts. I don't see any great sustainable rally in the market from here on. Maximum we get to 8,500-8,550 where we turned from last time around. Have we met a bottom at 7,900-8,000? It is always nice to think that but I wouldn't put my full bet on that yet.

I think this is a very painful phase, locally and compounded by global factors. It wouldn't surprise me if that 7,900 low were to break. So, for now I am putting my money on a 7,600-8,500 kind of range. But one would have to reassess given how circumstances pan out.

Latha: Should we be preparing for a bit of underperformance on our part because of demonetisation?

A: That has already happened over the last few days, but the global backdrop is going to be challenging. I don't know whether this is a Trump bear market for emerging markets (EMs) for a durable length of time but the way the dollar index has been behaving, the way EMs have done relative to the US market and given the noises that you are hearing about what course monetary policy might take going forward, also the bond market in the United States is indicating that maybe we should prepare ourselves and hunker down for not so loose monetary policy which favours EMs over the next few months. We should also prepare ourselves for lower Foreign Institutional Investors (FII) inflows which is not a supportive technical factor.

Could there be accidents, last few days all the talk in India is focussed around what is happening at home with demonetisation and maybe in part with whole dollar US bond scenario. I don't think people are talking too much about Europe or there is an Italian referendum on December 4, things could go wrong there and that could come back as a risk on the table. Generally speaking it does not seem like a great backdrop for liquidity fuelled emerging market bull market for the next few months. So, I don't think you can think of that as a tailwind any longer. So, as I said there is a combination of headwinds which are affecting us right now and I feel far more bullish today than I was six months back because valuations have corrected and if one is a long-term investor and you have to think of yourself beyond 6-12 months, if you are one, then it is a good time to start buying. So, I am on the buying side now for long term investment but the near term is very challenging regardless of any pullback rallies to 8,300 or 8,500.

Sonia: What do you see as the cumulative impact of a higher cash reserve ratio (CRR) in the near term, the possibility of higher non-performing asset (NPAs) due to demonetisation and lower credit growth for banks? Is this a space that one should avoid now or for long term investors is this a good opportunity?

A: In some banks, if they come off substantially it would qualify as an opportunity, but you need to be patient even in banks. I don't see banks returning great profits or great returns on capital invested over the next six or nine months. I actually was not in the camp which believes that banks are the biggest beneficiaries of demonetisation. I think that was a fairly myopic view to take and very short-term kind of view because I don't think we have analysed or we can analyse the tertiary implications, economic implications of what this move would lead us to in the next three-nine months. Would there be a lot of fall in demand, you know what most banks' track record dealing with assets is and asset quality is.

You tell me, if a bank cannot assess the quality of loan that it is giving out, a loan of Rs 2,000 crore, which is supposed to be the most vigilant. What would it do with a loan of Rs 2 crore or Rs 20 lakh.

I think people are underestimating the pain that a lot of the small and medium-sized enterprises (SMEs) and retail public are feeling at this point in time and it wouldn't surprise me if a lot of asset quality problems start cropping up but to answer your question which is whether one should be buying banks I would not be buying public sector banks (PSBs) and that was before the Reserve Bank of India (RBI) move happened which of course shoots a lot of those profit expectations in the foot.

I would not have been a buyer of PSBs to begin with given the enormity of asset quality issues which might crop up and their track record in dealing with it but high quality banking franchises if they come off in this very difficult environment then I would be looking at certainly accumulating them but you won't make a lot of money in the next six or nine months even fro bank stocks because people are underestimating how difficult this phase is and I hear lot of people glibly talking about how one should look beyond three and six months and everything will be fine. They will have a few surprises coming. So, buy yes, but buy if you are not of the fainthearted variety and you can really look through nine months of intense pain as I think very few people can.

Anuj: What about portfolios because this is a market in which you have made money by buying midcaps over the last two-three years regardless of where the index has gone. Some portfolios are in pain now because of what has happened over the last two weeks, what is the strategy now on the midcaps as a broader class?

A: I would buy midcaps, high quality franchises but I would buy slowly and I keep reiterating that point because the propensity is to say something has fallen 30 percent therefore I must buy and it is good that stocks have come off 30-40 percent and I remember discussing it with you a few weeks back that there is froth in midcaps and the fact that non-banking financial company (NBFCs) have fallen 40 percent in many cases is factoring in or skimming off some of that valuation froth which had built up over the last few months.

But I stress the point about buying slowly and let me give you an example because so many midcaps have been multi-baggers over the last couple of years. Some of those great home building franchises where genuinely there is a massive demand story. I will give you an example of a stock like Century Plyboards. A lot of people piled on to that, it is a good company, great prospects going forward. So, that stock in February 2014 was Rs 20. Till on the day before demonetisation or a week before that that stock was Rs 250. In two and half years that stock had gone up 12 times, not percent, 12 times, 1,200 percent and then from Rs 250 it has fallen to Rs 180. The last close was Rs 175-180. So, your eyes light up saying the stock is down 30 percent, such a great franchise from Rs 250 to Rs 180, I should be buying now. But at Rs 180 it is still nine times what it was two-and-a-half year back.

So, you must keep in mind the context of the enormous rise which has happened in many of these midcaps and therefore stagger your purchases, buy those great quality franchises but buy them slowly because the market has probably not discounted al the pain that some of these companies are going to feel over the next many months. Some part is discounted but I don't know whether all part of it is.Sonia: What are your thoughts about the IT space because on one hand we do have the banks under pressure on the other hand IT has been seeing a bit of a pickup? Would you suggest buying there?

A: It depends on who you are and I think that is very important at a time like this because the ground rules have changed for investment right now. Globally, the turf is changing after the US election results and that is clearly visible and that is a very important thing to take on board. Locally, you have probably short earnings for the next two or three quarters, you will not get major earnings growth. So if you are a tactical investor or if you are a fund manager like a mutual fund investor then I think right now you need to be buying IT and probably export oriented companies because domestic companies will not give you earnings growth over the next two or three quarters. It is a relative trade.

I am not terribly excited by playing this relative trades because this is fund management or fund manager talk that right now my net asset value (NAV) should be protected and should not fall more than my neighbour's NAV. I think a lot of individual investors particularly long-term investors are not very well served by thinking like this that right now in the next six months I should actually fall less than the Nifty. How does it matter if you fall less than the Nifty by owning a few IT stocks.

I don’t see IT stocks - they may rally 5-7 percent because they have underperformed such a lot, but IT stocks I doubt will create great wealth over the next couple of years or next many years. At a time like this when stocks are falling very hard because of general panic and a lot of pessimism warranted by global and local events, I think you need to go back where the pain is. You need to go back to some of the structurally strong businesses which will create a lot of wealth. Now these are the same businesses which will hurt in the next six or nine months and you want to buy them when they are hurting because you will get them at very good valuations. As a long-term investor you have to focus on absolute wealth creation and not in trying to protect your portfolio for the next six months against a fall in the consumption related stocks.

As a long-term investor, l would not get into this relative game of playing IT or stuff like that to protect my portfolio. I would buy stocks which were trading at 40 price to earnings (P/E), which are great India franchises and which will go through intense pain with earnings and their stock prices over the next six or nine months and the 40 PE might come down to 23-24-25 P/E. However, they will bounce back because they are the real high quality businesses you want to own and from those businesses at these entry points you will end up making serious absolute wealth over the next five or six year. So, if this is an opportunity to buy, it is not an opportunity to buy IT stocks to shield your portfolio; it is an opportunity to buy out stocks which are getting bombed out because of demonetisation, but where the underlying business still remains absolutely beautiful and untouched.

Latha: You are staying, so to speak, in the hinterland and you also have a ground realisation of what this demonetisation impact could be. We only have an urban view here. What is your sense in terms of even the longer term? This is a high risk-high return step that the government has taken. Can things go awfully bad; even as a longer term investor will you take a long time to start building your portfolio?

A: It will take longer. I am not in the camp which believes that everything will be discounted and the pain will disappear in two weeks time. That is the risk we often take as people who analyse the stock market. We believe that everything will be discounted in a week or eight days and life will carry on. It often does but sometimes it does not, sometimes the pain is longer. So, right now what I am saying is the backdrop is difficult.

My view is and I could be wrong and everybody has different views on how this will play out. I think the pain will be higher for longer and it will not disappear in two weeks or four weeks as a lot of people are suggesting and it might have derailed consumption momentum for longer than we hope. If I am wrong we will all be happy and these stocks will bounce back.

However, what we are seeing right now is the first pullback from stocks which have fallen 20-25 percent, very high quality franchises and somehow, after all this commentary, you have got used to the demonetisation fact that it was very bad for two or three weeks but every day we are talking about it and we have sort of come to terms with it at least from our acceptance point of view, but that doesn't mean that the economic pain that it is unleashing will actually dissipate or disappear with that. That still has to be lived through and as that gets lived through in a not very supportive global environment you will probably find that many of these stocks will go down and make fresh lows. You would still want to be buying these stocks but you need to make allowance for the fact that this time when you buy these stocks you average lower and you don't chase the price on the way up because you think the market has formed a bottom and you need to be averaging the same stock at a higher price and that is my only submission today.

I am also feeling far more optimistic about the fact that valuations have corrected but I am not in the camp which believes that you should be averaging on the way up and chasing stock prices because there are very few triggers for the market to go higher right now. The only trigger is perhaps short covering for the near term, but once that is done you will scratch your head and ask yourself why should I be buying? Are earnings going to be better? Is FII flow going to be higher? Is the macro going to be better over the next 2-3 quarters? Give me a reason for market to climb higher over the next six or nine months.

So, next six months could be a mini-bear market and you want to be buying through that and when eventually the bull market resumes you will make a lot of money. So, buy slowly and don't jump at every dip in the market to pronounce a bottom and say, I had to be buying this otherwise I would be left out. The market doesn't have enough triggers on the way up right now.