Sensex can slip to 22K, FY16 GDP sliced to 6.8%: Ambit Cap

But lower levels of 22,000, he adds, are not inconceivable.

"With a high likelihood of the Chinese central bank embarking on a continued  devaluation of the yuan, the Indian stock market stands exposed to: (a) Indian products losing their competitiveness to their Chinese counterparts; and (b)  rising risks to India’s USD 0.5 trillion of foreign currency debt. Such a scenario could be a catalyst for more pullbacks in the Sensex with the trailing P/E multiple likely to drop to 14x (as seen in the Lehman crises), implying a Sensex level of 22,000," states the report.

Below is the verbatim transcript of Saurabh Mukherjea's interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.

Latha: Ambit has reduced its gross domestic product (GDP) growth target as well as its yearend that is FY16 end Sensex target from 32,000 to 28,000. Can you take us through your argument first?

A: It's a logic that we are highlighting in note. We have two different sets of adverse dynamics at play now. We have got the Chinese economy which is moving in a very divergent direction from the US economy and leaving aside the specifics of when America might hike and when China might devalue the yuan. That is a divergent movement in the two major global economies usually spells bad news for emerging markets. So, that's one big dynamic that we are drawing our clients' attention to.

The second aspect back home, closer home. There are several negative dynamics have played, not least a crumbling real estate market alongside and feeble banking system and consistent difficult on the government's part to get reform moving in the parliament. So the combination as a result of us taking a very circumspect view on the domestic investment cycle, domestic capex cycle, we are cutting our GDP growth there from 7 percent for the year end to 6.8 percent largely driven by our very despondent view on the domestic investment cycle, capex cycle and that in turn translates into a more moderated view on the Sensex.

So, we are cutting from 32,000 at the yearend to 28,000 whilst highlighting that there is a reasonably high chance, high possibility of the Sensex going down to 22,000.

Sonia: What is your advice to your client at this point? Is it to sit on cash for a while until the market stabilises or is there a good buying opportunity at this point itself?

A: We have been consistently been able to help our clients make money in the Indian market by focusing on good and clean construct. There are few variants that we see such as the ten baggers portfolio that comes out every January and the good and clean portfolio which comes out every quarter.

If I look at the good and clean outperformance over the last three months, it has been quite remarkable. The good and clean portfolio has beaten the index by 440 bps and largely because we are trying to be reasonably underweight cyclical and we are entirely avoiding speculative plays on the industrial cycle, on the investment cycle and our point of view to the client is focus on well run companies, market leading franchise, strong cash flows, strong balance sheets and if you do that you will have a reasonably good experience of what looks to be a difficult year ahead for the Indian economy and for the Indian market but I do not think there is any scope to do as has speculative bets on either banks or the industrial sector or construction or real estate. One has to be very careful about stock selection; what is it decidedly difficult market.

Latha: When the real estate market starts selling in bulk as we believe some papers are saying, is not that a sign of troughing out. Is this possibly one of the worst quarters and would second half begin to see green shoots?

A: My reckoning is that next calendar year we will see much sharper downward movements in real estate prices which will result in more volumes in the real estate market. Currently in top ten cities, residential real estate transaction volumes are probably at the lowest for a decade. There is hardly any movement in residential real estate transaction volume at the moment.

The price cuts are beginning to happen that will accelerate next year and that will result in better movements in volumes. The problem is that the banking sector will be at the receiving end of those pricing cut. As per Reserve Bank of India (RBI) data, 15 percent of system loans are in the real estate sector and that is the next big sector. The banks will have to reckon with in terms of loan loss issues there. As it is credit off tick is barely 8-9 percent and there is a good chance that that will even slowdown further next year which spells up in the macro side.

So yes, we are hopefully moving towards the climax of the economy and the real estate sector troughing out but I do not think they have reach the bottom of economic growth curve yet, we will see few more bleak quarters on GDP growth, on the investment cycle and that is what we are highlighting to the clients. Wait for the drop.

There is a good chance that the drop is coming on us both in terms of GDP growth and the stock market and that drop will turn much more emphatically positive on buying into the Indian market. So for now 'good and clean' remains very much the Ambit philosophy of not investing in India.

Sonia: Coming to the good and clean companies. In your top high quality buys you have names like Lupin, IndusInd Bank, Bata India, Power Grid Corporation. Do you see further value in these stocks despite the fact that many of them have run up a whole lot?

A: The note that we are discussing here, there are ten market leading franchises and distinguishing factors all of these market leading franchises is strong financial statements, good governance. So Power Grid, Coal India, Lupin and HCL Technologies, Bata, PI Industries, Union Bank of India, IndusInd Bank, these sorts of names very much passes the muster for us. If one is to invest in this sort of economy, in those sort of market. I think that's the degree of quality we would want in these stocks. However, what we are trying to avoid is any sort of speculative investment, trying to fish for the bottom or hoping for a sudden recovery in the market.

So, the philosophy is to look for a market leader like Coal India or Power Grid almost quasi monopoly type businesses and in the shoe sector but Bata is a similar play. In all of this we are avoiding macro risk; we are not taking big calls on macroeconomic pick up. We are focusing on buying high quality names with reasonable valuations.

Latha: Every hypothesis has its falsification caveats. What might falsify your call?

A: If we see an unexpected pickup in Chinese economy - that will make the American and the Chinese economies move in sync and a lot of the global risk that we are seeing could get mitigated.

At the moment our thinking remains that the Fed will hike at some stage in calendar 2015, don't know whether in September but it certainly looks to be in some stage in calendar 2015 given the strength in the American economy and China looks to be the inverse of that but if those two economies move in sync then a lot of the problems are mitigated and back home if we see decisive government action, my reckoning is goods and services tax (GST) should see the light of the day sometime soon.

There is probably a potential for a rate cut at least bond rate cut from the RBI Governor in the next three-four months. But on the long side we see a decisive upmove in the economic cycle that too could give investors much more hope for good room for bullishness than we currently see.