With realty, gold in funk, equity only game in town: Ambit

The recent stock market run -- the Sensex is up 18 percent since the Narendra Modi government came to power -- has largely been based on hopes the government's steps to kickstart the economy will boost corporate earnings, says Saurabh Mukherjea, CEO - Institutional Equities, Ambit Capital."The domestic investor sentiment has been the most positive in three-four years," he told CNBC-TV18's Latha Venkatesh and Sonia Shenoy, a belief that is borne out by inflows data into mutual funds.Mukerjea said this comes on the back of the fact that the traditional asset classes Indians love, gold and property, have flattered to deceive in the past few years.He also discussed the now-famous call he recently made, in which he said he expects property prices in some pockets such as Mumbai to fall as much as 50 percent."We are seeing a fall in property prices in the range of 5-25 percent across the country," he said, adding that transactions in the past few months had fallen off a cliff.But, he warned, investors in the stock market will have to be patient, as actual fundamentals from earnings were yet to pick up in a significant way and that the market could pull back from current levels."It will take a year or so for me to say we're in a structural bull market," he said.Below is the transcript of the interview on CNBC-TV18.Latha: This rally came a little bit out of nowhere, how do you justify it and do you think it has legs? A: It is always dangerous to justify market moves after they have happened. However, if I look at investor sentiment, domestic investor sentiment both at the institutional level and at the underlying retail level it is the most positive I have seen for a good three or four years. I would say domestic investor sentiment is even more euphoric than it was after the elections in May 2014. So, these domestic inflows are powerful, they are pushing a lot of money into the market; something like USD 9 billion of domestic money has come in. As long as that money continues the market will find a lot of strength and support. We can talk about oil prices, commodity prices coming off and the monsoon being broadly according to plan but my hunch is that the key driver of the market has been very strong domestic inflows.Latha: Do you think that will continue, a bunch of fund managers we spoke to referred to the fact that gold is practically down as an investment option and real estate is also fading. So, is your conviction that domestic flows will continue? A: If you go back to the Finance Minister’s February 29 Budget speech he had spoken about this. He said that the government explicitly wants to make sure that India’s savings which are USD 420 billion, India’s savings get redirected away from physical towards financial. As you know historically we have saved two thirds of our household savings has been in physical savings -- real estate or gold -- and financial savings have very much taken a backseat. To be fair to the government they are very much prioritised this and so far it is going as per plan. The area I worry is the SME, the small businessmen in our country is under a lot of stress. I think SME stress in the economy is probably at its highest in the last four to five years. If the economy doesn’t pickup and the SME stress doesn’t pickup, domestic flows will peter out at some stage. So, broader economic pickup is necessary for these flows to sustain.Sonia: What exactly is boosting domestic investor sentiment if we do not have any great positive triggers at this point? And when you say that there is a lot of money coming in, what are the pockets in which you are noticing value and where money seems to flow in?A: To be fair to the domestic investor, what they are buying into is the whole premise that there is a new government, the government is pushing through some degree of structural reforms which will benefit the economy in the long run. And with real estate and gold no longer on the table as asset classes that can deliver, the stock market is the only game in town. That is the broadly the construct that the domestic investor is buying int. Now, that necessarily is putting money into the funds or into the hands of domestic mutual funds who are then looking for midcaps particularly to lesser extent smallcaps to put their money in. The challenge, I think, the fund managers are finding, the challenge I am finding is that if I look at the largecap stocks, I look at the Sensex for example, it is not easy to see where do you deploy more money. The economy is soft. I do not think there is any impending economic recovery that will come and take place in FY16 and hence, you do run into a challenge as to where do you deploy money. My sense therefore is that as the economy stays soft, as GDP numbers come off, we are likely to see earnings stay weak and that could result in a short-term pull-back in the market, not because of the flows, but largely because of the fact that earnings simple are not coming through to support the gold market. It will take another year or so for the economy to find a degree of sustenance and support and therefore it will take a year or so for me to say that we are in a structural bull market. At the moment, it feels like we have had a degree of euphoria, the market has run up on the basis of that. but the fundamentals are not there at the moment and unlikely to be there over the course of FY16.Latha: From the early-bird results that you have seen so far, what is the verdict on the earnings season? Will at the end of September or August when the results are fully in, will there be more downgrades or upgrades?A: If I look at result season in our country in the last 3-4 years, they have followed a reasonably predictable pattern. In that company with stronger numbers to show come early in the results season and as the season wears on, the weaker results come out. But even, for what we have seen, two or three things are reasonably clear. Firstly, small and medium enterprises (SME) and corporates are struggling. You can see that in the credit quality numbers that the smaller banks are posting. That will stay a theme of the results season. SME, mid-corporates are struggling, as a result, credit quality being a challenge being a challenge for the banking system. Secondly, rural is a challenge, whether you look at rural wage growth, minimum support price (MSP) hikes, crop prices. HUL’s results are an indicator of what rural centric companies might have. Similarly, the cement companies like for like, volume declines also point to rural and semi urban India being a challenge. But the biggest spot of brightness, the biggest spark of hope is raw material prices easing off. So, as the commodity price cycle turns south, it is giving companies relief on raw material prices which is allowing them to post better margins albeit with more modest top-line growth. That will be the tussle; can raw material price easing give India a cushion to go through this economic downswing? And I do believe the economy is decelerating. But if raw material prices give us a cushion to go through the downswing, we might be able to see some earnings upgrades come through by the end of the results season. It is a bit of a see-saw, but that is the best thing I can see at the moment; a cushion being offered by raw material price easing allowing margins to surprise on the upside.Sonia: Actually, we have seen that for many companies. We are including some of the tyre-makers, etc. this morning, but you briefly mentioned how real estate and gold are offering no opportunities or no returns at this point in time. You do not have any interesting report on how the Mumbai real estate market is all set to witness a big crash. Just take us through what your findings are and we have not seen any major fall in the real estate market up until now. it is just one of those things that people talk about. But do you see a crash coming soon?A: The report we wrote was on pan-India real estate. And what we did was we travelled extensively, went to property registration offices. Met unlisted developers, met plenty of real estate brokers and tried to reach an understanding of what exactly is happening in the market. And what we found was prices have fallen but modestly so. Prices are down anywhere between 5-25 percent depending on which neighbourhood you go to and there are actually some neighbourhoods where prices might be holding up. And broadly speaking 5-25 percent is the range within which prices are falling. What is falling far more sharply is volumes. Because of the way our real estate market works, because of these ready reckoner rates or circle rates, you cannot really have too sharp a drop in price, because the ready reckoner rate props up the price. But if the price is too steep, what you are seeing is volumes are evaporating at a rapid rate. And my reckoning is with the last 3-4 months have been the sharpest drop in real estate volume that we have seen for a long time. As a result of that new launches are drying up. New launches are down anywhere between 50-80 percent year-on-year and that too on a low base figure which in turn has a knock-on effect on the economy because real estate is half of our capital expenditure (Capex) story is real estate. 70 percent of cement demand is real estate. 30 percent of non-agri jobs is real estate. So as real estate throttles off, it is pulling the economy down with it. The good news is for the fund management community because real estate throttles off, the flows are getting redirected into the fund management community. The bad news is for the economy because the economy is getting sucked down with it. So, we are seeing a very interesting situation; the stocks are rising on the back of inflows, but real estate is sagging and pulling the economy down with it.Latha: You used the words the economy is still decelerating, a bunch of people we speak to think that it has troughed out and especially CMIE is saying that projects came unstuck at the fastest clip in the quarter to June, you don’t buy that? A: On the project data as some of the newspapers have reported, you can read it two different ways that the number of stalled projects is reduced; this is one way to read it. The other way to read it is that project cancellations have happened at the fastest pace that I have seen in the last eight to nine months. You have seen a rapid spate of project cancellations. Net-net I am not seeing a big pickup in stalled projects. What we definitely are seeing is more tendering activity by the government. So, National Highways Authority of India (NHAI) tendering activity has picked up and on the transmission and distribution (T&D) side, both from the center, power ministry and from state electricity boards (SEBs) you are seeing more tendering. However, that tendering turning into economic activity will take time and hence as an FY16 economic growths story it is a bit by the by. Coming back to real estate, real estate is the dominant driver of capex in our country. Unless real estate is shored up in some shape or form, capital formation, capex will keep sagging and my reading is economic growth is decelerating, So, Q4 we had something like 7.5 percent on the new series, 7.3 percent for the full year FY15 and my reading is FY16 will be very fortunate to get to anywhere near 7.3 percent because of the downturn in the real economy. Real estate coming off, rural India coming off, government spending moderated, fiscal discipline being shown- all of that does amount to a meaningful moderation in economic activity in our country which is not been reflected in stock prices. Latha: Let me come to another of the companies that you have not liked for a bit, Infosys. Have the numbers turned your attention or turned your sentiment towards that stock?A: We have to give it to the management that what they have posted in this quarter is as a clear sign of a turnaround. We have turned our sell into a buy. We are still a little circumspect as to how far this can go. It feels to us a little bit at the moment that within the Indian vendors Infosys has taken share from couple of others. However, as a meaningful sign of a turnaround, the latest results are an undeniable sign that the company seems to have turned the corner.Sonia: One stock that you have got right is Ashok Leyland. That one has seen a significant turnaround and a very good performance in the last many quarters. Do you still like that name?A: In the commercial vehicle (CV) cycle, although passenger vehicle sales seems to have throttled off, all the data we are getting suggests CV sales are buoyant. So, whether you look at the Society of Indian Automobile Manufactures (SIAM) data, talk to truck dealers, distributors, CV sales are holding up. Fleet operators are replacing ageing fleets. In fact corporates are asking for ageing fleets to be replaced. And Ashok Leyland is a natural beneficiary in that. what they are also benefitting is Tata Motors seems to have somewhat lost its way even in the CV market and as a result, market share gains for Ashok Leyland are coming through. So, we have to stay comfortable buyers here and as an economic recovery play which is holding up in a soft economy, this would be something I would focus on. This would be a stock would focus on for some quarters to come.