Yuan fall worse than China hard-landing for India: Axis Cap

Sonia: Today and yesterday we have seen some semblances of sanity return to the market. Do you believe that the bottom is somewhere in place or do you expect more downside in the months to come?

A: Earnings growth has not gone up because liquidity is an issue. So it will take some time. Let me layout the three background context to this. First, there is something known as a panic market which can happen in a bull market which can happen in a bear market. It can happen at any time and that is what we saw last week. A panic market by definition does not necessarily lead to either a bull market or bear market or anything. It is simply a panic market. It should be treated as such and we should get used to it.

There is a lot of literature on panic markets but essentially in a panic market it can happen in any type of market, bull or bear market and can lead to any type of market. The only sensible thing to do is not sell unless you have sold right on the first day of the panic.

The only decent thing to do is what happens is lot of stocks fall irrespective of valuations because of holding patterns and cascading effects and so on. So, you can improve the quality of your portfolio out there by switching to better; because see both fall. So, if a great stock falls much more than a lower quality stock you switch. So, that is one context to keep in mind. So, don’t get confused between a panic market and therefore it should be a bull or bear market or whatever. It is no sign of turnaround.

The second most important thing to keep in mind is a lot of people have said this 2015 and the current scenario is like various stages of a previous market. I would like to remain everybody that 2015 was unique. It was most like 2015. The key reason I am saying this is because then the indicators you spot may be completely different from the indicators that you had before.

Why was it different? This is a first time that you have had three unrelated negative factors. Most of the time earlier you had one main negative factor so you could easily spot--now when this turns around that means this is the issue then we get in.

There were three unrelated factors. One, global growth related. The subsidiary, the corollaries of that are emerging markets (EM) allocations went down, oil went down and therefore your sovereign fund allocations also went down. Then there was comparative devaluation and stuff like that so that was one basket which led to our problems. Second basket was climatic. There was crop destruction across the board; there were droughts in India for second time in a row. So, obviously that hassles your water table and so on and so forth and floods in Chennai and all that. Third is the terrorism business in Middle East and so on which led to lot of budget swings screwed up all over and so on. It also led to oil becoming even further down because of the sanctions being lifted on the Iran. So, we were at different points.

However, what is the implication of that? Implication of that is what signpost like the question that you are asking should you look at now for a turnaround versus what you looked at in the past. So, there are three things that I want to mention in that - one, is the worst possibility is not a very hard landing in China. Yes, there are lot of foreign banks, let us not go into the names, but essentially which are exposed to China. So, there is some amount but that is not the worst possibility. The worst possibility is a yuan devaluation that can seriously affect our economy.

What is the best possibility? The best possibility is basically the US reviving. You may see some sort of relief rally in the middle of the year because of quantitative easing (QE) and so on but essentially if the US doesn’t revive and therefore doesn’t drive world growth irrespective of what happens in China. So what I am saying is, don’t look at Chinese Purchasing Managers’ Index (PMI) look at US growth recovery, why because earlier whenever we had QE, our whole research department used to hurray because QE there that means money is going to alternatively flow here. Now that is not so much the case.

Now whenever there is a QE going to be announced there may be a relief rally but it will be more interpreted as a symptom that there are problems galore and therefore the markets may not go up because it is no more a developed versus EMs. Third signpost is price of oil is not going to be an indicator of global growth. Price of oil is driven by EMs whereas what we are looking at is US._PAGEBREAK_

Latha: Generally how are you approaching the Indian earnings scene itself? Did you have more downgrades at the end of the third quarter? Have you downgraded Q4 or Q1? Have you postponed the earnings recovery?

A: We still at about 17 percent odd Sensex earnings per share (EPS) growth because of the low base of this year. I will tell you some reasons for that. The domestic scene right now is very mixed and it was pretty bad. There have been downgrades which are not as bad as earlier but still the downgrades continuing.

There are two things I want to talk about, one is a Sensex earnings and other is a government policy part. As far as Sensex earnings are concerned one is there will be a government spend on roads and rail. That will spur a little bit of capex so that is one part of it. Two, is commodity prices are going to stop falling at some point. I think a lot of our Index which I will come back to later is commodity related, so that helps our earnings. Three, is monsoons this year - hopefully after two years in a drought - what happens is the areas which had drought last year versus floods are going to reverse. So, hopefully we will get good monsoons this year.

Finally, we will have to move to marginal cost based funding for the banking system from April 1st. That plus other reasons will lead to basically your interest rates in the transmission system going down. I think these are going to be the earnings drivers for the coming season.

I want to come back to one point that you mentioned which is about government policy. For India, the government whatever it does is within the context of what happens to the globe. So, if the globe does not go up there is very little that the government can do which will affect the market. I want to keep that first in mind because number one is we are dependent on flows and that is very clear. Number two if you take the top 10 companies that contribute to Sensex EPS growth you will see roughly 60 percent; it is 60:40, is global related, so you have all the IT, pharmaceutical; you have all the commodities. So, if you take that whole basket you are far more prone to global growth than local in the Sensex EPS.

Then coming to jobs, what happens since there is no confidence in the globe whatever the government is doing is not translating into private capex. So, given that whatever advantages you had because of oil prices coming down and so on are not translating into import advantages and therefore jobs.

On the other hand the exports related jobs are suffering because of global growth. So, what happens is once global growth comes both your import jobs will go up because of increase confidence and you export related jobs.

Sonia: You have spoken about the global factors, the domestic factors etc. How high is the possibility of a post- Budget sell-off because of two reasons one the possibility of that long-term capital gains tax tenure getting extended and two the government perhaps not meeting its fiscal deficit target?

A: I don’t think it is the wisest move to make long-term capital gains which will give you very little returns in a time like this. I doubt the government will do it. I think it will affect the market if that is brought in. On the other question that is more important which is a fact that every government, you can do one of two things either you can reduce the fiscal deficit or increase it to increase pain in a time like this. The balance is very difficult to figure out for any government.

The Reserve Bank of India (RBI) has very clearly said that if the quality of the fiscal spend is good that means for example that it includes recapitalisation of banks then it is not going to treat it as a deterioration of the fiscal deficit and therefore it will move forwards in terms of cutting repo rates and so on. I think between the balance if the government does not spend more and control fiscal deficit it will be held as a good Budget.

As I said earlier and that is why I wanted to lay the context first, even if it spends much more, it may not translate into major seeding of capex given the anemic global growth conditions right now in the confidence levels abroad, which is why I think if the fiscal consolidation is maintained and the money spent on the higher quality, which is may be just roads, rail. Yes, there will be rural spends because obviously there were drought and so on so that is fair enough and maybe bank recap, which is also fair enough but if fiscal consolidation is maintained the that will be the best thing about the Budget. The other thing I am looking forward in the Budget is there could be housing sops because the best way to pump prime the economy is housing sops.

Coming back to what you said earlier in terms of results what we have seen in terms of surprises, I will mention about EPS but I don’t think that is too important, as an EPS the positive surprises were in cement and telecom because it was worth than what was expected. The negative surprises were in PSU banks, infra and engineering. However, it is far more important to look at sales than EPS because in a bad time you can always cut down expenditure. The margin is anywhere high for most companies and the margin is not going to be higher, margin is actually going to fall going forward. So, it is more important to look at the positive sales surprises.

So, there you have things like cement, reality and private banks. On the negative side you again have engineering and infra. Now look at companies which have volume increase rather than looking at the optical illusion of EPS.