Interest rates in the system have already begun to rise even before the RBI has formally signaled it. The RBI will likely hold benchmark rates for now but warn the market of an impending hike at the next policy meet in August, says Udayan Mukherjee, consulting editor, CNBC-TV18. At the same time, he does not think it would be a huge surprise if the RBI raised interest rates even in this policy, he says.
In an interview with Moneycontrol’s Santosh Nair, Mukherjee said that the damage to the broader market has been quite severe , but that is not really reflecting in the Sensex and Nifty levels.
“The small cap index is down 20 percent year-to-date since the middle of January,” he said, adding that the Sensex and Nifty are holding up because money is going into frontline stocks. “….but underneath that there is a significant layer of damage which is going on,” he said.
Mukherjee says capital preservation should be the theme for 2018.
“We haven’t seen the end of volatility and investors would be greedy in thinking that they will make very significant market returns in 2018,” he said.
“Throw out bad quality, focus on bluechips, focus on defensive names and generally make the portfolio far more defensive, so that we don’t see too much capital erosion,” he said.
Edited excerpts of the interview:
Q: The immediate trigger for the market is the RBI credit policy. What you think is the probability of a rate hike on Wednesday?
A: It is a fine call this time around because you could argue as easily for an RBI pause as an RBI rate hike or a hawkish tone this time around. I don’t think it is an easy judgement call – my own sense is that the RBI may choose to wait it out this time and maybe do something in the next policy.
It might hint that the mood is turning, the tone is turning and the signal might be slightly more hawkish this time than the previous one. It will prepare the market probably for a rate hike the next time, but this time it may wait out a little bit. Particularly, because market interest rates have already gone up quite a bit.
First, the bond yields went up and then banks started raising their lending rates as well. So, from a de-facto point of view interest rates have already gone up without the RBI giving that signal and therefore it may say, “let me not sort of vitiate the sentiment too much, because the banks have already done their jobs and the bond markets too – therefore let me just prepare the market saying the risks are rising, inflation is inching up and therefore we are vigilante right now and at any point we might raise interest rates once again”. That may be what comes through this time a preparatory statement from the Reserve Bank, but holding the rate hike for the next time. I don’t think it would be a huge surprise if the RBI raised interest rates even in this policy.
Q: Market has been quite volatile over the last couple of month, you saw the Nifty fall below 10,000 then a relief rally again the markets struggling at higher levels. So, how is it looking in the short term?
A: I think it is not the right way to look at the market now by just focussing on the Sensex and Nifty because the broader market actually is not doing very well. May was a good series if you looked at the Sensex because the Sensex went up some 500-600 points – but if you spoke to investors and traders, they would tell you that May was actually not a good series for them and that’s because the midcap and the small cap indices fell about 5, 6 percent apiece and many midcaps fell much more than that.
The actual portfolios of HNIs and retail investors did not do very well in the month of May. In fact, since the start of the year we have been seeing a fairly significant midcap correction. The small cap index is down 20 percent year-to-date since the middle of January in just four and a half months and that is a significant correction.
My sense is it is a little misleading to look at just the Sensex and Nifty which is holding up because the midcaps continue to get a lot of money and this midcap inflow which is coming in is going into high quality index names now like HUL, Asian Paints, Kotak Mahindra Bank etc and that is holding up the index above 10,500 but underneath that there is a significant layer of damage which is going on – so that market is not as rosy as the Nifty might suggest to you at this point of time.
Q: What exactly is causing this selloff in second-line share is it just disappointment over earnings or is it due to factors like market not really believing the numbers because of the developments in some of these companies like Vakrangee and Manpasand Beverages where you saw the auditors resign?
A: A couple of those instances and before that PC Jewellers etc have led to some kind of suspicion about whether investors should be holding on to some of these midcap names, but the rot or the problem had started at the start of the year. At the start of the year if you spoke to a lot of the smart professional investors they would be telling you unequivocally that 2018 large caps would do better than midcaps because midcap valuations had expanded far too much in 2017 – so the fundamental reason was that that midcap valuations were stretched, earnings had not yet come through and they needed to compress their valuations.
Now there were many triggers. First, all these string of scams and audit problems with numbers etc and then some of the technical factors like the additional surveillance measure which has come through now on 61 stocks which is putting the squeeze on a number of names. Before that the mutual fund reclassification schemes had led to some amount of selling in midcaps as well. F&O margins went up so these technical problems also sort of accentuated the basic fundamental problem which was of valuations having run ahead of fundamentals – so we have seen a significant correction in mid and small caps but we may not have seen the end of it and you could see further underperformance in midcaps relative to large caps for some more length of time.
Q: What is your view on public sector undertakings, barring state-owned banks?
A: Not very good, because their numbers are not coming through. I know Coal India has come out with a reasonable monthly volume number which is why there is some excitement, but it is difficult to make a case for buying a lot of public sector undertaking (PSU) names. You could get trading rallies but otherwise they just don’t have the kind of market performance in terms of their core market share in the businesses that they are involved in.
I mean you look at the oil stocks they have disappointed so much, ONGC and the oil marketing companies (OMCs) for fear of interference by the government and they have been wealth destroyers because all the mutual fund portfolios had these oil marketing companies at the start of the year and they have lost money because of that.
Then you look at some of the power companies they are not going anywhere, PSU banks are mess though we have seen a big rally in State Bank of India (SBI) after the horrendous Q4 numbers. I think it slowly dawning on people that PSU as a basket are not going to create a lot of wealth and they are better off playing some of the private sector counterparts.
Sometimes, if you are a very nimble trader you can do some trading in some of these PSU names but the basic thing is that they are not able to compete successfully wherever there is competition from private sector counterparts and therefore wherever there is some monopoly kind of a business like Coal India – they could have wishy-washy flattish performance, but broadly barring one or two names in the service space you would probably not make too much money out of public sector companies.
Q: So, what is your view on the rupee? We have seen a bit of a recovery over the last few days but is this a clear trend reversal for the time being?
A: It is difficult to call, it is not easy to say and that is tied in with the price of crude. Crude has given up about USD 4 odd from its recent high of USD 80, the rupee has also pulled back in line. Whether this is a pullback in an otherwise stronger trend which means eventually crude is marching towards USD 90 and this is just a pull back, prompted by the higher supply in the market, it is difficult to call. It is tied in with the kind of pull back that you are seeing with the rupee because it had been a one way fall all the way down to USD 68 plus. So, let us see where it stops, maybe we go to Rs 66.5 against the dollar in the near term because of this pull back but a longer term call is difficult to make.
The picture is complicated by the fact that there are lots of reasons for volatility even other than the price of crude over the next few months. The political landscape is changing, that on the margin is keeping FIIs on tenterhooks. I just came back from a tour of London where I spoke to a lot of very large FIIs, they are not very convinced that India is a place to be right now. For a whole variety of reasons and even last week you saw selling of Rs 2,700 crore from FIIs and that tells you that there is constant selling away at Indian stocks from the global investors and that may just keep a floor on the rupee and I don’t know whether a trend reversal is a phrase one can use at this point.
Q: So, what is the theme that investors should be looking to play in the near term?
A: I think capital preservation. In 2017 people made a lot of money in large caps and midcaps. 2018 when it started, all of us, including me thought that volatility will stage a comeback this year and volatility has staged a comeback. We haven’t seen the end of it and investors would be greedy in thinking that they will make very significant market returns in 2018. The best case scenario is that if we don’t lose money, we make very small gains and the year passes. And if we end with that kind of an outcome, investors should be more than happy.
So, as you can see with mutual fund portfolios and where the money is going which is essentially out of bad quality or questionable quality into the best blue chips and the highest quality names, it is a sure sign that the market is saying that we need to preserve capital this year and all the portfolio designing now from smart investors is moving in that direction which is to say throw out bad quality, focus on bluechips, focus on defensive names and generally make the portfolio far more defensive, so that we don’t see too much capital erosion and we can just ride out 2018 and prepare ourselves for 2019 a post-election scenario where once again earnings willing we can be in a position to play for gains in the market. But this year has been about volatility and flattish ranges and maybe the second half will be more of the same. So, the outlook should be to be in defensive names and to try and preserve your capital for next year.
Q: The earnings story for this season has been largely top line growth but the pressure on profits continue. So, is it some kind of a feel good factor that we are finally seeing, demand returning back?
A: I am afraid not because Q4 profit after tax (PAT) went down 9 percent, but the number which stood out for me was that even if you take out the three banks Axis Bank, ICICI Bank and SBI and you look at the earnings before interest, taxes, depreciation and amortisation (EBITDA) growth in the fourth quarter for 47 companies that number was about 8 percent and that is just not good enough. You cannot have a 20 plus PE multiple one year forward with EBITDA growth ex of financials and the more biggest damage happened in financials at just about 8-9 percent which means that there are margin pressures, that profitability growth is not commensurate with the kind of valuation the market is giving stocks and that leaves the market vulnerable to corrections in case there is bad news on either crude or on the election front.
I was terribly unhappy with the FY18 PAT number because it is way below that Rs 452 per share for the Nifty is way below what the street was expecting at the start of the year and we are setting ourselves up for some disappointment in FY19 as well because it is very unlikely that we will get 23-24 percent growth next year. I would be happy if we got 15-16 percent growth next year but banks are impossible to predict. So, I don’t know what these three banks will report and a lot depends on that. But we are still in that phase but the market is over expecting profits, they are getting under delivered and valuations therefore are still maintaining at very high or elevated levels and any potential external risks can dent those valuations because the earnings support is still not there.