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Markets factoring in big pick-up in earnings cycle for 12-18 months: Gautam Chhaochharia

Momentum to continue for next two months but one year down, markets to turn very expensive, says UBS MD

Updated: Mar 29, 2019, 09.28 AM IST
Gautam Chhaochharia-1200
Markets are hoping to see Narendra Modi coming back to power, said Gautam Chhaochharia, M anaging Director and Head of Research, UBS Securities India. For the next couple of months, markets will have momentum irrespective of valuations or underlying fundamentals. However, if one looks beyond two months -- at a one-year period -- again the markets become very expensive, he warned in an interview with

Edited excerpts:

Recently, we have seen a lot of inflows from FIIs and with the Fed also signalling no rate hikes in 2019, what is your near- to medium-term outlook for the market?

There are two parts. One is the near term --for the next couple of months -- and one is the typical call we take for a full year. In this case, the two-month call is also relevant because the global liquidity/Fed outlook which ties in with what we are seeing locally and RBI being much more relaxed about liquidity and interest rates than last year.

So, along with this factor, the biggest driver for Indian markets locally for the last few months has been the local political outlook, whether Mr. Modi is going to win or not. That outlook in the market participants’ minds seems to have changed after the Pulwama incident who think Modi will come back for the second term. These two factors will defend RBI’s broader liquidity part as well as local political outlook.

For the next couple of months, the market’s outlook seems positive or it will have momentum irrespective of valuations or underlying fundamentals.

If you look beyond two months, at a one-year period, then again the markets would become very, very expensive and quite rich. They are factoring in not only a very supportive liquidity and low interest rate environment, but also Mr Modi heading a very strong government, if not majority, a very, very strong coalition where the reforms can be continued and which will help markets.

Markets are also factoring in a big pick-up in earnings cycle for the next year to year and a half which can theoretically support the implied valuations. This is what markets are trying to factor in post the next two months. While it is difficult to argue on the RBI policy, the point worth highlighting from the RBI perspective is whatever we have seen from RBI is a reversal from a tight policy towards a neutral policy. It is nowhere near a stimulative policy and even the rate cuts we have seen till now and whatever we might see going ahead, would not show a scenario of real interest rates going back to 150 bps which is the RBI target.

It is not really that stimulative for the economy from an RBI perspective. For the markets the sentiment is negative but the real economy is still far from it. The earnings cycle in our view is still a big disappointment from momentum perspective. If you look at this together, then you might take a one-year view where the risk reward for the market is definitely unattractive. But for the next two months, markets will have legs based on all the narrative which you talk about.

What is your target for Nifty?

We have not changed the targets. Our target still remains 10,500 for December 2019 and we look at a framework which is a base case market price than the risk reward from upside downside pace. Our upside scenario for Nifty is 11,800 which kind of builds in all the narratives we discussed above and which builds in a material pickup in earnings trajectory. If everything plays out, even then the upside for market seems very limited from current levels if I take a one-year view. That is why I said the risk-reward is unattractive. But for the next couple of months, there could be more momentum in the markets.

Do you see an earnings growth rebound for FY20 or is it still elusive?

Earnings will rebound, optically driven by financials. Financials earnings will rebound because of the reversal in the credit cost or NPL cycle. Being a part of the index. that will drive the broader markets earnings trajectory. But that will be largely financials driven and optically driven from a NPL cycle perspective. It does not suggest a pick-up or the beginning of a next earnings trajectory yet. Except for financials. it is still going to be a single digit earnings growth market.

Currently, in which pockets do you see value in the markets and where do you think one should lock-in gains at this point of time?

From a risk-reward perspective, when we say markets are actually valued, it is from a broader market call. In the next couple of months, our advice to investors would be that it could be a good opportunity to lock profits in a broad-based way.

In terms of value, we see value from a very selective, stock-specific mode rather than broader market perspective. Private corporate banks which are a consensus trade right now, and are well owned, but we still see some value there selectively in some names. Post elections, where we see value would be oil and gas companies -- both downstream as well as gas companies. Those are pockets of value.

IT services is more of a relative separate call. It may not work for the next two months but given our risk reward for the next one year, we do see opportunities there. Auto names have to be chosen very selectively. In the broader consumer space, obviously there is no value, but the entire focus of government post elections on a rural India is an extremely supportive narrative for consumer sector.

You mentioned you see value in upstream and downstream oil companies. Could you elaborate more on that?

Again, if you say look at downstream, in a very simple way despite the recent rally we have seen over the last couple of weeks, these stocks seem to be pricing in a fairly high level of national service. It is much higher than what they have done even at the worst of the periods we have seen historically. Therefore, unless we see a very extreme scenario where the entire notion of price deregulation is thrown away by the new government or we see crude oil prices going back to $85-90, these stocks are definitely mispriced and the biggest overhang for them is the near-term elections.

Considering various scenarios for election results -- a) the NDA or the BJP or NDA comes to power with a majority; b) the current Opposition comes to power with a strong majority or c) we are in for a hung parliament. How do you think the market could react in different scenarios here?

Clearly based on the market movements over the last one year, last few weeks, investors are clearly suggesting that markets are hoping and want Mr Modi to come back ideally in a majority government or at least in a strong coalition government. If that does not happen, markets will react adversely in the near term. Over the medium term, obviously the fundamentals will come back. It will depend on the new government’s policy, trajectory and stance.

Is pharma sector a good value at this point of time considering that it has really not performed for some time now?

Let me put it this way. Pharma has always been a more individual company story rather than a broad sector story and that still remains the case. There are companies which could look interesting but from a sector perspective, big theme for the last few years was the US generics where the worst may or may not be behind us. The sector may be bottoming out. Having said that, we do not see that US generics opportunities coming back as a big earnings growth driver in a hurry for the broader sector.

Individual companies which have used the recent downturn to take care of the right product mix along with some innovations, there could be opportunities in terms of investors looking at ideas there. But the broader sector opportunities still looks difficult or not visible yet.

Midcap and small caps have rallied significantly. Could this rally continue or do you think it is already in the risky zone at this point?

I would still remain underweight but I have the same view that for the next couple of months the rally could have legs with this recent narrative, which is supportive of more risk-on asset class-based allocation towards small and midcaps.

However, if we take a year-long view, then the risk-reward is definitely unattractive. They are not looking at reasonable value zones, specifically the names which we like or the companies with good business models. So as an asset class, we are still underweight.

What do you make of the entire L&T-MindTree saga?

I cannot comment on individual companies.

Going by the way the entire events have been unfolding what are your thoughts on such a hostile takeover attempt?

In any hostile takeover scenario, it is the target company’s shareholders who decide ultimately. If the majority of the shareholders are fine, then all should be fine.

If it becomes an uncertain environment where it is not clear where the shareholders are and there are a lot of things going, then it is not good for businesses in general. As long as they reach a conclusion quickly, in these kinds of scenarios the trickiest part is to have uncertainty for a long period of time.

What are your thoughts on the aviation sector considering it has been in news for all the wrong reasons?

Looking at macro perspective, it is kind of strange that in an industry where we are seeing such strong volume growth, where crude oil price has also been reasonably stable, we are still seeing large companies struggling. It is not a great scenario for the industry or a great comforting factor for the industry from investor perspective.

Hopefully, something comes out of it sooner rather than later. There are banks involved, and some way, it is ahead of elections and so that is not a good thing for this to blow up. Hopefully, we will see a solution soon.

Which are the sectors you would advise investors to stay away from at this point?

The capex cycle and the industrial cycle definitely. Also, to some extent, small and midcaps because the narrative is only till the elections. Post the elections, reality will sink in that the big cyclical recovery in growth and earnings will be possibly elusive. Secondly, one reality is that whichever government comes to power, the fiscal space to do capex is gone.

When would private sector capex really pick up?

We do not still expect it to pick up in a hurry. Our view has been that for the last 4-5 years, it still remains that at best private capex can normalise from being a drag on growth to not being a drag on growth. But a private capex cycle, that will drive growth recovery in itself is not visible for the next couple of years. Roughly 20% of the private capex happens in sectors where we are clearly seeing a pickup but especially that cannot drive an overall capex cycle.

Also Read

We remain underweight on auto and neutral on consumer stocks: Gautam Chhaochharia, UBS

Bottoming out process of the economy has begun: Gautam Chhaochharia, UBS

Still overweight on largecap stocks in these 4 sectors: Gautam Chhaochharia

Long-term compounding opportunities for small cos in media, healthcare and entertainment: Gautam Chhaochharia, UBS

Gautam Chhaochharia on themes to totally avoid in an election year

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