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Robert Parker of Credit Suisse said most markets have fallen recently as most of them look oversold. He feels the rally may fade by April but will be more durable in the second half of 2008. "I see limited downside risk in India and most other Asian markets."

The only positive from US is strong exports due to dollar devaluation, he said. "The US Consumer Confidence is down sharply and will remain subdued for the next few months. The housing market is in a bad shape. The default rate may go up to 20%. However, most of the US sub-prime write downs have already been accounted for." He feels the uptick in the offshoring market turn out to be a positive for India.

Parker sees significant risk factors for the next quarter. "Growth has moderated but that has happened from very high levels. However, growth divergence will persist and will continue to bring FII money into India."

According to Parker, investors need to distinguish between commodity exporting and importing countries. "Lower commodity prices will be good for importing countries like India." On inflation, Parker said higher food and energy prices are driving inflation. "However, core inflation is not as high."

Nilesh Shah of Envision Capital said the markets are in an extremely oversold zone with leveraged positions being squared off. "A small liquidity infusion can take markets higher. I see room for a 3-5% upside. However, the markets will find it difficult to sustain gains." Shah feels we are into an era of higher prices and inflation. "The data is throwing up nasty surprises. Inflation over 7% will be bad and the market may not be prepared for that." The impact of earnings season will also be key market sentiment driver, he added.

Excerpts from the exclusive interview with Robert Parker and Nilesh Shah:

Q: Can you see any kind of base building process happening across global equity markets?

Robert Parker: Obviously with one or two exceptions notably the Middle Eastern markets and to some extent the Taiwanese market, all equity markets YTD have shown significant declines. We are technically very oversold on all markets and there is very significant cash sitting on the sidelines and I think those investors who have been investing in the leveraged way have reduced their leverage consistently throughout the first quarter.

As you have mentioned, the economic news remains very bad especially from the United States and I would actually say that the only positive note from the United States is the strong growth of exports due to the devaluation of dollar.

In terms of where we go from here, my central case is that we will see a rebound in April in global equity markets including the Indian markets. I think there is a risk that the rally in April may fade as we go into late May and June but then I think that we could actually see a base being formed for more durable rally during the second half of the year. I do not see an equity market rally whether it is in India, Asia or globally starting on a sustained basis for April. I think the second quarter has still got some significant risk factors in the markets.

Q: How are you feeling about the way we have performed in this week itself and are you getting this sense that this series might be a little bit stronger than what we have wrapped up because the damage was quite hard on prices through what we did in March?

Nilesh Shah: Clearly the last few months and the last few weeks have essentially been extremely weak for the Indian markets and clearly we are into an extremely oversold situation. I think the biggest driving point for this rally has been the fact that a lot of the leverage positions which were essentially coming in from leverage players were really already significantly squared off in the month of January but in February and March, it has essentially been the investors who are carrying leverage positions. I think a lot of those positions have got squared off.

So the way we really look at it is that the market is extremely light and even some amount of liquidity infusion in the market essentially could be good enough to drive this market up further. But having said that clearly I think, a lot of these trading gains that we could have had in the short-term are already in place.

The reality is that the market has rallied about 1000-500 points, which is about a good 10% from the low. It has already rallied to that extent and our sense is that probably there is a room for a further 3%-5% increase but I think beyond that, it is going to be hard for the short-term rally to sustain itself.

Q: Because of the oversold nature of most of these markets particularly some of the emerging markets, how much would you give this bounce that we might have for ourselves in April?

Parker: I think it is going to be very divergent and looking at emerging markets globally I think you have got to make a very clear distinction between the commodity importing countries and the commodity exporters. Obviously in the first quarter of this year, it was the commodity exporting markets, which outperformed. For example, markets like Brazil are highly correlated with commodity prices and the Middle Eastern markets did a very good performance in the first quarter obviously with the positive impact, of the oil price rising to close to USD 110/bbl.

So I do think that the pattern of commodity prices is important. Now if we are right and if this speculative overhang in commodity markets stops to reverse over the next month or two and if we see oil for example coming back down in to a range of USD 90-100/bbl, I think that would be very good for the commodity importing countries and the two that really stand out there are obviously India and China, which are highly sensitive to not just the oil price but obviously industrial metals and soft commodity prices.

Q: Couple of shockers that we got by way of data this week, do you think the market is adequately hedged against that or will come around to the idea of inflation at more than 6%?

Shah: I think everybody realizes that we are into an era of relatively higher prices and therefore the kind of advance, which the broad inflation data has been registering week-on-week is basically catching a lot of people by surprise and clearly the inflation data is throwing up a lot of nasty surprises.

So yes, one had expected the inflation data to slowly inch towards the 6.5% mark but here we have a week where inflation data has very conveniently crossed the 6% mark and stands at as high as 6.8%. I think if this is the pace at which it continues to advance, then we could be in an era where the inflation rate is basically at about more than 7%, which is significantly higher than what we have seen for several years.

I clearly think the financial markets do not seem to be yet ready for the kind of a situation, you would also see some kind of response mechanism emanating from the government side and I think depending upon what kind of response mechanism it is that would be probably good enough to ensure that the financial markets do not get too carried away with any of the other positive developments and inflation data will ensure that this market remains capped.

In addition to that as we progress ahead in the next few weeks the earning season unfolds, so yes on one hand we have the macro data affecting us but on the other hand we have the micro situation through the earning season unfolding over the next few weeks. So both of these factors will continue to be the dominant forces impacting our markets.

Q: Just scratch the 2 points that you made first liquidity still waiting on the sidelines and secondly on extremely disappointing US data what stood out in the data that was reported through this week?

Parker: If we look at the United States we have had a significant decline in consumer confidence and I assume that the consumer sector in the United States will remain depressed for at least the next 2-3 months. We might get some moderate recovery in consumer spending but I think that is probably going to be the later third quarter and the beginning of the fourth quarter.

The United States housing market will remain very troubled; the default rate on subprime mortgages continues to edge higher up. Our target is 20% for default there and nearly in term of other data on the housing market, the figures for house sales and house prices have also been negative.

House prices nationally in United States are now down YoY close to 10% and one interesting feature of the global economy is, where we have real estate bubbles and I don’t see much evidence of the real estate bubbles anywhere in Asia. But the UK, the US, elsewhere in Europe- the Sapnish market and the Irish market, the real estate prices are under downward pressure and in those specific markets that is negative for their equity markets.

Q: For many analyst, the expectation or approach is that the equity market tends to bottom out before the worst news hits us. Do you think any of that has begun or might there be a lot more financial stress that a lot of markets have to go through and a lot more bad news to wade through before we actually start recovering?

Parker: First of all, I think that most of the write-offs in subprime in the US mortgage market have now largely been accounted for, where we have I think further problems is obviously with credit spread widening that could cause a problem for leverage buy out market, it could cause a problem for the high yield, where I assume we are going to see quite a sharp increase in defaults.

So for the first half of this year, I think the European banks, the American banks probably will face further write-offs. One positive point for India which I did think that many people have not picked up on yet, is with the universal banks under pressure to cut cost that means that many of them are now exhilarating, they are off shore. Therefore I think the process of moving to operational departments out of Europe and out of the United States into India that process could exhilarate and therefore that off shoring market, I think would be positive for the Indian sector.

Q: Banking has been under a bit of a cloud over here perhaps because of expectations of fears of what the RBI might do, how would you approach all these banking stocks both public and private?

Shah: If you look at and dissect the entire space both into public and the private space, the public sector banks have essentially kind of not being too involved with lot of the controversies or lot of the issue points, which have been quite adequately debated and discussed and as always, the valuations continues to be very attractive in that space. Most of the public sector banks continue hover around at a marginal premium to their adjusted book value on March 09 earnings basis, so I think that is the segment that we like. However having said that probably for the next couple of quarters, you could see the sentiment continue to be depressed in that segment essentially because of the loan waiver and its impact.

Flipping over to the private sector side, I believe that valuations are very challenging and stand alone private sectors banks, we don’t see an issue with them because the core banking related business continues to grow very well and most of them we believe will grow at more than 20% and will continue to grow and build their franchise over the next few months. But it’s the private sector banks or the private sector players, which are significantly dependent on the capital markets and that’s the segment which will continue to be the most vulnerable, a lot of them will see degrowth and degrwoth essentially because of shrinkage essentially in business and volume and also some amount of provisioning, which they may have to do because of essentially hits on the foreign exchange derivative transaction. So I think that’s the segment, which one has to be very careful and use rallies to basically cut positions or exit positions and probably reallocate that capital back into either in public sector banks or the stand alone private sector banking players.

Q: Is it your sense that we might have some more of those individual blow-ups or accidents that we saw last month?

Shah: I wouldn’t rule out that possibility as it really depends upon the management of these banks, the way they want to deal with the situation and the way they want to provide for these kind of contingences. So you might have a situation where there would be some banks, which are just conservative and essentially write off or provide for most of the contingent losses, and therefore cap the downside that they could. So that is something, which will depend upon what standard the respective management of these banks take.

Q: What’s the call on India at this point, there are some concerns about what earnings might deliver the estimates are being scaled back closer to probably 20% at the ambitious side 24%, GDP targets are being scaled back. How would approach India as a market now?

Parker: I would just like to emphases that the problem, which was discussed earlier about inflation I think it is a global problem and it is being driven by higher food prices and higher energy prices. If you strip out food and energy core inflation remains fairly muted in the next 2-3 months commodities stabilize or even come back a little bit. I wouldn’t be so pessimistic on Indian inflation continuing to rise. I think the second positive is that when we have had these discussions in the past, I have highlighted one risk factor for India, which has been the strength for the currency. I think we are now in a situation where the currency has stabilized and we could go through a good 3-6 months period, where the Indian rupee lost against major currencies and stays at approximately at current levels. There is a very strong upward pressure that we have seen, in the last 6 months to one year and we no longer see that as a factor in the market and that would be a positive.

The third factor is the growth being moderating and we have highlighted that in the past but it is moderating from very high levels indeed and the growth divergence between the emerging markets notably India and China, with the developed economies of Europe and Japan and America. The growth divergence will persist and that will continue to drive foreign direct investment flows into markets like India.

So in terms of where that leaves us and that is a quite risky position we had in the Indian market in the beginning of the year, where we will be concerned that the significant downside risk and certainly the downside risk was greater than the upside risk. I think that we have now moved into a situation where downside risk in the Indian and for that matter Asian markets as a whole is fairly limited. Though I’m worried that we may have another market reversal later in the second quarter, I very much doubt that is going to take us back to the lows that we saw recently.

Q: Now that we have stepped into this series, it is going to be a big one. There is earnings, lots of policy announcements as well both from RBI and Fed. What is the base-case scenario you are working with for the market?

Shah: The recent lows that we had tested would not get re-tested. That’s the base-case situation because we seem to have moved about 10% higher from there. The first set of earnings would clearly come out from technology companies. I don’t think there is going to be significant disappointments on that front. Most IT services companies will continue to give good guidance or very robust guidance about their prospects for next year. So, the earnings season will be put into good motion. There are too many expectations on the credit policy.

If at all a segment had some expectations about rate cuts, with the latest inflation data, those kinds of expectations would have gone into the background. We are getting into this whole set of developments with virtually no expectations. If at all there might be some positives surprises only during the May and June where a lot of the non-technology companies would start coming out with their results. It is quite possible that we might face some amount of disappointments in those kinds of months. Those companies may exert some caution in terms of their expectations for the new financial year.

May be April looks a lot better than what the last 2-3 months have been but I am not too sure whether that’s going to be the case for the next one-quarter or so.

Q: What would your preferred spaces in India be right now?

Parker: I continue to see foreign direct investment flow into the infrastructure sector. Our client base is still very interested in investing in infrastructure in India. If one looks at Indian technology companies, I do think corporate earnings growth is going to be stronger than the earnings growth we have seen in technology companies in the US or Europe. The market’s reaction to the Oracle numbers that we had recently was disappointing. If anything, there is going to be a switch in global corporate earnings growth in technology in favour of the Indian tech sector.

The third area to highlight is that although consumption in India may moderate somewhat inline with the moderation in overall economy, we still see consumption in markets like India remaining very robust, relative to consumption in say Europe or the States. So, that’s going to be an area, which is interesting.

In terms of valuations, this is an area where we are seeing clear client flows. There is more interest in private equity than in publicly-listed equity. Although the ratio of market upside to downside is now positive whereas in the first three-months of this year it was negative. I do think the upside on the publicly listed market is probably fairly limited. The possibly upside from these levels is plus or minus 5% for the year as a whole. The upside is perhaps of 10% from here.

We are seeing strong interest in private equity. That’s because the multiples, the cost of actually investing in India is more attractive to overseas investors

Source: Moneycontrol.com