Share Bazaar News India

R Sukumar of Franklin Templeton said the markets will see more declines than advances. "Another 10% downside cannot be ruled out from current levels. News flows will remain negative from a fundamental perspective."

Sukumar expects earnings to grow in 15-20% band instead of 30% earlier. "Forex derivatives losses will also impact profitability."

Bluechips will stabilize soon as they are looking close to the bottom, he said.

Alroy Lobo of Kotak AMC said the worst might not be over. "The Sensex is likely to go down to 14,000. Global cues are also poor. We have not seen the end of bad news."

Lobo is concerned about earnings and the impact of forex derivatives. "Many companies are exposed, that's why we concerned about exposure to FCCB market. Close to 500 companies involved, around 75% of those are in the listed space. We don't see significant earnings upgrades or target price hikes."

Excerpts from CNBC-TV18’s exclusive interview with Alroy Lobo and R Sukumar:

Q: Is the market showing you some signs of stabilizing or are we still on shaky ground?

Sukumar: The blue chips will probably stabilize soon if we do not hit the bottom. We are probably close to the bottom. If one is looking at the advance-decline ratio for the year, there will be more declines than advances.

Q: That’s an interesting take because midcaps and smallcaps have been hit 50-60%. In many cases they are still down 50% from their peaks. Do you still think they cannot strike out some relative outperformance versus largecaps?

Sukumar: The quality names within the midcaps probably can, but a lot of companies’ plans have hinged on capital raising. With weak capital markets and growing inflationary pressures, there can be a lot of fundamental disappointments. I don’t think everything has been factored in.

Q: Do you agree with Sukumar that we are somewhere reasonably close to the bottom for the index or do you see more downsides?

Lobo: The next couples of months are going to be very defining and that would basically tell us whether we are close to the bottom or not. Fundamentally, there is still downside. I would place it at close to 14,000 levels on the Sensex. In the next two-months, we have events like the result season. This result season is going to be defining on account of two reasons. One, it’s the year-end results, so one is going to get some guidance from companies for the next year. Two, there will be more clarity and disclosures on the mark-to-market, or MTM, losses on forex derivatives.

On the international front, I don’t think the problem is out of the woods. Close to 40-50% of the total provisions have been taken. There is more bad news that could basically come in. At present, the problems seem to be concentrated in the residential real estate market. If it spreads to commercial real estate market, then one is in for a longer haul. The next couple of months will tell us whether we are close to the bottom or not. But on a fundamental basis, the market could sort of test around 14,000 levels before it bounces back.

Q: We are essentially talking largecap names now on the index. Do you think another 10-12% odd downside is possible or fundamentals and valuations don’t justify that?

Sukumar: 10% downside can never be ruled out. In emerging markets that’s a normal type of volatility and is not extraordinary. On whether it is a possibility? It is a possibility at any point of time. We have to keep two-things in mind. When we look at economic fundamentals, whether they are bottom? I don’t think they have bottomed. We will see deceleration in corporate earnings and see a slowdown in economic growth rates. Globally, we will speak about more bad news. Inflationary pressures will be difficult to control because we are importing inflation.

From a fundamental view, news flows will continue to be negative. The markets have bottom out before economic fundamentals do and incremental bad news at some point of time will stop having an impact. We are coming close to that point.

Q: You spoke about that 14,000 mark. At that point, would valuations put a floor to this market or do you think it is another 10% leg which is determined by poor newsflow and which the market had not priced in quite yet that will lead us down another leg?

Lobo: When I am looking at a floor of around 14,000, it’s factoring in some amount of bad news that could possibly come in. I just want to caveat it by saying that the amount of leverage positions out there in the market is clearly unknown. One case of a blowup and you find those leverage positions being unwound. That’s very difficult to estimate. Sometimes you tend to overshoot on the downside when these leverage positions get unwound. On a fundamental basis, I am factoring in some amount of earnings deceleration, and bad news.

Q: How worried should the market be about inflation going forward and the kind of policy responses which are expected to cool it because that is being perceived as a bit of a threat?

Lobo: This times inflation is definitely different from the last time you saw high numbers. The reason being you are seeing high inflation at the time when you are seeing slowing growth.

Second, the rupee is far stronger now than what it was last time, when you saw high inflation numbers. You are also seeing that globally and in emerging markets in particular where inflation is on the rise. The policy responses which have happened in the past, in terms of tightening monetary policy, gives you little scope to maneuver. Since we are coming close to the election year patch, inflation is getting far more attention than before.

Somewhere in mid-July, you should see the trend reversing. Perhaps this time around in addition to supply side inflation, there is also some kind of demand side inflation that you are seeing. If the monsoons are good, supply side inflation abates. The second half would see only the demand side inflation. To that extent, you should see some reversal post mid-July, but the trend is definitely likely to be in a 6-7% band at least for the next few months.

Q: What worries the market more, is it the possibility of policy responses which are unpalatable? There are already fears of more tightening by the Reserve Bank of India. Do you see it as a material threat to equity markets?

Sukumar: If there is a trade off between controlling inflation and growth rate, I think the central bank and the government might tend to tilt towards controlling inflation and probably compromising on growth rate. I don’t think the policy responses are going to have an impact on inflation. If you look at the wholesale price index, or WPI, basket, it is a very small portion of the basket which is having an impact on inflation numbers. These are because of global commodities on which the Indian policy responses are going to have the minimal impact. Policy responses might have the effect of not being able to control inflation and might end up reducing growth rates. The government and RBI are sensible. We have fairly intelligent people, so I wouldn’t expect them to do something very irrational.

Q: Do you expect to see significant growth deceleration this earnings season keeping the problems of the derivatives, and Mark-To-Market aside in terms of core earnings deceleration?

Sukumar: We have been growing above the trend. We believe that long-term earnings trajectory has to be probably in 15-22% band, 30% has already been reached in the last five years, which means that we have been growing above the trend. We have to return to trend and when we go to trend, we might even under shoot. Now, there are enough pressures to force our earnings path into trend or below trend. Inflationary pressures will put pressure on margins. This forex derivative thing is one off and it is going to have a near-term impact on margins. The fact that people are adding more capacity and cost structure is going up, and all these things are going to have an effect on profitability.

Q: Will we come out of this earnings season feeling really shaken about the underpinnings of this market, or do you think that we may come out feeling confident?

Lobo: I don’t see significant earnings upgrade or target price changes happening. Right now, analysts are downgrading their target price and earnings because they have inflated these numbers quite significantly during this bull run. On one hand, even if you see some good results, it is unlikely to be a significant upgrade in numbers.

Q: And the derivative MTM that you eluded to, which sectors or largecap names are you most unsure or apprehensive about on that score?

Lobo: For what I gather there are quite a number of companies which are exposed to this forex derivative issue. I would basically be more careful of companies which have been exposed to the Foreign Currency Convertible Bonds, or FCCB markets. That’s one segment that we are watching very closely. The other segment includes companies which has got some kind of exposure to the export market in terms of forex loans.

Almost close to 500 companies are involved and close to 75% of them would be in the listed space. It is very difficult to say which company has got and to what extent they have written off to cover their positions. It is difficult at this point in time to estimate that.

Q: On Tuesday, we will have Infosys giving its guidance for the full year and the stock have had some amount of confidence built into them going into that event. Are you optimistic going into 2009 on IT or do you think it will be a very conservative guidance and a difficult year?

Sukumar: It is very difficult to figure out what they are going say on Tuesday. Volumes are fairly stable and the risks are minimal at this point of time. Buyers of Indian IT services seem to indicate that the volumes are intact. Indian IT venders were looking at some price increases which might not come under current circumstances, so that is a marginally negative. The other positive could be that the rupee is weaker compared to what was forecast and that might help their margins.

Q: Can one expect IT to assume some mantle of leadership post the Infosys guidance or is that being too optimistic?

Lobo: IT tends to perform when growth estimates get revised upwards. It's unlikely to see significant revisions in earnings based on the Infosys guidance. One doesn't seen further blowups in YoY growth, assuming normalized conditions, as debt basically starts bottoming out somewhere in the June quarter. So, we would basically wait for may be one more quarter to take that call.

Q: One quick call on the oil and gas space, which has started outperforming. We have seen good performances from Reliance which was up 10% this week. Cairn has had a meaningful rally and also RPL, and GAIL. Do you think there is case for upstream oil right now?

Lobo: It is a largecap sector, so one has to be exposed to the sector. There is also a play on oil prices which have been basically moving up. That's another reason why one is seeing interest building up in that sector. In case you see any kind of reversal in commodity prices, then some of these stocks would not give you that kind of an upside, but it is more to do with a play on oil prices.

Q: The big disappointment of the last fortnight has been capital goods and they have bounced back a bit in the last few days. How have you read all this de-rating of BHEL after numbers and the subsequent pullback? Where do you stand on capital goods as a story?

Sukumar: That sector had the maximum momentum in 2007. When there has been so much of buying and people being net long on it, if there is a lack of buying and some shorts then obviously it creates a big fluctuation. From a fundamental point of view, the top tier companies don't see as much change in their order book or profitability, but the second and third tier can see deterioration in fundamentals. Some companies will bounce back and some will continue to languish.

Q: Was this a buying opportunity for you or do you have apprehensions on this space on valuations, and delivery and execution capabilities?

Lobo: It is clearly a call on relative valuations. Some of the target prices have been factoring in a pretty high growth rates sustaining over a long period of time. The order flows could actually start decelerating though the order book is quite strong and you would see visibility. To some extent, some of the de-rating in the stocks seems to be valid. This is one sector which will continue to report very strong earnings. If one is getting them at reasonable valuations, one has to be more stock selective within the space. We would be buying into this space.

Q: One quick call on the banking space? Bond deals have gone up or the benchmark yield is above 8% and inflation persists, would buy into this fall in bank stocks or do think this underperformance may continue and frustrate investors?

A: One could play banking by getting exposed to the private banking sector because they are less exposed to the bond portfolio. At the same time, the second half of this calendar year should see inflation trending down. So, it is matter of where you want to position yourself. It is quite possible that in the next couple of months one could see financials underperforming. I am pretty bullish on the sector for the longer-term. It is function of GDP growth rate and financial deepening the Indian market. This sector is perhaps the most promising sector from an Indian perspective.

Q: Steel has been derated over the last couple of weeks after all those fears of government interference, would you stay away from that sector, or is it an opportunity for you?

Lobo: I would say that clearly within the steel space, we would like to play companies, which have captive raw material particularly iron ore and there are companies like Tata Steel which is a big component of their overall operations and which is not really impacted by domestic government policy. But if you are asking me in totality, clearly commodities particularly metals is one area where we are actually underweight.

Q: What is your stance on this commodity, specially in the light of the events of the last fortnight?

Sukumar: Indian steel is not looking very exciting because the best period for the steel companies is probably going to be the next one to one and half years and if there are going to be policy pressures and if they cannot improve their margins at this point of time, then probably it is not very interesting. I think on a regional basis, steel is definitely looking good and some other steel makers are seeing improved profitability but inspite of it, I am not too bullish on the local companies.

Q: We have seen some out performance from the under performers of last year, like FMCG and pharmaceuticals; do you think that is likely to continue?

Sukumar: In pharmaceuticals, I think the issue is discipline among companies to use capital wisely and the reason the sector has got derated is companies have made a lot of acquisitions and acquisitions have not been value accretive. Unless they see a change in the mindset I think it is very difficult for the sector to become major outperformer. There might be individual companies, which are doing well, which could do fairly well.

FMCG I think is a good case and I think it can give very good risk adjusted returns. If we see a volatile market condition, I think it will do very well.

But suppose there is a big revival in a market again, it could tend to underperform. It is definitely a sector for people who are looking at risk adjusted returns not just absolute returns.

Q: Finally we have had a good period of resilience from the US market and it has been surprising everybody that the market where all the problems are that has been the biggest outperformer, do you see that continuing because that has become a bit of a hopeful poster boy for most other emerging markets or do you think there is another big leg down coming there?

Lobo: I do not think that the worst is over in terms of numbers coming out from there; only about 50% of the total write offs have been provided for, so you want to see more bad news coming in there. But I think as Mr Sukumar rightly said, some of this gets priced in before the bad news comes in. So maybe you will not see significant downside unless this spreads to the commercial real estate markets in which case there is further downside in the US market.

Source: Moneycontrol.com