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Stuart Smythe, Head of Equity India, Macquarie, expects the markets to remain volatile. "India is getting in sync with global markets. We have not seen the end of the unwinding in global financial markets. India has rallied to some extent recently due to short covering, but moderation of GDP growth, currency, and inflation risks remain a concern."

According to Smythe, the markets may see another 5% downside, as value investors have not come in. "We will see more stock specific interest and have not seen the market bottom yet."

He feels there will be a moderation in earnings. "We are likely to see some pressure on margins."

Excerpts from the exclusive interview with Stuart Smythe:

Q: What do you make of this kind of trading pattern, quite volatile, flip-flopping between days, but essentially not going anywhere? Do you expect this to continue?

A: I do actually; I expect we’ll see this for some time to come. You’ve touched on the point that we are actually synchronizing with the rest of the world so far as the downturn and so far our market performance is concerned. I think that investors should actually take it away as a positive rather than a negative. If we weren’t behaving in a similar vein to the rest of the world markets, I think we’d have a bit more to worry about.

Q: That’s what has happened last week; India and China were singled out for punishment. Do you think most of that underperformance has played out or when you talk to institutional clients, these are the markets they are most worried by?

A: The performance suggest that and it is very evident that they are the ones that have under performed but I don’t necessarily see it as being an issue of redemption which many people are talking about. I think it is more country allocation specific and risk specific. If one takes a look at India in particular relative to the rest of its peers in the Asian region, it is still a high risk market, at one point 1-2 times beta. It is on par with the likes of Indonesia, China. So one is seeing that an aversion to risk is starting to take its course across the Asian markets in particular and we are actually noticing across the region flows to Taiwan, Thailand and even Pakistan and that’s also evident by the fact that they are the only real outperforming markets in the region.

Q: What's the sense you get from your clients? Are you seeing buying resume at lower levels or is it still a very lackluster liquidity inflow scenario from FIIs?

A: To be honest, FIIs have been reasonable. I would say it is certainly nowhere near as exuberant as it was into the close of the calendar year. The interest is certainly coming and all stocks obviously have a price and it gets down to multiples that we haven’t seen for quite some time and that was one of reasons one saw support coming from BHEL today. We were certainly very keen and have been a supporter of the stock and retain our outperform on that but one will find more and more specific stock interest will come in once we see even further value and I don’t think we are have actually seen the bottom yet.

Q: So, what is the bottom according to you?

A: I wouldn’t be surprised if there is another 5% or so. We haven’t seen the traditional value buyers come back into the market. India has been off their radar screen for some time. It has been very much driven by momentum, event plays and some traditional supporters of India, who really haven’t seen the large value players put India on their radar screens just yet despite the fact that we are 25% down year-to-date.

Q: What about earnings, we have started or just got into earnings season this week? How do you think we’ll come out of it, with a sense that things are slowing down more than we thought or with a note of confidence?

A: Without question we’ll see QoQ moderation in earnings growth. We are still reasonably positive on the topline. From a margin expansion perspective, this is one quarter where we expect to see that continue. However, the pace of margin expansion will definitely start to decelerate. I think unfortunately markets are working on a three-month or a quarter-by-quarter assessment at the moment.

So, in that context, Seshadri Sen, our strategist has recently released a paper that spoke about revenue growth being fine, but earnings moderation certainly starting to be seen right across the board with the exception of probably cement and the property sectors.

Q: Just heard you saying that maybe the bottom is not here yet, what is giving you that sense and how much further can we move southwards you think?

A: We still haven’t seen the unwind of the global short that is happening on the financial stocks in particular. The short covering rally that we have seen in many of the financials has supported that sector’s relative outperformance particularly this week. But I still think the US remains fundamentally weak. I don’t think we have seen the bottom when it comes to the crisis in credit. I think we have seen the first wave. I still think there is more to come in that regard, which will destabilise.

A couple of interesting points there too that were made by other commentators today with regard to both the elections, GDP growth - certainly the moderation of expectations there to around 8% if not below 8% and also you’ve got currency risk, which is another one, and the inflationary concerns that are out there in the market. That is a nasty confluence of events to actually be happening when the markets are so jittery.

Q: What's your feeling on this earnings season? Do think we will have some nasty shocks in this earnings season or do you think we will come out of it okay on this derivatives disclosure bit?

A: It is certainly noise that the market doesn’t need at the moment although having said that, the transparency that the ICAI is putting in place will actually improve and certainly gain brownie points if you like with international investors who are much happier to see the transparency being played out. The quantum is the real issue. There are expectations of somewhere between USD 2-5 billion could potentially be bought to the markets attention - that’s a fairly substantial number and obviously has a potential to be nasty if they have to actually come into effect.

Q: How big is this whole interest rate spike risk, which the market is dealing with right now? Where do you stand on what the RBI might deliver at the end of this month and what's your stance on interest rate sensitive sectors like banks therefore now?

A: There is the need to look at the CRR. Our house view at the moment remains that they won’t necessarily be a rise. But although having said that, our regional economist Bill Belchere has just spent yesterday in Delhi where it is quite evident that the only mechanism really left for the government is to play around with the CRR and then at the repo level as well. Our view in that context is 25 to 50-bps obviously would not be outside the realm of probability come the monthly meeting at the end of April.

Whether that’s enough is potentially the question. We have done some analysis looking at where CRR’s come from and many people remember that back to the early 90s, the CRR actually spiked as high as 15% and whether or not we see anywhere near that level is out of the question but certainly soaking up excess liquidity that’s in the market at the moment is something that the government needs to do in order to take some of the heat out.

Q: You spoke about BHEL earlier, do you think the worst is in place there because that stock has got derated quite a bit and today L&T got singled out for some punishment? What is your general take on what is going on with the capital goods sector?

A: I think what surprised the market more specifically was the execution risk. BHEL has been one of those companies that has continually beaten its guidance. So, to come in and read just their guidance down, I think took the market by surprise. I think because the sector has been so hot, and contracts are coming in, you do have order books that are 3-3.5 times larger than they were literally, two years ago. The execution risk and the potential for some of these projects not to be delivered on time is something that the market is starting to price-in.

Q: What is going on with IT, we have seen it recover in the last one week or so? Are people buying in ahead of the Infosys guidance and is that a trade that you are recommending to your clients now?

A: We saw some positive sentiment coming out certainly from the Accenture result. At the same time, I think there is quite a lot of discussion around the currency. I think you’ll find the currency being rangebound between 39.50-41 and it has certainly put some confidence back into the IT sector, given the exposure it has to the strengthened of the rupee. I think that is why you are seeing some confidence.

Having said that, I don’t think we are necessarily on the front foot recommending this sector relative to others. Having said that, we still remain positive, we have got an outperformance on the sector because we do see particularly with Infy some reasonable expectations about a big guidance and that again should be a positive sentiment driver but not necessarily the most bullish sector that we have got at the moment.

Q: Finally, when do you see emerging markets getting out of the woods for this year? It has been a sticky three-months and we haven’t seen anything meaningful byway of flows not just in India but in other emerging markets - when do you think risk appetite recovers and we get out of the rut that we have got in?

A: I would be expecting last quarter of this year before it turns around. There are still issues that need to be resolved. There is the political issue with up coming elections. There is an issue with interest rates and then there is inflation and slowdown in GDP growth. We are definitely testing the market or testing on a quarter-by-quarter, earnings-by-earnings mentality at the moment and I don’t think that’s going to go way in a hurry.

Q: Does it look like a bear market to you?

A: I wouldn’t say a bear market. I would say it is certainly just a reallocation and a de-risking or an appetite for risk that’s definitely diminishing.

Source: Moneycontrol.com