Experts differ on road ahead for mkts

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Surjit Bhalla, Chairman, O(x)us Investments, said the markets look attractive at current levels. "India doesn't look better than it did three weeks ago. Sentiment is still poor. We may see further downside, but the markets are unlikely to drop too much."

He feels the markets may be making a major bottom now. "We are close to a bad patch in the market. The economy may bottom in months."

On triggers, Bhalla said there are no domestic triggers left for the market. "Price-to-earnings levels are at single-digit, which are the lowest in several years. We don't believe fundamentals are too bearish. The oil bubble may not last. Crude needs to cool-off for any upside to emerge."

He is not too bearish on the Indian economy. "Market valuations now consistent with the economy. Usually, markets bottom out six months ahead of the economy."

According to Bhalla, no market, other than oil, has given positive returns. "We have seen a synchronized bear market across the world. A bear market rally is a distinct possibility."


Devina Mehra of First Global said the markets are definitely in a bear phase currently. "History shows that bear markets have lasted for 2-3 years. We may see at least another year of negative returns. The underlying macros are also not supportive. We will see pressure on fiscal deficit, and current account. Corporate margins are also expected to be under pressure. We are likely to see earning downgrades going forward."

Bear market rallies will be sharp and fast, and tough to trade, she said. "These rallies are too swift for retail to trade effectively. Equities as an asset class don't look too attractive. The Sensex could drop to 10,000-11,000 levels."

According to Mehra, there is still considerable pain left. "We expect more negative newsflows. Domestic demand sectors may be strapped for cash and raising money may be a problem for corporates. Order books for construction, capital good companies are under pressure. Cost escalation issues may plague companies and hurt margins. However, an oil price fall would be the only positive trigger."

Source : Moneycontrol India

 

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Excerpts from CNBC-TV18’s exclusive interview with Surjit Bhalla and Devina Mehra



Q: Since we spoke last, have things worsened significantly? How do you assess the global and local situation for equities?

Bhalla: When we last spoke, the market may have been somewhere around 4,500-4,600. I was in the camp that felt that this was very close to the bottom, if not the bottom. Over the last 2-3 weeks, we have moved systematically down.

I don’t think India actually looks better than it did three-weeks ago, yet we are 15% down. For my advantage point if it looks attractive at 4,600, it certainly looks attractive at 3,900. I don’t think this is an India story at all. This is a world story. There is no market where you can find respite in. If you were trading a fixed income in India, then you lost a lot of money. If you were trading a fixed income in the US, you lost a lot of money. If you were trading currencies in India, then you lost a lot of money because you didn’t catch the move either way. If you are trading currencies in the US, you lost a lot of money. So, there isn’t a single market in the world where you have made money except oil.

What we have seen globally or seen this quarter is a synchronized bear market.


Q: Can you now say with certainty that we are firmly in a bear market? If so, can we hope for a bear market rally now or are we going further down before any recovery takes place?

Mehra: Yes, we are very definitely in a bear market. It is actually an eye opener for us. A few months ago, we took a look at the 100-year history of world markets and looked at periods of 40-50% trend compounding. In every single case, where you had 4-5 years of 40-50% compounding, the next three years did not get positive returns in the market.

There was no exception barring one where there was a marginal 2-3% positive. That really was an eye opener, because we have had that kind of five-year market where one had 50% compounding. So, the most likely result was one or at least a couple of years of negative returns. One could say that this time it would be different if the underlying levels things are going great guns, which they aren’t, nor in the world nor in our country.

India had a great bull run from 1987 to 1992 and then for almost 8-10 years the market did nothing. Even though in the first half of the 90s, industrial production was doing very well. Right now, we are in a situation where all economic indicators are turning scary. Many of them are really out of the control of the government or regulator. So, one would see pressures on the current and fiscal account deficit. On the corporate earnings side, there are margin pressures, and there is going to be growth pressure. Even if you can make a case that this time India is doing something different, which will change the history of how markets have been, then there are concerns.

Bear market rallies come, but the problem is that they are very sharp both ways. This week, we saw a very sharp rally, but the next day we have a gap-down. So, whether you can actually trade that becomes a question.


Q: Having gone through six-months of this bearish kind of patch and lost above 40% on the index, some people believe that may be most of the price damage, if not all, has happened. But the problem with bear markets is that it doesn’t end with price damage, it lingers on for a period of time which is very frustrating. When to your mind do things start getting on the mend once again, where you can see the uptrend resuming?

Bhalla: Sentiment is the same with bull markets. Once we get away from fundamentals, the price action is over. Sentiment is still bad and that means there is further downside. We all are looking for triggers. I am not as bearish on the Indian economy, even valuations are now consistent with economies.

For example, in the mid-90s when you had industrial production growing at double-digit rates for a few years, the market had already anticipated that. Therefore, one could with hindsight say that the market was ahead of the game and fundamentals won’t have that much of an impact anymore. It didn’t. For 13-years, we were in a range of 3,000-4,500, with a spike up to 6,000 as part of the dotcom boom.

At present, we are looking for a trigger. What are the possible triggers? I don’t think domestically there are any triggers left or would have mattered anyway. The only one being elections and that clearly may have an effect for 1-2 days, it is not going to be long lasting. The real trigger is internationally and within that it is oil.


Q: Are we gearing up for some kind of bear market bounce now or you are not even that much optimistic?

Mehra: Those rallies happened, but the problem is whether a retail or institutional investor can actually trade that rally. So, that becomes a concern. The most important thing is to keep the broad market contours in mind rather than trying to catch every move. That is the area where I am not sanguine about. Last year, we had a situation where India and China were way above every other emerging market and lead the emerging market rally. This year, they are among the bottom performers in the emerging markets space year to date.

It’s not even an India specific thing that we are talking about, both in terms of the economics of it as well as the market movements themselves. We do not think emerging markets as a pack will do well, and within that India is not going to do well. In fact, equities as an asset class don’t look too attractive.


Q: When you map valuations from where we have reached right now, is it conceivable that the index could sink to 10,000-11,000 levels? Is it in the realm of possibility?

Mehra: It is in the realm of possibility. When the markets were going the other way, many things didn’t make sense. For instance, the valuation of power utilities or real estate, which no matter how one ranked the economics of it, didn’t make sense. At the time, they were the flavour of the month or quarter. The valuations paradigm themselves didn’t make sense. So, one cannot say that just because something has fallen 50-60% it has now becomes attractive.

In the first part of this decade and right up to a year ago, many old industrials, like cement, were still utilising capacities that were set up much earlier. So, one had a big kicker coming from the asset turnover side. Then one started to run out of the capacities and started investing more. Now, lower asset turnover and returns on equity will start kicking in. At the same time, when one has pressure on both demand and the cost side, that is a concern.

So, a lot of negative factors have come together for many industrial sectors. Just because valuations on historical earnings have become cheaper, it doesn’t mean that it is now looking very attractive.

When would earning downgrades happen? We would now be seeing them, because in Q3 itself the earnings slowdown was visible and Q4 was again the same story. So, one will not see FY09 earnings anywhere close to what they were anticipated to be three-five months ago. The whole valuations picture will look different once the earnings number changes.

 

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Q: Do you envisage this kind of dire situation, where from here the market losses another 15-20%?

Bhalla: I have a different take on the situation. There is an old adage that markets will make one insolvent long before rationality creeps in. So, markets can or do extend far beyond any rational explanations. Any price is possible. It is within the realms of possibility that the market can touch 10,000, and maybe 8,000 and 6,000. Is it likely in my books? No. Is it something an asset manager could incorporate in its decisions? No. I clearly do not see fundamentals as bearish as Mehra does.

The US market isn’t down that much given all the shocks that it has had, like the financial system meltdown, oil melt up, and the economy going through the ringer. Everything conceivable possible that could go wrong in the world has gone wrong.

The fact that we are at 13,000 is somehow optimistic. What else could go wrong? Could oil stay here? As a fund manager, I don’t think it is likely to stay here for an extended period of time. This means that a bear market rally is a very distinct possibility. May be we rally 10% and oil falls, and then we look at a different world again.

There are reasons why the market has come down here. So, one can speculate on the reasons and agree on most of them. The question fund managers have to ask is where is the next one-two year move for long-term investors. At these levels, the market is very attractive. Price to earnings is back to levels that were the lowest in the last 15 years. Single-digit PE for industrial firms suggest there is value.


Q: What is your best guess of how long this bear market can extend, having seen similar such markets in the past?

Mehra: If one goes by past history, then it is normally 2-3 years of negative returns. If we considering that we started six months back, at least a year from now is the best-case scenario. We can all hope for the best because bull market are good for all of us, but markets are not about wishful thinking. They are about how markets actually behave. So, we should see another year or so of not very good news from the markets.


Q: When you say another year of negative returns, do you mean that we won’t go back to previous highs in a year-and-a-half or from these levels it will be difficult to get returns out of equities?

Mehra: We would not go back to he previous levels or highs for at least a year-and-half to two years. From today, I would say there is still considerable pain left, because on the news front we would see a lot of negative news coming in.

The whole story, or a lot of it, of this bull market was predicated on domestic demand. A number of those sectors are not really cash generating sectors. There are sectors which require cash, so whether you look at construction, industrial, capital goods etc, they were all in a mode of raising money. Very buoyant markets were also very good for corporate fundamentals, so it’s reflexive relationship.

If the market goes down, cheap sources of finance and a lot of growth options go away. A lot of other things, which were positive a few months ago, have turned negative. Earlier, the order books of construction or capital goods companies meant that earnings ability is high. Now, in a situation where there is lot of input cost pressure, those become a millstone around the neck of these companies, because typically the cost escalation clauses do not account for one to one escalation. Some of them are linked to indices which may not reflect the price rise in steel, so we would see pressures on that score.

One would see pressures on numerous scores: demand, margins, and the fact that cheap money from markets is no longer available. I don’t think there would be a great deal of good news which would act as a trigger to shorten the period. The only trigger which is possible is that oil price might come down. We think it’s a bubble. If you look at commodity indices baring oil and to some extent steel, the move has been extremely narrow. That shows that at some time it will fall. Bubbles give up 100% away from trend returns but we don’t know how long the bubble would last.

The positive trigger on the fundamental side could be oil. Even then I don’t see how one would see less than a year of pain.


Q: The other big problem for equity markets has been rising interest rates. The inflation number is convincing people that it won’t go away in a hurry. What are your takeaways from the newsflow and the anticipated pain from that side?

Bhalla: There are two things about fundamentals that I wish to emphasize. Most of our studies have been done in the US markets, which is the most sophisticated. First, markets tend to basically bottom out six months before the economy bottoms out. So, I wonder whether the same will happen here.

If the fundamental news is going to get worse, be it inflation or the real economy, about 3-6 months down the line, then this is where there is a very high chance of a major bottom being made, let alone a temporary bottom, with the proviso that the economy is going to get worse and will bottom out six months from now. If oil prices do go down sometimes in our lifetime, then interest rates will fall, and that is obviously a major plus for equity markets.