Stock Market

Deutsche Equities sees Sensex at 27,000 by year end

Almost 21 percent of the Indian markets are determined by foreign institutional investors (FII), says Abhay Laijawala, Managing Director and Head of Research, Deutsche Equities. Any negative move which leads to FII outflows will have a significant impact on Indian markets.

There is an expectation of a small correction in markets, says Laijawala, but if we see a global market contagion, there could be bigger sell-offs in the Indian markets.

So, he maintains a December 2016 Sensex target of 27,000 points.

However, he is positive on Indian markets and expects India to outperform other emerging market peers.

Below is the transcript of Abhay Laijawala, Ashwani Gujral and Mitesh Thacker’s interview to Anuj Singhal and Sonia Shenoy on CNBC-TV18.

Anuj: Have the bulls charged a bit too much? Is it time for them to take a little bit of a retreat?

Laijawala: This is a question that we should be really asking all the strategists around the world, because this seems to be pretty much the case across markets globally. But in our view, what we should really be looking at is beneath the surface of this excessive optimism, what really is happening. So, we at Deutsche Equities, India are cautious on the markets and our caution is primarily premised on global factors. We remain very positive on India, and I will talk about those factors, but with almost 21 percent of our market determined by foreign institutional investors (FII), any move that leads to FII outflows will obviously, have a significant impact on the Indian markets.

Now what is really happening around the world, what we have to really see is at this point in time, there is an excessive belief or an excessive reliance in the belief that central bankers are going to remain accommodative for a long period of time. In fact, the way the markets are behaving, it almost looks like markets expect central bankers to remain accommodative into infinity.

Now, what has this led to? This has led to a massive amount of repression in financial market volatility. The volatility index (VIX) today is at about 12.8 times relative to 18 times in the second half of last year. More importantly, we are seeing a convergence, we are seeing a correlation between asset classes globally, developed market equities and emerging market equities are moving in tandem, high yield bond markets are moving in tandem with emerging market yields. So, what is really happening is that there are excessive one sided bets. When excessive one sided bets build up the way they have globally, it can lead to a very large build up of risks as and when factors change and what the markets are least prepared for is the belief that central bankers maybe running out of tools in their policy toolkits.

Sonia: If we do see a correction towards the end of the year, do you think that correction could be shallow because up until now, through the course of the year, at worst, we have had about a 10 percent correction?

Laijawala: So, we have to see what really leads to the correction. Obviously, with systemic risks building up as and when the correction takes place, there is a potential that the correction could be quite significant. That is not our base view at this point in time. Our base view is for a modest decline in the markets. But as I said, the risks are building up and should we see global financial market contagion, then the sell-off will be quite extreme. But I am repeating, that is not our base case at this point in time and we are watching global events very closely.

Anuj:The talking point for last two weeks has been IT. That has actually been your biggest underweight sector as well. So, you would not have been surprised by the kind of statements that companies like Mindtree , TCS and even Infosys have delivered. However has the sector corrected enough now or you think there is still lot of over ownership that needs to get sorted?

Laijawala: We are going through the sequential process as we had envisaged when we cut our rating on IT services from neutral to underweight. In fact IT is now our biggest underweight in the model portfolio. We think that we are not yet done with the risks. With the banking and financial services sector globally under stress, discretionary IT spending remains a risk area. Therefore until things have settled, until we see the banking and financial services sector globally look better, I doubt if this overhang on the IT services sector will lift. So, probably the market will be expecting the guidance change from the IT services sector companies could continue to go down, at least that is the expectation.

In fact if you looked at the recent Gartner study as well which had just come out after Brexit but the poll was done pre Brexit, it was talking of IT services sector being flat and this was before Brexit. So, clearly we still need more visibility on what is happening over there before we get more confident.

Sonia: On the upside you have been overweight on the domestic consumption and rural theme for quite a bit and that theme has made investors a lot money what are you seeing in spaces like autos now is anecdotal evidence suggesting that the festive demand could be very high and what kind of value do you see for many of these stocks?

Laijawala: In our view relying on the domestic consumer is probably the best bet amongst all emerging markets globally. Here I am referring to relying on the domestic consumer in India. What we are seeing right now is confluence of factors beginning to come together for a very positive confidence shock in the remaining part of the year and perhaps into the next year as well which will continue to buoy consumption orientated stocks. So, obviously we have the pay commission recommendations which have now manifested in the higher salaries with the august salary. Close to around Rs 35,000-38,000 crore has been put into the accounts of public sector employee.

In addition, we will probably see the state governments as well raise their salaries following expectations and most of the states have accepted that. This in our view could give a boost of as much as 1.4 to 1.5 percent of total private final consumption expenditure. In addition this is also coinciding with the harvest after two years of drought. We are going to see a good harvest and something that we have highlighted in all our reports is that rural India was really hurting in the last two years.

A farmer in India cannot handle four consecutive crop cycles going bad. So, clearly rural consumption has been impacted. In our view rural income constitute about 56 percent of total incomes in India 60-65 percent of total expenditure, so it is a very large segment of the economy. So, answering your question specifically expectations have been high, but could be see consensus earnings upgrades in many of the consumer oriented stocks? Our answer is yes.

We had actually written a report about three weeks ago where we had highlighted that in the year 2010, we had seen a very similar monsoon at that time we had also seen that the monsoon had been bad for the two years. After two years of drought we would see an above normal monsoon and at that time we had seen very significant increases in consensus upgrades for many of these consumer interfacing names. So, our advise to clients at this point in time is that consumer oriented stocks have been emerged as strong defensive plays and there is this prospect of consensus upgrades as well towards the later part of this year.

Anuj: Consumption has lot of legs, you have your normal consumption, the likes of Hindustan Unilever and ITC , you have auto stocks most of them are at lifetime highs. You have cement stocks which are also at lifetime highs. Which sub pockets will you be most bullish on?

Laijawala: Why did you leave out the oil marketing companies (OMCs)? The OMCs are consumption companies as well. What we are saying right now is do not look at consumption just from a very myopic view, look at consumption from a very holistic view. Everything that is consumer interfacing is going to do very well because the drivers are all turning very positive. So, what we like therefore at this point in time selectively, it is not that we like the sector entirely, we like companies selectively within the sector. So, we like tractor companies right now, we like two wheeler companies right now. We like the oil and marketing companies and we like some of the staples companies as well. So, it is a mix and I will also not leave out NBFCs as well as retail oriented banks. These are consumption oriented stocks as well.

Anuj: Despite their valuations having run up so much?

Laijawala: Despite their valuations because as I mentioned that for many of the companies there this expectation of consensus earnings upgrades coming through. One of things is, in a market like the one we are in, where only certain sectors are being preferred, the scarcity premia is going to go up for sectors which are perceived to be safe, for sectors which have the prospect of consensus earnings upgrades and at this point in time that is cement, OMCs, two wheeler companies, retail banks, NBFCs and that is quite a wide mix.

Sonia: Coming back to the first point you made about the fact that the only curve ball that could come for our markets could be from the globe. In that context we have two policies from the FOMC, one in September and one in December, where do you see the first rate hike coming in from, when do you see it come and do you think it could have a big ripple effect on emerging markets?

Laijawala: Our house view at Deutsche is for a rate hike in December – one rate hike. However we have to see what really the Fed does because the financial stability related risks are rising  in the world. As many members of the Fed have recently come out and warned that US employment is close to target, US inflation – personal consumption expenditures price index (PFCE) based inflation is close to the target of 2 percent and I think what perhaps the global central bankers are going to be very concerned about is the massive levels of debt that are being taken in the system. So, if the Fed is equally concerned about financial market stability then it is likely that that could lead their hand because if they have reached the targets on inflation and on unemployment, clearly this would be the third lever that they may want to look at. Therefore this is the level of risk because as I mentioned what is really happening around the world right now is one way bets that central bankers are going to remain accommodative. The risks are building up in the financial system and you are seeing a huge amount of leverage being taken for financial reengineering. You are not seeing leverage being taken for capital expenditure.

So, in the US for example total issuance of debt is up 25 percent over and above the high levels that you saw last year and a huge chunk of that has been taken for financial reengineering and very little of that has been taken for genuine capex.

Anuj: Let’s discuss some more sector I am looking at your top large cap picks and I see couple of pharma names. It’s been a stock specific story for pharma companies, but do you get a sense that the worst is over for Indian pharma?

Laijawala: As you rightly said, pharma is more of a stock selection story very, very specific names over there, so our preferences are for those stocks, where the FDA track record is good and where there is significant earnings pipeline. Therefore, our preference in the sector is more for those stocks. It is very, very selective therefore we have just two pharma names in our model portfolio.

Sonia: Two sectors that the market has lost complete interest in this year one is IT that we discussed and the other one is telecom. Do you think the days of serious wealth creation as a sector are over for both IT and telecom?

Laijawala: I think in my long innings in this market, I have learned one thing that just because a sector or a company is down and out for some time doesn’t mean that the days of value creation are over. Many drivers could converge at some point and time, which could bring back that value creation, so far from it.

Sonia: So do you think that perhaps this is a good time to bargain hunt in some of these stocks, I mean Infosys is down 20 percent from its highs, Bharti is down 20 percent from its highs. Would you bargain hunt anyone?

Laijawala: Well, if investors are looking from 2-3 years perspective and would not want to see or can withstand the volatility in the very near term then absolutely, but if investors cannot withstand the volatility that will come through in these sectors, then maybe they need to wait. I guess it really depends on the horizon that investors are looking at.

Anuj: This market has been driven purely by liquidity. In the past, we have seen that there have been phases where foreign institutional investors (FIIs) have withdrawn money, but the domestic investors have comeback and they have supported the markets, though of course FII money still remain the major driver. If because of a global shock, we have big pullouts from emerging markets (EMs) India included, do you think we have enough support from domestic investors or do you think we will have to go through a period of correction, if there is a pullout?

Laijawala: Unfortunately, given that foreigners constitute close to 21 percent and domestic institutional investors (DIIs) including the insurance companies are at about 7 percent, maybe 7.5 percent. If we see a very significant outflow by foreigners then unfortunately the domestics will not be able to offset the selling by the foreigners, but if it is just modest outflow then to that extent probably the Indian markets may not be impacted as much as any other emerging markets, which rely primarily on foreign institutional inflows.

And to the point, we are seeing foreign institutional inflows come in, but what you really need to see is in the last 3 months close to 40 percent of the FII inflow has been ETF money, that is something that we need to watch, because the ETF money can go out as fast as it has come in and the key point here is that, is that ETF money a precursor to more active money or are we probably going to see a big change, that remain very difficult to say right now.

Sonia: There is lot of money going into bond funds these days. Even if you look at what happened last week, equity funds got about USD 200-250 million, but bond fund saw more than USD 6 billion why is that happening and do you think that trend could continue?

Laijawala: That’s right. That’s very, very interesting as you rightly said average flows into bond funds this year is many multiples of what you are seeing in terms of equity. So, bond funds on an average seeing close to around USD 2.5 billion relative to around USD 200-250 million last year average per month and equity fund is the reverse. We think that what’s really happening out there is a massive flow of liquidity, so the increased in the flows into bond funds are a manifestation of declining bond yields and more importantly the huge boost to liquidity, which is driving down bond yields, which is leading to massive amount of financial savings.

Plus if we really look at the savings profile without even seeing the data, the data will obviously come with a lag, but it almost looks like the Indian investor or the retail investor is moving into financial savings from physical savings. So, if you recall around 2 or 3 years ago the biggest problem was physical savings being preferred by the retail investor and that was on the back of real interest being negative. With real interest rates in India turning positive with this huge boost to liquidity with bond yields coming down, bonds have become attractive, equities had become attractive two years ago.

Anuj: What are your trading picks for next week?

Gujral: Torrent Pharma is a buy with a 3-6 months target of about Rs 2100. Aurobindo Pharma is a buy with a 3-6 months target of about Rs 1000. Lupin has also bottomed out, so out there target of Rs 1800 could be seen in the next few months.

Thacker: I have a buy call on JSW Energy which appears to be triggering some kind of short t o medium term up move. My sense is that the stock could head towards targets of around Rs 88-89 in the next 1-2 weeks. I would recommend accumulating the stock at current levels of Rs 82 and on any declines to about levels of Rs 81. Keep a stop loss just below levels of around Rs 78.50.

Sell call is more of a short term call, that is a sell on Hindalco . I think that is again looking like a setup wherein profit booking is very likely and the stock could get into some kind of a mild correction. So, sell with a stop at about Rs 158.50 and look for declines to levels of about Rs 150-149 in the next 2-3 sessions.