2019 a tale of two halves; be watchful in H1: Aditya Narain

In the first half of the year, you could lose a certain amount of value and then there may be a more normalised 67376938 67376545 67366445 kind of trend in the second half, Aditya Narain, HoR, Edelweiss Securities, tells ET Now. Edited excerpts: Good year, bad year, what is your sense for 2019? Well, it should be an up and down year. In parts, it will be a bad year… That happens every year… Up first or down first? I suspect, down first. I suspect it is going to be down first and up a little later in the second half. We actually think it is going to be a year of two halves. The first half is going to be a half when you need to be watchful and when we think you could lose a certain amount of value and then get into a more normalised kind of trend in the second half. And why is that? Is it because this year the market does not have a clearer picture on the election outcome as it was in 2014? That is one part of it but that is preceded by the fact that globally, things are looking quite soft and uncertain. That is the key part. The extent to which India has outperformed over the last quarter, is something investors need to keep in mind. Plus at the end of the day, you have actually had a liquidity event. There was a credit squeeze towards the latter half of last year and one does not really know what the ramifications of that are. In that context, a market that has outperformed so substantially, is valued a little on the higher side. You just got to be a little watchful given that you have the dividing line in terms of the elections. But are you worrying that are we going to fall in line and align ourselves with the US equities, the kind of fall that they are seeing and continue to see? Not necessarily, but that needs to be an influence. Typically, over the years, markets have got more correlated. If you have a very significant standout, unless there is a huge change on the underlying, that standout does not sustain. There is a reversal to mean at some level and I think India is set for that. And the huge underlying is unlikely to take place at least in the first half? In the next six months, it is really hard to make that call. Cycles in India also tended to get a little extended and so for people who keep expecting earnings to suddenly bounce back or for the investment cycle to kick through very aggressively, that is being a little optimistic. What is the worst case scenario in the next six months that you foresee? Typically we would tend to believe that the market range over the next six months is basically going to be about 9800 to 10,500. We are basically overvalued relative to our range and we are at least 10% off the bottom of that range. I have a report from HDFC Mutual Fund. They said elections come and go but they never change the market return at least in a meaningful manner. But market commentators seem obsessed with election. Why is that? It is a very simple thing. We are all being asked to call the market in a shorter term context and that is why we are making those calls. If you ask us what our year-end target for 2019 is, it is 11,800. If you ask me what is it looking like until the elections, I gave a slightly different view and we have to nuance our call to that extent also. That is where part of the story is and we are making the argument that when you have this level of uncertainty, the election being one element of it, the market should trend towards its mean valuations. Beyond that, you got to see it in the context of longer-term cycles and how they are playing out. We think you could be at a little bit of a premium closer to the end of the year once the dust has settled on this. Actually the way we are looking at it, this is a point in time to be defensive in one’s portfolio but to be optimistic in approach, you will potentially get opportunities in this period of time whether it is the global, whether it is the elections, whether it happens on the liquidity squeeze where things could actually break a little bit and that is the point in time when you treat it as an opportunity. Autos are not defensives, but at this kind of level, you would argue at 13-14 times two-wheeler stocks, 20-22 times four-wheeler stocks like Maruti and you will not lose a lot of money. Can auto be that bombed out space, where you could be a buyer now? I would not rush into that space at this point in time, not so much, because the valuations are not much more reasonable but from the fact that the discretionary demand cycle is clearly under a certain amount of question. Now these cycles are not down for three months. They typically tend to take more time. On top of that, you have the underlying event of the liquidity crunch in the system and this is a purely discretionary spend with financing as the backbone. If you do not have a clear outlook on that front, I would be cautious about expecting a lot of financing coming into the market in a very aggressive manner. It is not going to happen. In that context, you got to be a little watchful. In terms of looking at opportunities in the market, a lot of the market is looking at stocks that have come off 20-30% and are saying this has become cheap. It is a point in time when you have to look at absolute valuations rather than valuations vis-à-vis where they were three to six months back. You like IT and are saying it is the safest bet to invest in the first half of 2019. If you are worried about the US, would not you be concerned about IT earnings given that the rupee has turned around? There are two elements; first, the rupee is not that dramatic a component of that call, it moves up a little. Even when the rupee was falling, it was on the basis of our call. The basis of our call is that the whole push towards digital is something that is going to be a three-four year spend that will happen effectively. It is a cycle that is actually going to be much longer and you are in the early stages of it. That the US has been slow in the recent past will put a little bit of question mark to it, but quite honestly, when things get tough in the US, the digital part is where the spend will continue to be there because it is a base for looking ahead. There is a base spend and there is a spend that comes on top, this has actually shifted gear to being a base spend.You are saying real estate, autos, SMEs are likely to bear the brunt of the NBFC credit slowdown. Don’t you think the slowdown is somewhat easing? Again, there are two parts to it. The first is the supply of money into providers of credit. That has eased off quite clearly, which was the NBFC funding squeeze that you saw. That has eased off distinctly. The other part is these borrowers who then become lenders and what is going to be their approach in terms of putting money out. They themselves are going to be much more watchful rather than be in a hurry to put out money. This can easily mean two, three quarters before the money is available to them. They are also going to be slow in effectively putting it out and that is what you need to watch for. Reliance is very close to demerging their telecom business and they could list their retail business. 2018 was a trend changing year for Reliance in terms of stock performance. They got the Jio model right, their retail was able to scale up significantly. There was talk about big data. Markets are saying this is the next Tencent. What do you think 2019 could be for Reliance? There are two parts to it -- how the business continues to fare and the corporate action that go in and around it. From a business perspective, it should continue to be positive. The petrochemical cycle remains comfortable. As far as Jio is concerned, that is on a good wicket. If anything, some parts of it is tending to accelerate. That is likely to continue and that is what is going to be the basis or how the market will look at it. The kind of corporate action that you are talking about will tend to be a function of market conditions and I would not invest on a stock based on sum of this. I would actually stick with what the fundamentals are looking like and I we remain actually fairly comfortable.But their debt has gone high. The debt levels are highest ever in the balance sheet; telecom is still not making money. Is that a concern because markets always value businesses based on cash flow and that is where there is a fly in the ointment now? Our analyst does not see a big trip-up as far as this is concerned but I remember absolute debt is not a measure of anything because as balance sheets expand, absolute debt will expand. What it is as a percentage of the balance sheet is what actually counts and I do not think there is any real issue from a cash flow perspective. I would not really get too caught up with that. You have a big overweight on pharma? Overweight is not a sectoral call, it is more a stock picking call which effectively makes it overweight. As far as trends in the pharma space are concerned, they are still pretty mixed. You have some businesses which have transitioned which are in good shape and which should see an upswing. There are others which are more generic in nature. They still have the challenge of pricing pressure. So our call on pharma is actually more stock driven. Our stock bets are really Dr Reddy’s and Lupin. What about a stock like Sun Pharma? You know at this point in time we really do not have it in our portfolio but it is a good company, it has a lot of strengths but there is always a timing element to it. The stocks that we are really calling are Dr Reddy’s and Lupin. Why Lupin?In many senses, their business cycle has effectively tended to turn the stock. If you notice, it has come off very substantially over the last couple of years. As I said, a lot of it when it comes to pharma stock calling it is very specific in terms of the cycle they are in terms of their product pipeline. And there we are actually pretty comfortable in terms of what is going to roll out. When it comes to pure play FMCG, Dabur and Nestle are your top picks. Clearly, the Maggi issue is not a factor for you? We have got to be watchful about building portfolios on some of these events that come and effectively go. As long as the business cycle where they are operating is good, we are effectively very comfortable and that is the story both for these two stocks that we are talking about. What we would like to emphasise is that one of the themes that we like in this whole space is really the rural theme, not necessarily because there is a lot of pricing as far as agri products are concerned. The political shift that is taking place at this point in time towards the rural irrespective of which government comes into play is likely to result in a fair amount of money going to that space over an extended period of time. That is really our call in that space. But specifically in terms of the Maggi issue, our calls are based in terms of the business cycle and unless there is something very specific, we are watchful at a stock level.A couple of year ago, you said markets will always get surprises from two pockets -- metals and corporate banks. The view in the market is that corporate banks will surprise us and metals will disappoint us. Would you agree? Our portfolio strategy would suggest as much because we have got an overweight on the banks and in particular the large banks and we have got an underweight as far as the metal space is concerned. Is that in the price already? If you were to normalise and look through for another year rather than talk about weeks and a few months I do not think it is in the price at this point in time. Markets always tend to focus on what is in the price and what is not in the price. Where do you think the news would be strong but the stock market reaction may not be large because either it is in the price or valuations are stretched? Similarly, where could the news be bad and the stocks may not fall because those stocks are cheap, like Tata Motors? The challenge exists with the market rather than at the stock level. It is a bigger issue with the market. The market is sitting at a slightly elevated level relative to what has happened to the rest of the world. In the last quarter, you have outperformed the bulk of the world by 10% to 20% on a currency basis. Only the Nifty. Our fund managers friends have not even beaten the index last year. Yes, but when you call markets, there is a large element of it and it is really hard to believe that the top end of the market struggles and the lower end or the mid end of the market has a lot of appetite to bounce back. But is 2019 also that year when you need to take that tactical call because in 2018 you were busy playing it safe? Is it time to increase exposure to small and midcaps or do you balance it out with largecaps? I would actually shift the way one looks at it. Instead of talking about largecaps and midcaps, I would think of it in terms of market leaders and secondary players in respective businesses. You can be a smallcap and you can be a market leader in your space. Business consolidation is likely to happen over the next couple of years and is going to put a distinct premium on market leaders. Whether you are largecap or a smallcap, market leadership is something where people will increasingly pay a premium for for the reason that those businesses are going to grow in a premium manner. In terms of market leadership, in several sectors like IT and consumer, the leaders do well as also in pharma. But in investment-led themes, even a stock like L&T has not scaled up as much as one was anticipating. Same is the case in some of the engineering business which have been badgered and power sector. So, it is not across-the-board that leaders have performed, it also depends on the sector that you are representing. Absolutely. The underlying business cycle of that sector is very critical, but what I am talking about is within that sector who does better? If the sector grows at 15%, the leaders are likely to grow at 20%. It is my call that within sectors, there is going to be a leadership bias in terms of getting a larger share of new business and logically a larger share of the economics also. That is what the market will eventually value up. But coming back to your point, in terms of playing it tactically, the next six months is both the time to be defensive in portfolio but opportunistic in terms of outlook. That is a tactical approach saying that if stocks do come off, rather than getting too excited by relative valuations over the last three months, you have to be aggressive. But will you stick with the leaders?At the end of the day, stocks and businesses reflect their ability to generate a greater level of growth and profitability. You have reached a little bit of a shift in the economy where leadership is going to dominate rather than what has happened in earlier growth patterns, particularly if you go back a decade when the smallest guy actually managed to disproportionately get a larger share. Would you buy a stock like HDFC Limited? Serious market share consolidation will happen in NBFC space after this liquidity crunch. We have upgraded the stock when this whole liquidity crisis broke out and our argument was very much this and this is an argument that got extreme over the last three-four months. But is something is actually going to extend beyond and the stock has performed likewise. What do you think could be a differentiated proposition for 2019? There are two ways of looking at it. Our positioning is very distinct in that we are saying be very watchful at this point in time. We are not saying that this is going to be a trend line that I put a year-end number and I extrapolate it. I say this market is likely to fall and so to that extent, you need to hedge against it. If it falls enough, you need to be aggressive and we would be ready to switch our portfolio if that effectively materialises. Beyond that, we are making the call that it is going to be a normalised market environment first but you should step back. That is the bulk of our argument. We think that economic cycles in India have got extended. For the last two years, everyone has been calling earnings will recover and the investment cycle will come up and that has been a disappointment. The reason that has happened is that there has been three-four-year historical cycles in India. This one has got stretched to six-seven year cycle. You are looking at the bottom of a cycle that is actually shallower but when it starts coming through and plus/minus six months is the timeframe that you are effectively looking at, it is actually going to be a pretty extended cycle. So instead of playing this whole tactical thing over this period of time,you are getting to a stage where… and elections are a good defining point in it from a timing perspective. Over the longer ,term you are going to get a much more solid cycle which may not be as sharp. If anyone is expecting a 30% earnings recovery in 2020 because it is bottom, they are running ahead. What you will see is 15% to 18% for five to seven years and that is going to be the nature of that recovery. You really have to wait and watch how the markets value it. They could value it upfront or it could be a more extended valuation. But what is changing actually is that you are reaching the bottom of cycles and that can be earnings, the investment cycle, the asset quality cycle, the risk cycle or the regulatory cycle. You are getting into the bottom and what is going to really happen is that beyond this period, it is hard to time plus/minus six months. But you are close to near the bottom and you are going to get an extended cycle. It will disappoint only if people exaggerate the response. It is going to be a more structural kind of cycle rather than a very heavily cyclically inclined one.

from Economic Times http://bit.ly/2FbshQB