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    Only 6-12 months of bull market frenzy left now: Saurabh Mukherjea, Ambit Capital

    Synopsis

    In frenzy period, nobody listens to fundamental people like myself: Saurabh Mukherjea, Ambit Capital

    saurabh-mukherjee1ET Now
    "I am not so sure tweaking the CGT rules will be that damaging in the long run."
    Talking to ET Now, Saurabh Mukherjea, Ambit Capital, says there is another 6 to 12 months of fuel left in the bull frenzy where people ignore fundamentals, bond yields and PE multiples and just buy because they are making so much money.

    Edited excerpts:


    The market reminds me of a Teflon pan. It does not matter what you put on it, it never gets scratched. It appears the markets have become Teflon coated.
    I think Jeremy Grantham, the GMO chiefm put it very nicely. On 3rd January, he published a note saying that he expected equity markets to be in melt up mode over the next 6 to 24 months and specifically in the context of the US bull market. We are in the final lap of a 10-year bull market. I do not know whether we have had a 10-year bull market in India but it certainly feels that we are in melt up mode because fundamentals clearly are not driving this rally.

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    You have got the Nifty or the Sensex whichever index you care to use. You have got both of those at PE multiples which are comfortable to standard deviations above their 10-year averages and that is after forecasting, that is after factoring in earnings growth, double digit earnings growth for the first time in five year in FY19. So, it is not fundamentals but clearly this is the nature of markets, this is the nature of stock markets. Once the confidence is high, once across the world people believe an economic recovery is on the horizon in our country, we are clearly seeing tangibles signs of an economic recovery and alongside that, there is inflation pumping up as well, which in turn boosts earnings growth.

    It is very difficult then to control animal spirits. We have got incredibly strong bullish sentiment in India. FII sentiment across the world has become very bullish vis-à-vis global equities. I do not think I have seen western fund managers so happy in a long, long time. All the signs are that this party will continue through the year barring some unforeseen political events at home or abroad. The signs are that we can have a bit of wild party over the next 6, or perhaps 24 months if Mr Grantham is to be believed.

    What should we expect in terms of price action because we are staring at a market which is largely dominated by liquidity/the Johnny-come-lately crowd which are feeling left out. What happens to the fundamentals? What happens to the price action? What happens to the basic parameters which fundamental experts like you track?
    Both fundamentally oriented people like me as well as the speculative people will say now that we are in a clear state of economic recovery. Let us focus on cyclical sectors where capacity expansion will be a long time coming but where demand is picking up and a classic example of that in India is metals. Whether you look at non-ferrous or ferrous, in our country it is very difficult to put up new capacity for any type of metal processing and as a result, as global metal prices run up and domestic demand recovers, we are going to see two-three years of bumper profits for the metals and mining sector.

    That is the sector which will see plenty of price action, earnings impact and probably capital raisings in the NCLT process. A number of metal processors will get disposed off in the NCLT process. So, a sector, which I think will be in the thick of things over the next couple of years, classic late cycle sector -- metals and mining --- will be in the centre of a lot of action.

    Similarly, construction, road building will also see action. There is one large company there and a range of smaller companies. The government has been clear that they will continue tendering roads at a brisk pace.

    The PSU banks once they get their fresh capital will also start giving working capital to the construction sector, to the road building sector and my recurring will is we will see plenty of price action. Finally, one sector which has done well over the last three years and will continue doing well is discretionary consumption.

    We have had two very big GST rollbacks in October-November. The biggest tax cuts in 10-year is what I have called those rollbacks. Those will stroke discretionary consumption. I think there will be more GST rollbacks in the coming next six months or so. So, whether it is auto, jewellery, apparel or retail, discretionary consumption will continue to boom through the year which is what we will expect in an economic recovery. The only sector I really worry about is the wholesale funded borrowers, NBFC, housing finance companies.

    The order books for pure EPC builders seems to be swelling up. Last week, we had the Chairman of NHAI and he was pretty excited about how the Bharatmala project was progressing. Do you think we could be in for an earnings surprise and a strong PE expansion for some of these EPC companies? For last three years, the top line and bottom line has been flat for some of these good EPC companies?
    I am not so sure how much of an earnings surprise they can generate in the next 9 to 12 months. For growth, order books will have to swell up enormously. What we are hearing from across the construction sector is that there is growing anticipation backed by clear guidance from the powers that be in Delhi that there will be a big swelling of order books and some of these companies are even hitting the road to consider raising capital in the coming few months. So, I am not sure how much that was translated into revenues straight off because there will be some fiscal constraints that the centre will face over the next 12 months as we approach the general elections. But certainly there will be plenty of tendering and the banks, especially the PSU banks will give working capital lines for the construction work to kick off.

    Let us talk about the good old topic of LTCG ,a topic which we often discuss, debate and deliberate before the budget. Let us not change from our pattern. Let us deliberate and discuss at this time as well. One of the basic premise why equities have done well is because they are tax free, if there is a tinkering in long-term capital gains, do you think that could act as a handicap for investors?
    If the government was to say that you need to hold for say two years or three years to get CGT exemption rather than the current one year, obviously it will have some short-term dampening effect because specifically income funds in our country have taken in lots of money on the premise that they will be giving steady returns. Yet, they get equity type taxation which is, if you hold an income fund for longer than 12 months, there is no CGT consideration. So there could will be a short term impact. I am not so sure tweaking around with CGT will have that much of a long-term impact in the Indian context where I think the government might be wary and apprehensive about changing the CGT rules now if they are targeting heavy amounts of disinvestment next year.

    I am hearing from some sources that it could well be a one trillion rupees of disinvestment in the year to March 2019. If you have that sort of disinvestment target in the penultimate budget before the elections, you probably do not want to be messing around with the CGT rules because that could dampen the appetite for equities. But I am not so sure that even if they did, it sits at that bigger deal in the longer term context.

    There could be some short-term volatility but I am not so sure that given the underlying fundamentals of this country in the long run and given overall attractiveness of shifting from physical assets like gold and real estate into financial assets like equities, I am not so sure tweaking the CGT rules will be that damaging in the long run.

    What happens with the underperformers, especially the likes of pharma and IT and even finding value for that matter in infrastructure? A lot of money is chasing a few quality stocks because with infrastructure, execution capabilities and funding these projects for timely implementation has always been an area of contention?
    It is worth it. For the last six to seven months, I have repeatedly said that the top layer of IT companies and midcap pharma are worth looking at because these are clearly well run companies which were sensibly valued, at least in the case of IT. That thesis seems to be bearing out.

    Our IT analyst Sudhir published a note last week saying that Is Trump falling in love with Indian IT? The reason we wrote that was it does seem that his initial hostility to H1-B Visas to the whole Indian IT services companies seems to be receding and alongside that, there is obviously a concerted economic pickup across the western economies which is helping the Indian IT services companies.

    I reiterate my view that amongst the top four Indian IT services, there is a couple of stocks where I think there is merit in buying and sitting tight. You do not get too many companies in our country with 30% ROC but trading at 16 times earnings. It is worth buying in and sitting back and ignoring the noise.

    Large-cap pharma has worried me over the last 12 months and continues to worry me both because the regulatory environment is still in a flux and it is not evident that the whole FDA issues have dissipated.

    There are attractive midcap pharma companies to buy. The overall theme that will result in money coming into large cap IT and midcap pharma, is in smaller midcap in a higher inflation climate which is what we are heading into. In a higher inflation climate, you will see operating margin pressure on small and midcap companies because their larger customers will squeeze them if you are an auto ancillary supplying an auto OEM. Your OEM customer will squeeze you this year and as a result, investors will start checking some of the rational exuberance vis-à-vis small and midcaps.

    Money naturally rotates into sectors like large cap sectors like metals, construction, and IT. So that is the theme, we need to look out for economic growth is clearly on the upswing but so is inflation. High and variable inflation is an enemy of small and midcap companies.

    So where does that leave the cyclical story? It is not just about infrastructure, it is also about metals. We are talking about getting into a multi-year bull market for metals. What we have seen so far has just been a major catch up rally because they were oversold into 2014-2015 and has made a comeback from there. What can you say about the demand-supply environment that would be driving up interest in metal stocks?
    As you were saying, the biggest attraction of the metal stocks is new supply will be a long time coming and therefore you have got two dynamics which helps these metal companies.

    Global prices are picking up and secondly there is some modest demand pick up domestically and therefore these come together to help the metal companies. Over and above especially in steel, we have got dozen or so companies going through the NCLT process and they will get swallowed up presumably by the larger steel companies.

    So, metals, road building, construction, consumer discretionary, even the CASA funded banks – both public and private - which have CASA ratios upwards of 40% are well placed to benefit from the rally. The only element of cyclicals which one worries about is the wholesale funded lenders. They struggle as inflation picks up and bond yields tighten but barring that, cyclical should have a really good 12 months now.

    How should one look at metals? I just want to extend your point there that new capacity addition is still a distance away and lot of existing capacity in China is getting mothballed. But ultimately, it is all about demand. What is your understanding of the metal demand because the global economy is growing at about 3% plus which means things are moving in the right direction. Can one be reasonably optimistic of the demand side for metals?
    One thing I have learnt in my 15 years in the market is that with cyclical stocks and especially cyclical stocks in capex intensive industries like metals, one should not too much second guess the demand. It is difficult and often futile. The best time to buy a sector such as metals is when supply addition completely conks off and that has happened in our country in the last couple of years.

    Given the amount of land, the amount of coal you need to add a steel plant in India or to add a zinc plant, I simply cannot see how there will be any supply response in the next couple of years, certainly not until the next general election. So, the best time to buy cyclicals, is when there is no supply response, incremental supply addition has conked off. In fact, there is supply getting mothballed in China and in India.

    The bankrupt companies in our country also mothballed themselves that is the best time to buy cyclicals and especially metals. Do not try to second guess the demand, look in what data you have on supply and I think the supply data clearly gives a buy signal on both ferrous and non-ferrous.

    Let me connect the dots here and reverse positions. Let me be the big bear for a change. The cost of capital will go higher, inflation is making a comeback and historically we have seen that every time when cost of capital goes high, inflation goes higher, it will have impact on market valuations and the positioning of the market. That is a genuine concern but how long do you think markets will ignore it?
    The 10-year bond yield has gone up from 6.4 per cent to 7.2-7.3 per cent now and if you invert the bond yield, that should give you the PE multiple that holds true for over three-four-five-year periods.

    What happens in the final frenzy of any bull market run whether it is in America or India is that the bond yields go up and PE multiples go up. That is the most euphoric phase of the rally. People stop caring about fundamentals whether it is bond yields or PE multiples and it is basically euphoria and excitement driving the rally. I think that is the sort of phase you are in. I am not saying that the market is sensibly right. Clearly the Indian stock market is overvalued, clearly the rise in bond yields over the last four or five months does suggest you should see market PE multiples coming down, not going up, but at this juncture I do not think anybody is interested in listening to fundamental people like myself or indeed more legendary fund managers like Jeremy Grantham.

    What I am seeing on India suggests that we are headed for the final frenzy of what for us has been a bull market which started in September 2013. We have more than doubled the index in September where broadly we have had from 04 to 08 we doubled the market, in the last five years we have doubled the Indian market cap. In my reckoning, there is another 6, perhaps 12 months of fuel left in this frenzy where people ignore fundamentals, ignore bond yields, ignore PE multiples and just buy because they are making so much money.



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    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
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