Sensex has strong bottom at 16000: Morgan Stanley MF

In April, the Indian market will be keenly watching the RBI policy action. There are hopes for a rate cut. Jayesh Gandhi, executive director of Morgan Stanley Mutual Fund expects Indian equities to inch higher led by interest rate easing. He sees 16,000 as a strong base for the Sensex. "We need clear direction from RBI on interest rates," he adds.

The Indian has been volatile over the last few days. In an interview to CNBC-TV18, Gandhi says, in the short-term, the market movement will continue to be determined by global cues. "Global liquidity will remain supportive for equities," he asserts.

He feels the emerging scenario and the key variables is turning positive for Indian equities from a medium-term to long-term point of view.

According to him, the Indian Market continues to be driven by consumption growth. Gandhi remains cautious on PSUs, given the lack of policy certainty.

Power, he says, is a long-term play due to high gestation. He expects power companies to outperform, once rates ease.

Below is the edited transcript of his interview on CNBC-TV18. Also watch the accompanying video.

Q: What is the prognosis for the market, after this up and down ride? Are you guys working with the range-bound scenario or do you think liquidity will push the markets higher, perhaps beyond 5,600?

A: Short-term movements in the market are difficult to predict. So, I would only stick my neck out for the medium-term to long-term. In the short-term, we will track probably the global environment or the global equity markets, which is what has been the principal source of the rally, since beginning of the year and that continues.

From my point of view, the emerging scenario and the key variables is turning positive for Indian equities from a medium-term to long-term point of view. That is very interesting. That, to my mind, will drive equity market performance with 12-18 months view.

Q: If you had to give us some sort of a target for the index by the time this year ends up, what are you working with at this point?

A: It is difficult for me to give you targets, especially on a yearly basis. But I would still fancy us making atleast double-digit returns even from current levels in the next 12-18 months kind of time horizon.

A couple of key changes, which are happening on the ground level, at the fundamental level for the Indian economy, are significantly better than what we saw in the last twelve months. If you look at the global environment, if you look at the changes in the import mix that we have, gold imports declining, also the fact that we would probably see interest rates cool off, all these factors to my mind will drive equity performance much better than what we have seen in the last twelve months.

Q: Also, likely that it provides a cushion for the market, do you think it is unlikely we breach the lows we have seen in this year?

A: 16,000-15,500 on the Sensex seems to be a pretty strong bottom. Atleast on the valuation front, we seem to be hitting a patch, which suggest that valuations are at ten-year low at those levels.

Corporate profits have been rising. My sense is that we will probably see corporate profit growth in line with normal GDP growth, 10-15% range in the next twelve months. That has not been the case in the last twelve months. That is predominantly the reason why we have seen valuations come off. But valuations can go down a tad lower, not more.

Q: What is it that you hear now in terms of flows and the interest coming into India? When you talk to some of your colleagues on Morgan Stanley global, does it look like some of the General Anti-Avoidance Rule (GAAR) confusion has been cleared up and whether or not liquidity is going to remain abundant?

A: On GAAR, I think there is still fair amount of uncertainty. I think that is going to remain for some more time. That apart, there is a fair amount of interest in emerging markets. There is lot of interest in India as well, especially because we have done so badly last year. Our valuations are at ten-year low levels.

India is one of the few markets globally, which is domestically driven. Corporate profits have been rising in India, although not in the last year but if you look at the historical ten year trend. So, there is fair amount of interest in India, there is fair amount of interest to invest in India.

Obviously near-term issues in terms of large government borrowings, our inability to take hardcore reforms like petrol price increases, diesel price increases etc are all factors, which are limiting the flows in a way. That is limiting the interest of the money that is flowing in. So, my sense is that if India were to take some high visibility reforms, there would be money coming to India in a big way.

Last year has been particularly bad for emerging markets, but yet we did not see that great outflow. Infact for the full year we were virtually flat. This year we have seen fair amount of inflows. I think the interest will continue, there is no two ways about it.

Q: So, if one wanted to capitalize on this optimistic view that you have on the market, how would you approach it with respect to specific sectors? What looks like a good opportunity at this point?

A: There are multiple opportunities in a market at this point of time. The best way to play the market is create a diversified portfolio. That is what we have.

In terms of sectors, we are overweight pharmaceuticals. We also like domestic consumption names, discretionary as well as some staple names. We also are overweight on software services. Basically, we are overweight in companies and sectors where there is decent visibility of demand i.e. the top-line growth and also the strong balance sheets. These are the companies, which will deliver returns irrespective of the market cycles. Markets have been very volatile in last few years. That volatility does not seem to be going away in a hurry. So, the best way to play is to look at companies, which have decent earnings momentum built into them because of the inherent strength of the business model rather than chase cyclical names.

Sectors, which we are underweight on currently, are metals, oil and gas and also some of the domestic infrastructure names like industrials etc because we don't see industrial cycle picking up in a hurry. What I think will change in next six months would be a significantly positive view, which has to be driven by the bond markets, towards the Indian financials because we should, if not immediately, in next three months or six months time look at a significant decline in interest rates. If that does materialise then the view on banking and financials will change for the better. That is when we will also look to make some changes in the portfolio.

Q: What you are expecting from the policy this time around? If you are expecting an easing of rates, do you think it will come in the April policy or do you think we will have to wait longer?

A: Second-guessing the Central Bank is very difficult. The bond markets are, in a way, expecting 25 bps or round about there reduction in interest rates. But I think the domestic liquidity situation is what we need to look at.

In Q1, liquidity situation should ease i.e. short-term interest rate should come off significantly. I think the commentary will be more important than the rate cut. Rate cut also will help, but commentary will be more important as well.

Q: How worried are you about the indications from the bond market? How tough do you think it is going to be for equities to perform over the course of this year, given what is happening on the fixed income side?

A: I am not an expert on bonds, but I will give you my two bets. I think the bond markets are going to continue to challenge RBI and push RBI to do OMOs because we have such a large borrowing programme. Also, it is more skewed towards first half. You see the volatile environment in the bond markets to continue.

I am focusing more on is how the short-term rates behave and how the liquidity situation improves, I think that should change for the better over the course of this month or even next two-three months. Liquidity should improve and short-term interest rates should cool off. That should steepen the yield curve.

Government is the largest borrower in the market today. Government is also the reason why bond yields are so high. So, government with RBI can very well ensure that the yields don't run up or go beyond 9% or you don't have a wild card situation in the bond market.

My sense is that RBI is at work here. They will continue to ensure that yields remain in a range. They may not soften very quickly, but as the year progresses, my sense is that we will see yields come off and of course some bit of rate cut will also reduce the yields. So, I am pretty positive on the bond markets from a 12-month perspective. Immediately, I think we have some challenges.

Q: How would you approach some of the PSU entities now, given what has happened both in terms of governmental intervention and generally the fact that corporate governance seems to becoming bigger issue for many of these companies? Do you think the whole clutch becomes an avoid?

A: I don't know whether we can make that general statement for the entire basket PSUs. But by and large the business fundamentals for many of these PSUs have been poor. We have seen that across sectors. So, we have been very cautious in adding PSU names in our portfolio.

Ofcourse there are certain sectors where you cannot avoid, for example, oil and gas which has been predominantly dominated by public sector companies. Another example is state-owned banks, we can avoid but we can only avoid to a limited extent because the basic fundamental business momentum for many of these state-owned enterprises, state-owned companies is deteriorating. They are not able to keep pace with the technology changes, they are not able to keep pace with the manpower requirements and also the corporate governance issues. So that affects the overall long-term view on the stock. Ofcourse you find limited number of PSUs in the portfolio as well.

Q: As a theme, do you like power after the kind of efforts made by the government to solve issues like coal supply and ofcourse SEB losses etc?

A: Yes, we do like power as a long-term potential business opportunity in India. Also, we like business model for a few companies in India. However, many of these projects are very long gestation projects. Some of the issues that have cropped up in the last 12-18 months are issues could derail some of these projects. So, we are watching this sector very closely, watching the way these issues are getting resolved, particularly the fuel supply issue.

Another important factor for the sector is interest rates. Interest rates need to come off in many of these projects to become viable. I see that happening over a period of next twelve months. So, my sense is that over the medium-term, I think this sector should do very well, maybe near-term headwinds may continue.

What is important is the sector has seen such a large beating over the last twelve months that the stock valuations have become very attractive. So, there would be worthy picks with a long-term view in the sector.

Source: http://www.moneycontrol.com/news/mf-interview/sensex-has-strong-bottom-at-16000-morgan-stanley-mf_688718-2.html