If the Federal Reserve goes ahead and hikes interest rates for the first time in nine years tomorrow, the market will take it in its stride. What the market won't take, says CNBC-TV18 Consulting Editor Udayan Mukherjee, is if the US central bank doesn't.
The Fed has strongly indicated over the past several months that it is on course to tighten monetary policy and markets have factored in a rate hike at its two-day rate-setting meeting that starts today. This has been on the back of improving macro data in the world's largest economy.
There have, however, been some concerns that the Fed could pause -- given the recent turmoil in the commodity markets -- and amid worries about weak global growth and the impact a Fed rate hike could have on capital flows, especially in emerging markets.
But "given recent statements by [Fed chair] Janet Yellen [indicating an impending hike], the central bank has painted itself into a corner," Mukherjee told CNBC-TV18's Latha Venkatesh and Sonia Shenoy in an interview. "If it doesn't hike now, there could be a problem."
He also outlined his views on a number of sectors, including banks and capital goods, and said investors should be cautious about investing in private sector banks, which suffer from high valuations and a worse-than-previously-thought asset quality picture.
Below is the transcript of Udyan Mukherjee’s interview with Sonia Shenoy and Latha Venkatesh on CNBC-TV18.
Sonia: It is 8,300 to 7,600 in less than two months. That is the kind of ferocity of the fall we have seen. Where do we go from here?
A: Well, it is a tricky time for the market and the next few days are very difficult to call because you have some events stacked up which will probably lead to those 200 point kind of volatility for the Nifty, so it is very difficult to say what happens on Wednesday-Thursday from here on.
You could have any situation, you could have a Fed rate hike, which the markets might respond to with a small relief rally which I do not think will be sustainable, but you could get those 100-200 point kind of moves coming on the Nifty. Maybe, even in the dollar-rupee. And the market might revert after that quite swiftly. On the other hand, if there is a sign of distress from the Fed, it does not move then you could see a bigger sell-off in global markets. Again, maybe 100-150 points, no more than that.
But, even so, for traders it becomes very important to map that in the near-term. I think just in the near-term, the important point to look at of course, is the previous low that we have made earlier in the year and I think every trader would be watching that very closely whether that gets taken out or for the moment, the market lives to fight another day.
So, the near-term thought in the market or discussion in the market will hinge around preservation of the previous low on the Nifty, I think around 7,500. So, a lot of the trader focus might hinge on that. In my view, it is not really relevant, but just in the next few days, it becomes quite relevant for a trader.
Latha: Is the Fed event definitely completely digested and discounted? Other than probably 150-200 point volatility, you think there would not be too many casualties in the fixed income or in the equity markets?
A: It is a non-event frankly, but now it can become an event if the Fed did not move. But, if the Fed does move as most people expect, I think it is fully discounted long in advance of the event and frankly, it will be a complete non-event for the market. I am not even sure it moves the market by 150-200 points if the Fed does move.
I think the Fed is actually a bit of back story right now. I do not think global market people or traders or investors are looking at or discussing the Fed as much as they are discussing the collapse in commodity prices. So, it has been relegated to a bit of a minor story at this point in time.
But, having said that, the one thing which can render it an event is if the Fed chooses not to press the trigger because Janet Yellen has painted herself into a bit of a corner with all the signalling ahead of the event which has prepared the market for a rate hike. And now, because of the pressure which has been put on the Fed in the last few days with a collapse in crude, and the junk bond and all things which are swirling around.
If the Fed panics now, and says I will wait and watch a bit more, this is not the time to affect a rate hike, then that might go down as a signal of panic in global markets and I think it might set the stage for a bigger sell-off out there. So, in my eyes, it is only an event if the Fed does not move tomorrow. If it moves, it is well-discounted and therefore a non-event.
Sonia: Some of these public sector undertaking (PSU) banks have now become quite cheap. I mean most of these banks, Punjab National Bank (PNB), Bank of Baroda (BoB) are trading at less than one time price to book, but even I you look outside the PSU bank space, even some of these private banks like Yes Bank have corrected quite a bit. How do you approach stocks like these?
A: With a little bit of palpitation, it is a true that the price point has changed quite a bit, but they are not looking very strong to me. You were just reading out ICICI Bank at Rs 245. The price is not telling you a story where people are actually flocking to buy value in some of these private sector banks.
On one hand, they might be having a technical problem because they are over-owned and that over-ownership has not corrected fully and on the other hand the very issue that you have been discussing, what the RBI wants to do an in my eyes, absolutely fairly, is to ask the banks to basically own up to their problems and call a spade, a spade. They have been hiding for far too long.
And I think the RBI Governor is messaging over the last 10 days has been very direct and consistent that he wants banks to make more disclosures and to provide more. I mean, he could not have said it more eloquently by using that phrase over the weekend in Kolkata where he said that God’s judgement will fall upon unrepentant lenders. I have not heard a more eloquent line in a long time. So, I think he will force banks to disclose more.
Yes Bank, I just heard the analyst talking about how it does not have a very bad book, but it was very aggressive in expanding its books and in doing that, it lent to companies like JP Associates, GMR, Lanco, Suzlon, Essar and those are sitting on its books now. For a small bank like Yes Bank, it is not just about what percentage is exposed to these kinds of risky assets, even if it is 4-5 percent, it is enough to drill a big enough hole in your numbers. So, I am a bit worried about Yes Bank frankly.
I know the stock was Rs 900 and it is now Rs 680-690 somewhere there or Rs 670. So, it has corrected quite a bit, but given the circumstances of this whole RBI direction and the discontinuities which technology will throw up for this space in the next 2-3 years which is not an insignificant threat, I think the comfort valuation level for a bank like Yes Bank should be no more than one and a half times book one year forward.
One and a half time book takes me down Rs 550-560. I am not suggesting the stock goes there immediately, but it would not surprise me if this market turmoil continues that you can actually get Yes Bank at sub-Rs 600 levels as well.
So, I would not be queuing up to buy these private sector banks right now. I have held that view for sometime now, as you know, that there is a valuation contraction and an ownership correction which is underway. And looking at the price performance, it does not appear to me that it is completely done with yet.
Latha: So, just to complete that argument, if one is building a portfolio for 2016, nobody starts from scratch, but if one is building an incremental portfolio, do you avoid this 30 percent of the market, the financials? One because, the world is still deflating and contracting and therefore, you do not know how much more bad loans will come out of the woodwork and also because technology is such a big disruptor. So, avoid this 30 percent other than maybe an HDFC Bank?
A: It is almost impossible to do for a fund manager, because you cannot avoid being benchmarked to one third of the market, because if it moves and you are left out of it, then you are completely out of the game. So, a mutual fund manager or a portfolio manager has no recourse but to have some of the banking exposure, but the kind of exposure which portfolios have today in the financial space, that worries me a little bit because the space has been underperforming for a while which would be hurting most portfolios by now already.
Also, these constant cries of buy every bank quickly because that is the space which will lead once again, I think is basically saying that history always repeats itself in the market and everything which did well in the last three years will automatically lead the next three years in the market, which is the point I have been trying to labour over the last few times that this kind of investment pattern, looking at the rear-view mirror does not always read very rich dividends.
So, I think it is not fair to say that you should have nothing in financials, but should you be terribly overweight financials? I do not think so. So, you could still pick one or two banks. The point is that the price point is coming down and as I said, last time to you.
If you get clean banks at lower price points that is what you should be looking at because this is not a time to get attracted to the bad bank because of a rich valuation, because of a good valuation, because that good valuation is hiding a lot of things. So, right now is the time, if you are owning banks, to move towards quality and actually pay a little bit more for that extra quality and not buy that broken beaten public bank for 0.5 times book because it is showing 0.5 time book on the ticker tape.
Sonia: let us move away from banks and talk about some of the other stocks that are generally barometers of the way the capital expenditure (Capex) cycle moves. So, Larsen and Toubro (L&T) for example, it has lost 35 percent of its value in just less than six months. Six months ago it was at Rs 1,900 and now it is closer to Rs 1,250. Investors have gotten quite frustrated waiting for the Capex cycle to turn, that has not happened, so what do you do with a stock like L&T?
A: The way L&T s getting bashed up, it is not entirely to do with the Capex cycle. I know that is at the top of discussion when L&T moves and L&T is now becoming an oil sensitive. And the reason L&T is getting pasted is the way oil has collapsed and there are two ways where L&T gets hit because of oil. Today L&T managing director would be terribly worried about this collapse in crude prices because in one hand, a significant part of this business, the hydrocarbons business and if you just go back and see the last 5-7 years, how much of L&T's business actually comes from companies like ONGC, Cairn, Oil India? It is a significant chunk of its business and I do not see how ONGC is going to do Capex over the next two to three years, the way crude has crumbled. That presents itself with a fairly significant threat in terms of order booking.
The other is what is going on with the Middle-east and L&T’s export book. The Middle-east is an important part of L&T’s export book and again, Capex and execution cycle in the Middle-east will get affected quite significantly I would imagine. It is intuitive after the kind of battering that crude has taken.
So, it does not exactly follow and people do not think about it in as many terms, but L&T is an oil sensitive at this point in time, and for a company which has already rung a few alarm bells about order booking going forward, this twin problem of the export market plus the hydrocarbon sector could lead to a little bit more of a technical hangover the L&T stock.
I think a lot of people are actually cutting their weightage in L&T because it has always been one blue chip that you own in your portfolio and like private sector banks, I would not be surprised if you that this quarter L&T’s ownership has actually gone down in the hands of a lot of institutional holders.
So, now the question that you started with. Has the stock corrected enough, it was Rs 1,900, now it is Rs 1,250. So, obviously, the price is much lower and some of these negatives are in the price. But, just looking at valuations, the way L&T is going, I do not see it doing more than Rs 62-63 earnings.
I know consensus might be a bit higher in 2017 which means even after the correction, the stock is trading at 20 price-earnings ratio (P/E) multiple. 20 is not a small P/E multiple given a stock which is beleaguered with so many problems or beset with so many challenges right now. So, L&T could lose a couple of percentage points, a couple of points on the P/E charts quite effortlessly bringing it closer to its longer term P/E multiples.
So, maybe Rs 1,100-1,150 is a point where you want to look at L&T and could the stock go there? I think, absolutely.
Latha: Let me come to the other big space which people have wanted to own in the Nifty – the auto space. There is a green cloud hanging over all of them, in some cases, more dense as in the case of Mahindra and Mahindra (M&M). Should one use this time and this conversation period to buy these stocks on the expectation that in any case, you cannot ban diesel in India just yet, or should we wait for them to get cheaper?
A: That is a matter of timing which I am not very good at or you could always average down, but auto is the space where you should own some stocks. You cannot say that I will not buy autos in India because longer term demand patterns are quite significant. They might be going through a bit of a soft-ish patch right now, but I would not worry overtly about it.
It is just that what you want to buy in autos and in that, my only theory is that you should actually buy pure plays in auto. Do not buy conglomerates who do a lot of things. You want to buy commercial vehicles, buy a clean commercial vehicle play like Ashok Leyland. Not very expensive, it has corrected again to Rs 85-86 kind of levels, may fall a little bit more, but that cycle will turn.
Ashok Leyland is in a nice place to play that up-cycle whenever it starts. It is not terribly expensive trading at just above 15-16 P/E. Play a pure play there. You want to buy two-wheelers, play a pure play two-wheeler company like a Bajaj Auto. Even TVS motors which is not very expensive at this point in time. Those conglomerates are a problematic thing.
Tata Motors, people say I want to buy Tata Motors because the commercial vehicle (CV) cycle is turning up. That is 15 percent of Tata Motors revenue. That is not very significant. Tata Motors is actually almost a pure international car play. Do we understand the dynamics of the Chinese Jaguar Land Rover (JLR) market, Chinese car market, I cannot profess to be one, therefore I am not very sanguine when people say JLR’s metrics are looking very good in China and therefore, we should go out and buy Tata Motors. So, Tata Motors is a stock which I ambivalent about, I do not claim to understand it and therefore it springs surprises on lots of investors. So, I am not in that group which believes that Tata Motors has bottomed out. There are too many straws floating around in the global landscape right now, business landscape as well, not just market. So, I would probably look at Tata Motors with a bit of suspicion despite the recent correction in the stock price.
M&M is good, it has corrected quite a bit, it is not terribly expensive, it has made an interesting head position, I do not know why they had to saddle Tech Mahindra with it. It was a car company, they should have just bought it on their own. But, the tractor market will slowly start lifting up. They are trying to address their CV problem, so M&M is a good management. In the longer-term it probably makes sense. So, short-story, you could buy Leyland, you could probably buy one two-wheeler, you could start sniffing at M&M, Maruti is over-owned, it is very good, but it is over-owned and Tata Motors, probably stay away for the moment.
