‘2012 will be directionally better, but won’t be great’

Is this a bull run? Was it a bear market? Such questions incense P Phani Sekhar, fund manager (portfolio management services) at Angel Broking. He doesn’t believe in categorising the equity bazaar as a bull / bear market. In this interview with Nitin Shrivastava, he says markets may have seen the bottom for now and 2012 may well be different. There, however, is no case for a secular bull run yet, he cautions.

What aspects stand out in the markets’ rally over the last two months?
Here, I would like to cite Newton’s second law of motion which talks about acceleration and retardation. Markets, like nature, will never be still, they either keep on accelerating or retarding.  Consolidation is a state of mind and not that of nature or events. You may arrive at compounded annual growth rates on historical basis, but at any point in time, you can’t predict the markets precisely.

In the context of the recent rally, countries like India, Turkey or Romania which were worst performers in 2011have been the best performers so far this calendar year.  Just like midcap stocks which, being high beta, run up sharply as compared to large-caps, these high beta countries have benefited from risk on trade globally. They were mainly buoyed by easy liquidity conditions and by the realisation that equities need to be re-priced. So, you actually saw a scenario where, against a backdrop of valuations below justifiable levels and peaking of rates in India, markets have rallied quite sharply which nobody had anticipated then.

Do you see any structural changes in macros that might support the markets?
First, the headwinds still persist, but the key thing is, inflation is showing signs of moderation. As compared to 2011, when the debate was whether inflation could be brought down by raising rates, the debate now is when, and how soon, will the interest rates come down.

Second, fiscal deficit is no longer a surprise, unlike in 2011 when we started the year budgeting it at 4.6%, but which kept on ballooning as the year progressed.  Similarly GDP growth expected in the worst case at 6.8% for fiscal 2013 is not significantly lower than 7.1% expected for the current fiscal. Third, the policy paralysis again can’t get worse than what we saw last year. So, because the government has been pushed so much to the wall, they will at least formulate some policy. So, direction of motion is not downwards but towards status quo or marginally upwards.

Even if economic decision-making, or any of the real economy parameters, doesn’t improve significantly, the very fact that policy rates will go down by at least 50-75 basis points, will provide huge relief. That will reduce the cost of capital for equity market participants which, in turn, should push up your valuations a little bit more.

Major international events, too, have gone progressively better. We were actually bracing for (sovereign debt repayment) default by four or five nations, but, for the moment, there is no default. The only worry is, what might happen to oil due to tensions between Iran and Israel.

Is the current rally a new bull run?
I don’t believe in categorising the market as a bull market or a bear market because then you tend to do extreme things like buying any dirt-small stock on rallies or selling your stocks right, left and centre on declines.

My message to retail investors is that one should not interpret the absence of a bear market as a bull market and vice-versa. So what you are going to see in 2012 would be a directionally better year, although it won't be great, because in 2011 many things were in the realm of disbelief. But when they manifested, it led to an overreaction. In 2012, you have already seen the worst and so, you would see some improvement although not a dramatic one.  From the market’s perspective, we may not see (the Nifty) upwards of 6100-6300 soon, but the levels of 4600 which were the last bottom we hit, are well behind us. We’ve moved up higher.

Many of the infrastructure stocks have risen 70-100% in the last two months. What’s your take on the valuations of the sector?
At this point in time, there is a lot of uncertainty in the entire infrastructure gamut, whether it is contractors, infrastructure asset owners, power generation companies, capital goods manufacturers. Today, I don't have any clue as to what sort of realistic valuations should the asset developers or owners with multi-year projects command. That's because I don't know how much damage have their balance sheets taken and how would they sustain as they are not cash flow-generating companies. For such cash-guzzlers, their health is always a function of the market sentiment.

Unless and until you see a concerted capex cycle coming up, the capital-intensive businesses will not make money. There need to be great infrastructure creation urgency, very proactive business climate,  fast decision-making, availability of capital and, more importantly, free flow of ‘animal spirits’ for these guys to get some advantage. Otherwise, you can keep arguing on PowerPoint presentations as to how much infrastructure is required in India, but is there a timeline?

Which sectors or themes are expected to perform well in 2012?
Other than infrastructure which we discussed, what is more predictable and is likely to do better in 2012 would be old economy sectors like autos, FMCG, pharma, banks. All those sectors with predictable cash flow - robust business models, basically the brick-and-mortar type business model - which did well in 2011, would continue to do so in 2012 with upward bias in their earnings profile trajectory.

With interest rate cycle set to reverse, when do you see the capex cycle picking up?
There is a belief that with interest rates coming down, the capex cycle may pick up, but there’s more to it. Though lower interest rates help, willingness to take up multi-year capital-intensive projects depends on one’s assessment and confidence that business environment has become friendly, stable and predictable.

To give an example, during the 2004-2008 period, in spite of the interest rates being in their third quartile of the interest rate cycle, there were so many projects that were taken up because climate was good. 

As on date, I don’t have clarity as to what will happen some years down the line. To assume that after five years, there would be a friendly business environment, I need to have a very courageous and adventurous mind!

How should investors approach markets at this point in time then?
Markets (the Nifty) may move up to 5700 or 6000. After all, it's just 5-10% away. But I don’t see the start of a secular bull market just yet.  So, if you are a long-term investor, you should be focusing on good quality companies with predictable cash flows and robust models rather than on market levels.

Whether you buy them at 5500 or 6000, these stocks would consistently generate alpha (returns) in the long term. But, if you are one of those smart Johnny types looking to benefit tactically, then you need to keep nibbling on declines rather than jumping on to any stock because the market has started moving up.