Book profits if mkt surges 25% from here: Shankar Sharma

Q: Your report indicates that over the medium-term you see both commodities like crude and equity markets continue to under perform. Is that your sense that in the medium-term both these markets are going to struggle?

A: That’s the interest paradox. One could normally on a logical basis surmise that if commodity markets sell off, then equity markets should do well and that’s conventional wisdom and that does work. However this time what might happen is or rather what will happen is, commodities will cool off on two major counts; number one being the strength of the dollar. It’s our belief that dollar will begin to strengthen and yesterday it had a good move. We still think there is plenty of room left for the dollar to strengthen.

Second and more important is going to be demand destruction; when you have demand destruction, commodity prices have to sell off and that’s been our case for the last couple of months that this was completely irrational; the bubble on crude, steel. The whole world is hurting and five producers of these commodities are making out like band-aid. I think that trade is over; that trade is over because you will see demand slowdown, demand destruction which itself doesn’t mean great things for the equity markets. So it’s going to be a paradoxical situation; commodities cool off, equities have a relief rally of the kind we are witnessing in India; even China-H is up strongly today.

But this theme will peter out in the next month or month and half wherein we will see downtrends in both commodities as well as equity markets. It was exactly what happened in September- October 2000, if I remember correctly. Equity markets started falling from February 2000; but commodity markets rallied, crude rather rallied till September-October and that’s when it started to fall because there was a recessionary situation in the US and elsewhere and equity markets continued falling as well for the next 12 months. So you had a parallel downtrend in both commodities as well as equity markets and that is a likely scenario even this time around.

Q: What is the medium-term prognosis though for our market because while we struggled at the top we have also struggled at the bottom? The market has been making new lows at many points through the last few weeks, do you think we have put a firm bottom in place or is that in question as well?

A: I do not think anything has been settled as yet, these are just too early days to call a bottom or a secular bottom to this market. It is going to be a bottom that may not be reached in the next month maybe two months time and in the interim there is going to be a lot of money to be made. But India in particular, has peculiar problems of its own, which is largely coming out of a new development, which is the drought. That is causing us a lot of concern because if that happens and irrespective of where commodity prices go, one will have a problem on food grains. That will be very hard to resolve quickly because then food prices would become even stickier than they have been that means inflation can remain stubbornly high even though on a global basis commodity sell off. That is the thing that is giving us a lot of worry that even if you have a softening of soft commodity prices just the drought locally will ensure that prices remain stubbornly high and therefore inflation does not cool off. So I think it is too early to still call the end to the bear market but this is going to be a terrific rally and let us enjoy it while it lasts.

Q: You are saying we could have crude at USD 100/bbl and still have a bear market in India?

A: That is very conceivable. That is a straight thing about market, in markets rarely easy correlation works and that is how most quant funds keep going burst every two years because they believe in correlated trades and very often correlated trades break down. This is one correlated trade people are betting on, which is that if crude falls, India does well. It will give you a sense that it is going to work out that way. But our sense is that the problem is deeper than just a superficial sort of simple long one commodity and short equity or vice versa.

One will see demand destruction in India as well, the slowdown is still not out of the way irrespective of what the government does there are core problems, which are largely out of their hands, none of those problems have gone away. So one will see crude cool off temporary relief rallies but deficits still remain high. Most of the problems will remain at the margin that the relief will be captured at 2,000-point Sensex rally - that is the way we are looking at India for that matter that is the way we are looking at equities globally. It is not going to be as simple trade to go short crude and go long equities on a six-month basis. That trade may not work out but it will work out in the next two months.

Q: To get back to the tone of the rally this morning; a lot of power stocks are rallying, utilities less and equipment more. Is that a space you would start looking at?

A: We started looking at it last week and not because we knew that the UPA is going to win but it just that they had reached levels that look relatively add factor. Let’s not forget they are still expensive most of them are north of 20 times FY09 earnings. So they are not like screamingly cheap. But within the context of where they were in January to where they are now they look amazingly cheap. So there was a trade there and I think the trade has just got warmed up in light of the UPA’s win and the nuclear deal hopefully going through. That’s a good space; we think that will be the leader of this rally as it clearly has been the case so far and the other one are banks. So its not rocket science to figure out where you will make a lot of money in this rally; the two space where you lost the most money in the last six months.   

Q: Do you think it’s conceivable that the beaten down banks could give 20-25% rallies from here and if you got that much would you sell that rally?

A: You could get that by Friday at the rate they are going. I would be tempted to say that if you get 25% from hereon that’s a good time to take money and go home because it’s a tough market to make money and keep money. It’s easy to make money in this market playing the odd rally here or there but it’s hard to sit on that money; the temptation is always to do too much and that’s a temptation we need to avoid because I do not think the problems have gone away entirely. One part of the problem is gone away which is the political part and the other is that the crude has softened a bit but other problems have emerged like drought. So (in cricket terms) you have to keep taking the quick singles rather than keep hoping the big over - those things are not very visible yet. So take a 25% and then sit back, I think markets will give chances to re-enter.        

Q: How would you approach the sectors that were being scouted as the erstwhile safe havens, technology for example?

A: That is an interesting space, if you were to make the case that the dollar strengthens, US financials do not go burst but more important is that the dollar strengthens and rupee-which has been one of the weakest currencies in the world in the last six months against the dollar, weakens in tandem too. Then irrespective of what guidance, what numbers these managements put out, they are guiding for tepid growth. But at least there is something which one can touch and feel unlike a lot of other companies a lot of flaky companies in India which went up many times which have no earnings no cash flow. So on a relative basis if the rupee were to weaken to 43-45 (to a dollar), irrespective of where the fundamentals of these companies are in terms of growth, these stocks will still outperform. But currently as has always been the case, in a rally of this kind, the guys who have outperformed will take the back seat and the guys who were beaten down will the front seat. That is precisely what is happening. One can see that the IT pack is not doing as well, pharma is okay but not great and the ones that have not been great had been terrific in this rally.

Globally pharma is doing very well, in the US that has been the stellar performer in the last three-four months time, European pharma has done phenomenally well in terms of stock price performance and over time we have found that there has been very big correlations between what happens to pharmaceutical companies in terms of stock price performance internationally and what happens here is whilst they have very different and diversed business models, it is strange that they are still very correlated. You can see the exact same thing happening here as well. So on a thematic basis, pharma still looks good even though it might lag this rally a bit.

IT in our opinion is largely a play on the rupee’s weakness, which will give it the legs to outperform once this market reaches 15,500-16,000 kind of levels on the back of banks and Larsen & Toubros (L&T) and BHELs.

For the moment they will be quiet but I do not think that the trade has gone away.

Q: If your call is that the market has another 10-15% and no more what to your mind would cause the next leg down. Would it be another reversal in crude, would it be weak earnings or weak macro numbers. What could drive the next leg down again?

A: I think drought more than anything else; to some extent crude is priced in, to some extent inflation is priced in, to some extent slowdown is priced in but what’s definitely not been priced in is drought because most estimates of GDP have been based on - monsoons been okay; no analysts including us is been able to say six months back that monsoons would be weak or would be a failure. That’s become the new joker in the pact and that’s the big worry spot in this market that that could if anything at the margin further hit estimates of companies as well as estimates on the macro front or the GDP front. To our mind that is a whole new villain; we need to deal with that villain, we need to understand how much damage this villain could cause to the markets.