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Bottoming out process of the economy has begun: Gautam Chhaochharia, UBS

Gautam Chhaochharia-1200
In an interview with, Gautam Chhaochharia, Managing Director and Head of Research at UBS Securities, India., said the bottoming out process of the economy had already begun. He believes there would still be downgrades to corporate earnings, as analysts are still too optimistic. Edited excerpts:

If your investment house had to rank Indian equities among the emerging markets equities, where do they stand?
Our APAC strategist is still underweight India, given his preference for some of the cheaper markets etc. At a global level, we do have a bias towards fixed income or bonds versus equities. Our EM strategist is underweight India too. Their view is based more on the expensive valuations and negative growth surprises that they have seen for the last few months to a year.

However, if the weak growth and weak equities factor play out globally, then there is a possibility that India can do better, but it will also depend on what happens locally. The way I would put it is that if India’s growth recovery keeps disappointing and is not resolved, then it will be a struggle for India to outperform in a weak global macro environment. But if India goes back to where it was over the last few years -- some growth, good agenda, good hope then it can do well.

As a corollary to this what is your outlook for the market for the rest of the financial year, Indian market, is there more pain in the offing, how do you see it?
We follow a risk reward framework upside, downside, base case etc. Our base case top down would be that the policy responses we have seen should be enough to at least stabilise the negative feedback loop or stabilise the slump we are seeing in the growth rates. It is still unclear, after stabilising, how quickly it recovers and how sustainable the recovery is. It will depend on how well they execute whatever they have announced and what they do in terms of announcements over the next one month or so. But with that kind of macro backdrop, if we keep applying that to the market’s valuation multiples and earnings, we find the risk reward still unattractive.
Basically, index upside potential is not there in our base case and looking at the upside-downside scenarios, the risk reward is unattractive. It is not a level or at valuations where we would say -- okay jump in. That would make sense if we get more clarity on policy responses. If we have a more impactful, credible reforms agenda set in motion soon then obviously you could get a pop up.

When do you think the economy will start to recover?
In our view, the bottoming out process has already begun. Either the June quarter was the bottom or September quarter would be the bottom. That will be our base case from a GDP perspective and general growth perspective. But does it really recover and how much and how sustainably we do not know.

So the shape and sustainability of the recovery is as of now unclear. The bottoming out process has definitely begun and we are at the bottom if not the bottom is behind us a;ready

Will it be a U-shape recovery and V-shape recovery?
A V-shaped recovery is unlikely. For that, you need to have a lot more aggressive monetary and fiscal response we have not seen that yet so if you see that we will get a V-shape recovery.

What are your thoughts on the bank mergers that were announced?
Is it really the optimum ideal way of reforming the banking system? No. Privatisation possibly would be a better option but given the political economy India has, it might be difficult. Compared to the scenario we had earlier of many SOE (state-owned enterprise) banks, merging them into fewer larger public sector banks is a better option, for sure. Will it make sense or not will depend on the follow-through from government reforms.

Earnings revival has been very elusive for a long time, even before the GDP growth started deteriorating. Do you expect an earnings revival within the next couple of quarters or do you think it is still going to be elusive?
We still see earnings cuts. Street estimates are still optimistic

FM rolled back the FPI tax surcharge but that has not been enough for FIIs to make a comeback. What will bring them back?
In our view, the FPI tax was not the single biggest driver why they were selling to begin with. They were selling because they had pumped in a lot of money pre-elections in the hope that Mr Modi with a new majority will push through policy measures to revive growth and reforms etc. Then the budget was a disappointment for them. I do not think this is necessarily was a reaction just for FPI tax, it was a reaction to the overall disappointment about the growth -- both locally and globally.

When do you think they will be back?
Either global risk appetite comes back, or we see policy measures taking hold in terms of growth recovery.

What are your thoughts on the auto sector? Is it time to buy or is there more pain left?
We are still underweight because there are issues beyond just economic slowdown in autos, from regulatory BS-VI norms, competitive dynamics in specific segments. We have not seen valuations become attractive yet. So, we still see more on earnings cuts.

Which sectors are you overweight on and why?
We are overweight on the retail liability-led private banks. We are overweight on oil and gas, on property, power utilities, life insurance and selectively consumer discretionaries. These are sectors where we see the least probability of earnings cuts in the next one year despite the weaker macro over the last quarter or two; sectors where we do not see significant risk from very rich multiples and then for some sector and stocks, where the valuations are expensive and where we have visibility on growth for the next year or two.

And which sectors are you clearly shying away from and why?
I still think it is not going to be a narrow market. We are still underweight industrials and infrastructure. So no private capex cycle is going to happen in a hurry in autos and even non-bank financials.

Barring the current calendar year, we had seen consumption as a theme ruling the market. In the last five years to 2018, consumption stocks outperformed everything. What could be the new emerging theme now?
The new emerging theme could be the corporate banks, if they get the credit cycle recovery in place. That could be the theme for the next four to five years. But there are still moving parts there. In our view, property will be one of the bigger sectors in the next three to five years in terms of potential. These two are the other ones I would highlight.

It is still not time to buy midcaps despite the correction? Is there more pain there?
Basically the valuations for midcap, smallcaps had become quite frothy. They are much more reasonable at overall level. They are not attractive enough as an asset class. You ideally want them to be at a slightly bigger discount versus largecaps then where they are. There are broadly similar valuations now, one is that.

Second, for them to do well, you need a much better risk environment both by investors and by the businesses. The businesses also should show higher visibility of growth coming back. That is when you buy them.

Lastly, just like the broader index level stocks, even in mid and smallcaps, some of the quality stocks are still very expensive. They have not de-rated. So, there are businesses which we would love to buy but they are expensive.

Any thoughts on when could we really see private capex picking up?
Private capex intuitively should happen after you had two-three years of good economic cycle, not before that. You cannot revive or drive an economic cycle via private capex. First, let us get those two years. it has still not happened yet.

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