13th February 2012

WF: We seem to have a dramatic change in global sentiment in the last 4 to 6 weeks. What's your perspective on the events that have unfolded in Europe and in US? Is the Eurozone event risk off the table or has it been postponed further into the future?

Anup Maheshwari: Our view on Europe and US for a very long time has been that due to constant cycle of excess, it will take some time for these economies to recover. It will take some time for the things to start normalizing in terms of the employment, GDP growth etc. Also we can clearly see that these bouts of introducing dosages of capital into the system are not necessarily going in for productive use. It ends up inflating the financial assets in the short run but does not really bring back the longer term or secular phenomena of economic growth which is what everyone wants to have a glimpse of.

These capital injections do tend to move markets up and down very violently. But eventually there is still a fair amount of time correction required to see these economies doing better and for these market valuations to rise more sustainably. For now, the focus is on how these economies are doing irrespective of the stocks markets performance.

From the economy perspective, I think the US economy is coming out sooner than other economies like Europe or Japan which are still struggling with fairly low levels of productivity, fiscal deficit issues and ageing populations that do not help in driving domestic consumption. Forced austerity due to their fiscal deficit levels is also likely to keep growth muted in these regions for quite a while. It's a long term process.

What these doses of capital injection are doing is to set a floor for the markets. Each time things look like breaking down, policy makers come in with fresh doses of capital, which put a floor to the markets.

WF: Given that now US has gone on record that they will keep interest rates low till 2014 and they have given indications that they are happy to consider another round of QE, do you see this fueling a relatively long running bull market in commodities and equities?

Anup Maheshwari: Yes, we will have to think of this possibility. The only problem is if you look at it in the purest form, if every economic cycle could be met with printing of money, then you don't have a cycle in the first place. We feel structurally it does not sound right that we print money and everything will come on track. I think it's a function of time and it will take some time for these economies to recover and those capital dosages sort of keep them going at the base level, so that as time passes, things come back to normal. But our view is that there is a big danger on the other side which is too much money printing and creating an inflationary scenario which could then lead you to a situation of stagflation. The economy is not growing much and too much of money is floating around which could imply an inflationary scenario with no growth. Stagflation seems to be a big risk down the road; money printing has been unprecedented and if that money does not find its way into the economic system anytime soon, there will be an impending stag flationary scenario eventually.

WF: What would that do to the prices of commodities in general and oil in specific?

Anup Maheshwari: What it does is it keeps these commodities elevated, but it keeps fundamental demand for these commodities also fairly low. It becomes debilitating for the economy to grow sustainably with high commodity prices either. So structurally, it just keeps growth low for a while and commodity prices just stay elevated without too much of a bull run from these elevated levels - unless there is hyper inflation. But otherwise commodity prices just stay elevated but won't necessarily have the fundamental demand backing for them as it is more driven by the excess liquidity in the system. In fact, the demand gets destroyed because costs remain too high. Unless the demand-cost equation comes somewhat under control, profitability of corporates will be constantly under pressure and the stock markets may struggle to perform.

WF: What is your prognosis for gold prices? They have met your initial target of 1800 plus and then corrected significantly. Where do you see gold heading this year?

Anup Maheshwari: Gold obviously is a lot more challenging now because of the levels it has reached and it has also started to exhibit some sort of weakening signs from the last 5-6 months. The only thing that is worth a thought is from an individual's point of view of asset allocation, it does make sense to hold some gold in the portfolio even now as it would serve as a hedge against a situation where inflation starts taking over.

If you have slow growth, economies will try and devalue their currencies more and more to try and get competitive so that they can grow. Devaluation of currencies implies that gold in the portfolio is justified. So what we are suggesting is that hold on to it for now, but it is finally a commodity.

Our original thesis was that if you get very sharp movement in a very short period of time, which is how commodities traditionally peak out, then you must consider exiting gold. Because of all these programs, it makes sense to hold on to some gold and moreover, we haven't really seen that sharp spike in gold prices yet. So, our call is to hold what you have and if you don't own it, consider it from an asset allocation point of view. Taking an overweight position in gold from a tactical point of view is not what we are recommending at these levels.

WF: Moving on to the domestic markets, is our market rally a pure beta play on global liquidity or do you see at the margin anything changing for the better in terms of domestic fundamentals?

Anup Maheshwari: I attribute this rally largely to what is happening globally. The flows are largely FII driven, and all markets - not just India - are experiencing this phenomenon. We had a slightly higher rise than others because we had fallen more. So it was natural that our bounce is a little higher. This is line with the trend we are seeing everywhere. We may rationalize it linking to the domestic factors but I believe the link is fairly international.

Having said that, the domestic factors are looking like gradually they will get better; I think across Asian markets, we are seeing a scenario where interest rate cycles have changed. Central banks are easing rather than tightening rates and are loosening the monetary policy. All of that somewhere down the road will attract some degree of capital especially when the cost of that capital is down to virtually nothing, thanks to the US policy of keeping rates low. So the element of flows will continue.

As far as the domestic factors are concerned, I still think it is going to take a while before our economy comes back on track. GDP growth this year is likely to be relatively muted, and we do need those 8% and 9% kinds of growth rates for economic momentum to really kick in. Hopefully, we will see that in a couple of years. So our feeling is that the macro support is fairly limited this year for markets in terms of overall demand in the economy. On the micro side, corporate earnings have not reached a point where we are going to start seeing an aggressive growth and it will take perhaps a year's time to reach that growth point. But we are being more optimistic on what will happen post the current fiscal year. We seem to be forming or sowing seeds that will lead to a sustainable growth momentum, perhaps from next fiscal.

WF: Are you therefore expecting the Sensex to trade in a broad range of 15000 - 19000 this year?

Anup Maheshwari: I believe that whenever we have such sharp movements in short periods of time, they tend to be more technical than fundamental and clearly what is happening now is just a scramble from over owned assets to under owned assets. So, there is no point trying to explain it fundamentally; it's just a technical re-adjustment. Therefore, what tends to happen eventually is that these rallies eventually run out of steam, as some of these assets become expensive.

We still need to see strong earnings growth coming through for a rally to sustain, which is currently not visible. Our view therefore is that 2012 may not be a strong trending year but it could be one of those big volatile years. We think that the year will end better than it started unlike last year which was a clearly consistent down trend and every quarter was lower than the previous one. I believe this year, every quarter will be different from the previous one. And by the end of the year, hopefully we should be positive.

WF: One of the things that some market experts have been commenting on is that this rally has seen relatively poor quality stocks outperform. What is your take on that?

Anup Maheshwari: I would drop the word quality for a moment, and define it as businesses that were stressed in 2011 versus those that were resilient in this stressful environment. Valuation divergence had gone to an extreme in 2011, where businesses that were stressed by high interest costs and slowdown in economic activity became very cheap and the more resilient companies became relatively a lot more expensive. That divergence is getting corrected to some extent in this rally. Now, what we need to focus on is whether the stress for these companies is falling or rising. Our sense is that the stress is easing off a little bit. But it will take time for a sustained recovery. As sharp valuation divergences get corrected, it gives more scope for bottom up stock picking.

WF: In this context, how are you positioning your portfolios? Are you moving at the margin away from defensives and more into cyclicals?

Anup Maheshwari: Yes, it's a sort of value versus growth argument right now. Fortunately for us, we got ourselves into a decent position ahead of the Jan rally in under-priced stocks and sectors. Blackrock has a central risk team that support fund managers globally. Over the last four months, this team pointed out to us that we were running fairly low beta portfolios and that we were carrying a significant beta risk. This is what typically happens when you go overweight defensives, which is what most of us did last year. In the last quarter therefore, we started actively adding some beta into our portfolios by picking some high beta cyclicals that had fallen sharply and were looking attractively valued. This adjustment in our portfolios helped us get some traction in Jan, when high beta stocks came back very strongly.

WF: What do you think are the key risks that you would be watchful for in the Indian market?

Anup Maheshwari: Obviously this whole rally's legs have been global and so that is one aspect. But eventually over a longer period of time, we will end up performing closer to our own earnings growth. And I think the theme for everyone to keep closer track on is the margins of corporates. Typically when the margins cycle bottoms out, you will start seeing more sustained movement in stock prices. I think this year; we will witness that phenomenon where the margins pressure finally reaches a peak. And from there, things start improving for the next couple of years. We are keeping a close eye on what's happening on the margin levels.

And in terms of other broader risks, there is clearly the global commodity rise risk which can dent operating margins of several Indian companies.

WF: If you expect earnings growth to bottom out this year, would it be fair to say that one should expect a broader bull market to commence next year?

Anup Maheshwari: Yes, I believe so. The fact is that when I see earnings projections for FY13, these are very similar to what was projected in 2007 for FY09. So, in a sense, we've lost 4 years of earnings. Typically when you have a cycle like that, you have to start getting more and more optimistic because this cycle will reverse. I think we are forming a good base from where we should start seeing above-par earnings growth in FY14 and beyond.

The other big factor that makes equity less attractive right now is that investors are still getting a riskless 9-10% from fixed income. That makes it very difficult to make a compelling case for equities for a sustainable move in the market. So we will have to really wait till rates get lower and markets are at the same point and only then we will get a more sustained rally.