In a chat with ET Now, Sanjay Mookim, India Equity Strategist, BofA Merrill Lynch, says broad based weakness lies in the capital good/equipment space because that will be a sector that lags an economic recovery. Edited excerpts





ET Now: Apart from private banks, what else? Private banks I am sure everyone loves to talk about them, I mean it is a no-brainer that if you are bullish on India, you are going to buy private banks, they are efficient, they are decent, they are large, they are growing and they have fantastic franchises. So I will keep that question aside. What else is my next question?



Sanjay Mookim: So let me talk about why banks are important because – a) they are a large part of the index and if you are constructing an equity portfolio in India, you cannot ignore the whole lot anyway, plus they are higher beta and are reflective of economic cycle. If the economic cycle does well, then banks are good way to reflect that. However, we have been saying that look the Indian consumer and consumption as a theme continues to do well. I mean it is not new. It has been discovered for a long while but there are still catalysts that can support the consumption going forward. One is the pay commission which has just been implemented and we expect a bump up in certain discretionary consumption as a result, plus of course, you have got monsoons which have been better than expected initially. They are kind of coming off now but the distribution of rains has been relatively okay and since you have got rains early part, the sowing has been okay. So you should see some pick up in rural India as well. So while the consumer sector stocks are expensive, we have been saying that that is the theme that should continue to tick and is something that investors should continue to focus on.



ET Now: What is not going to good, I mean is it time to now just completely turn blind eye to telecom, to even IT and pharmaceuticals perhaps or would you be selective in any of these pockets?



Sanjay Mookim: I do not think that these sectors are blanket stuff that you ignore. In fact, in many of these sectors as well there are stocks that we like where we think the companies will differentiate from the rest of the pack and one can be selective in many of these spaces as well. Where we think sort of broad based weakness lies is largely in the capital good/equipment space because that will be a sector that lags an economic recovery. You need utilisations to close, the output gap to close before meaningful capex starts to happen. So as a theme, we have been saying that look that there is road construction, there is some infrastructure investment but capital goods as a sector is likely to remain under a cloud for a while. In the other spaces, you mentioned IT, pharma, I do not think it is a blanket no. There are stocks which our analysts like and we think will differentiate from the rest of the pack.



ET Now: Where is scope for maximum PE expansion and earnings upgrade because that is the ideal case, buy something which markets are not betting on, maybe there is a bit of business disruption or maybe there is a bit of business disbelief. So the ultimate gains would be made when earnings and PE expansion they both could recover.



Sanjay Mookim: Yes so on an aggregate I do not think there is too much more room for the markets earnings multiples to multiply because they are already at relatively high levels. For sectors, predicting multiples is a very tricky thing to do. I mean if we get earnings right themselves that is I think an achievement and I think the bigger upgrades or just arithmetically the biggest upgrades will largely lie in the cyclical space. So, if let us say, metal prices were to improve some more or oil prices were to go up, that clearly lead to significant proportionate upgrades in those sort of spaces. I am not 100% sure whether the consumption space is undiscovered in a way which would lead people to upgrade meaningfully here on. The growth is something you will accrue if you keep holding on to these companies. I am not sure that you are going to see too much upgrade to where estimates already are and the combination of the fact that multiples are high and where earnings estimates are also reasonable to fair, I do not see too much upside to markets as a result.



ET Now: Just going by what you were earlier talking about is to it is time to tread with caution right now and global event of a kind of a Fed rate hike in the near term could indeed spook the markets and then, of course, you have got the US presidential elections as well. What is the take then on the markets right now? I mean is there likelihood that we could re-test February lows or do you think at best this is just going to be a very merger 5% or at best even 10% kind of correction and then India is going to be as is better placed amongst the emerging market lot so we are going to deal with our own story and move on from there.



Sanjay Mookim: So our Sensex target for December is about 26,000 and we arrive at that by taking the earnings growth that we expect for the year and FY18 and applying an average PE multiple to that. The downside on multiples would get you to about 26,000. If it undershoots, I think it is a great. It will become an opportunity to buy because India is instituting several reforms. There is hope that in two- to three-year period India’s outlook will decouple effectively from EM. So if it were to go beyond that 26,000 sort of level, I would look at it positively but our Sensex target for December implies about 10% downside.

ET Now: So how should I conclude today’s interaction, you are bullish yet you are sounding bearish.



Sanjay Mookim: There is great potential in the sense that India is doing the right kind of stuff in terms of policy. Our macro is good enough and in two- to three-year period that has the potential to create a decoupled performance on earnings. However, in the near term, the markets have run away ahead of themselves and like I said valuations are an indicator of risk and when at 18 times clearly the market is more riskier than it was at 15 times, so the advice for people is yes you should be in India. India should do better than the EM pack over an extended period of time. In the near term, you should not be adding to risk in your equity portfolios in the country.

Sanjay Mookim, India Equity Strategist, BofA Merrill Lynch



ET Now: Apart from private banks, what else? Everyone loves to talk about private banks. It is a no-brainer that if you are bullish on India, you are going to buy private banks, they are efficient, they are decent, they are large, they are growing and they have fantastic franchises. So I will keep that question aside. What else, is my next question.



Sanjay Mookim: Let me talk about why banks are important because – a) they are a large part of the index and if you are constructing an equity portfolio in India, you cannot ignore the whole lot anyway, plus they are higher beta and are reflective of economic cycle. If the economic cycle does well, then banks are a good way to reflect that. However, we have been saying that the Indian consumers and consumption as a theme continues to do well. It is not new. It has been discovered for a long while but there are still catalysts that can support the consumption going forward.



One is the Pay Commission suggestions which have just been implemented and we expect a bump up in certain discretionary consumption as a result. Plus of course, you have got monsoons which have been better than expected initially. They are coming off now but the distribution of rains has been relatively okay and since you have got rains early part, the sowing has been okay. So you should see some pick up in rural India as well. So while the consumer sector stocks are expensive, we have been saying that that is the theme that should continue to tick and is something that investors should continue to focus on.



ET Now: What is not going to be good? Is it time to completely turn a blind eye to telecom, to even IT and pharmaceuticals perhaps or would you be selective in any of these pockets?



Sanjay Mookim: I do not think that these sectors are blanket stuff that you ignore. In fact, in many of these sectors as well there are stocks that we like where we think the companies will differentiate from the rest of the pack and one can be selective in many of these spaces as well. Where we think sort of broad based weakness lies is largely in the capital good/equipment space because that will be a sector that lags an economic recovery. You need utilisations to close, the output gap to close before meaningful capex starts to happen. As a theme, we have been saying that look that there is road construction, there is some infrastructure investment but capital goods as a sector is likely to remain under a cloud for a while. In the other spaces, you mentioned IT, pharma, I do not think it is a blanket no. There are stocks which our analysts like and we think will differentiate from the rest of the pack.



ET Now: Where is scope for maximum PE expansion and earnings upgrade because that is the ideal case, buy something which markets are not betting on, maybe there is a bit of business disruption or maybe there is a bit of business disbelief. So the ultimate gains would be made when earnings and PE expansion they both could recover.



Sanjay Mookim: On an aggregate, I do not think there is too much room for the markets earnings multiples because they are already at relatively high levels. For sectors, predicting multiples is a very tricky thing to do. I mean if we get earnings right, that I think is an achievement and I think arithmetically the biggest upgrades will largely lie in the cyclical space.



So if metal prices were to improve some more or oil prices were to go up, that clearly lead to significant proportionate upgrades in those sort of spaces. I am not 100% sure whether the consumption space is undiscovered in a way which would lead people to upgrade meaningfully here on. So yes the growth is something you will accrue if you keep holding on to these companies. I am not sure that you are going to see too much upgrade to where estimates already are and the combination of the fact that multiples are high and where earnings estimates are also reasonable to fair, I do not see too much upside to markets as a result.



ET Now: Going by what you were earlier talking about, is to it is time to tread with caution right now and global event of a kind of a Fed rate hike in the near term could indeed spook the markets and then, of course, you have got the US presidential elections as well. What is the take then on the markets right now? I mean is there likelihood that we could re-test February lows or do you think at best this is just going to be a very merger 5% or at best even 10% kind of correction and then India is going to be as is better placed amongst the emerging market lot so we are going to deal with our own story and move on from there.



Sanjay Mookim: Our Sensex target for December is about 26,000 and we arrive at that by taking the earnings growth that we expect for the year and FY18 and applying an average PE multiple to that. The downside on multiples would get you to about 26,000. If it undershoots, I think it is a great. It will become an opportunity to buy because India is instituting several reforms. There is hope that in two- to three-year period, India’s outlook will decouple effectively from EM. So if it were to go beyond that 26,000 sort of level, I would look at it positively but our Sensex target for December implies about 10% downside.



ET Now: How should I conclude today’s interaction, you are bullish yet you are sounding bearish.



Sanjay Mookim: There is a great potential in the sense that India is doing the right kind of stuff in terms of policy. Our macro is good enough and in two- to three-year period, that has the potential to create a decoupled performance on earnings. However, in the near term, the markets have run away ahead of themselves and like I said, valuations are an indicator of risk and when at 18 times clearly the market is more riskier than it was at 15 times, so the advice for people is yes you should be in India. India should do better than the EM pack over an extended period of time. In the near term, you should not be adding to risk in your equity portfolios in the country.