Experts foresee a Fed rate cut next week

It has been another week of midcap and smallcap outperformance. The indices haven't done too badly, though they could not quite take out those levels of 20,000 on the Sensex and 6,000 on the Nifty. It has been a bit of a problem area for the market. It was the level from which we turned last time. This time the approach to those levels has been much better, much broader. Yet, as we keep going above those levels there is some supply that comes in inevitably and we retrace from those levels.

Psychologically maybe the market has got a bit worked up about those levels. But we are still up 3% on the Sensex, 4% for the Nifty, 6% for the midcap index, and 8% on the smallcap index week-on-week. So, the broader market hasn't done too badly at all this week. Some largecaps just fizzled out towards the end of the week.

Next week is an important one. We are headed for a Fed meeting. Expectations are that rates will be cut once again. What could that mean for global markets?

In an exclusive interview to CNBC-TV18, Ashwini Agarwal of Demeter Advisors said, most investors have discounted a 25 bps rate cut by the Fed.

He feels it is very encouraging to see a positive market breadth. He said, "We don't expect any significant events that might turn out to be bad news in the next couple of weeks. The next few weeks may turn out to be better for the markets."

According to Agarwal, the Finance Ministry is pushing for lower rates while the Reserve Bank of India is concerned about asset prices. He feels the weeks running up to the budget could be the next round of triggers.

Adrian Mowat, Chief Asian and Emerging Equity Strategist, JP Morgan also shared this view. He said that investors are expecting a Fed rate cut next week.

"The market may not respond strongly in either direction on a 25 bps cut. We expect another 25 bps rate cut in the next Fed meet in 2008."

He feels the markets are likely to go into 2008 on a strong footing. "A number of new investors are coming into equities. There is also huge domestic money which also coming into the markets."

According to Mowat, some hedge funds are switching to direct FII registration. He sees money moving towards growth areas, particularly to emerging markets like India where he feels there is substantial momentum in the fixed investment story. Investors need to look at consumer sensitives for the next year, he said. "We are moving more favourably towards sectors, more so PSU banks."

Excerpts from CNBC-TV18's exclusive interview with Adrian Mowat and Ashwini Agarwal:

Q: What is your sense after the Fed meet do you see the global equity markets, emerging markets going into the year-end strong or do you think it will be a bit of a volatile spell going into the New Year?

Adrian Mowat: I think we are going into the New Year actually pretty strong in these markets. We have had another series of growth scares, you had weakness in equity markets particularly weakness in the financials in the US. You saw bond markets discounting a recession with bond yields at the ten-year below 4%, and that sort of set your lows and then you begin to see activities such as ADIA taking a stake in Citi, announcements on some help for the subprime borrowers, and also just a reminder that Central Banks are coming in to help out global growth with the Fed cutting rates next week.

Q: What is your sense, do you think next week after the Fed meeting we break into that 20,000+ and 6,000+ zone or do you think more work needs to be done to get to all time highs?

Ashwini Agarwal: I have always been allergic to making short-term prognosis. But looking at the breadth of the rally, it has been very encouraging. Yes, obviously the market has shied away from making new highs this week. But just looking at the breadth and the fact that there is no significant event that I expect over the next couple of weeks, which might turn out to be bad news, in the sense that there is no major political event or anything major in terms of data points like results, I suspect that next few weeks might turn out to be actually a little bit better purely from a near-term view.

Q: The revelation has been the strength of the local money over the last few weeks. It is not very usual for us to see the markets at near all-time highs when FIIs have been net sellers to the tune of a few billion dollars. Do you think this theme might play out as more people rebalance locally towards equities, could that be a powerful theme even going into 2008?

Mowat: I think this is a huge theme. We call it the ‘new kids on the block’ and whether it is Indian savers moving some of their money into equities, whether it is the QDII money coming out of China, the sovereign wealth funds, particularly the amount of capital that is being generated in the Gulf. These are the buyers of equity markets going forward. And the fact that you might see FIIs as net sellers and mutual fund redemptions into emerging market funds is less of a negative by a long way than it used to be. I have been joking with my developed market colleagues that if you need some money do come and ask us, we will help you out, because we are now the source of capital as opposed to the destination of capital.

Q: How have you read that this big midcap outburst over the last few weeks and the fact that the local investors have absorbed such a lot of or quite a bit of FII supply so effortlessly and the market has actually broadened out? Can this continue?

Agarwal: Looking at the midcaps, for the last three months if you noticed midcaps had underperformed significantly and the valuation gap between the midcaps and the largecaps had expanded significantly. Year-to-date midcaps have still a long way to go. So, my sense is that with a little bit of confidence coming back into the market be it the retail players or be it even the financial institutions that are still there people have started to take a look at for the next year and some of these companies are looking quite good. So, obviously it is a valuation gap, which has started to play through.

As regards your question about the local institutions or the local money becoming more important than the foreign money, I think my sense is that if you look at the overall flows, foreign institutional investors in the Indian context are still quite important. But I am a little skeptical about how to read into these FII numbers in the very short run.

We have to remember that for the last month or so, a lot of the hedge fund investors have been very quiet because they have not been able to sell much because they are scared that they will not be able to build a position back and FII licenses will fall in place over the next couple of months. So, I am not reading too much into this FII data.

In the Mundra Port IPO, which was the first big IPO after P-Note ban had been announced, we were expecting that long-only foreign institutional investors might have a better crack at getting some decent allocations but that was not to be, institutional oversubscription was about a 160 times. So that just tells you that there is a lot of money around whether it is sovereign, whether it is local, whether it is foreign institutions, it is really hard to tell.

Q: How do you see this playing out in 2008 as the year begins, do you think the new FII registrations will fall into place after the P-Note curbs in India and much that last couple of months we have not got too much money we could see more money coming into India in January-February?

Mowat: I think there is pretty good evidence that the amount of FII registration that is going on is indicating that some hedge funds are switching from the use of P-Notes into direct FII registration.

I generally see money moving towards where there is growth, and there is growth in emerging markets, and particularly markets like India where there is substantial momentum in the fixed investment story. I think also the consumer story is going to look better going into 2008. We have digested the tightening in monetary policy that happened in the first quarter of this year, and now this is the time I think to look at some of the more consumer sensitive areas such as financials and the auto sector.

Q: What do you expect from this Fed meeting? Some say 25 bps and some say 50 bps, very few say nothing. Can you build a case for a bit of an equity party after the event?

Mowat: I don’t think the markets will respond particularly strongly either way to a 25 bps cut which is the consensus; it is what we are saying. And then we expect another 25 bps cut early in 2008. The markets have been discounting that. If you look at some of the more interest rates if the markets such as Hong Kong Property, stocks have actually been selling off a bit this week, a bit of sell on news type of environment as opposed to rally on the news.

Q: How do you read the global set up at least for the next few weeks? Going into 2008 there are many question marks on what the final outcome in the US could be. But if you just look at the next 8-12 weeks do you see storm clouds or blue skies ahead?

Agarwal: Eight to ten weeks, if you look forward into the middle of January all eyes will turn to what technology companies come out and say in terms of earnings growth and how they see the business environment. That is one big chunk of the Indian market where there are a lot of worries and many analysts are waiting to see what companies like Infosys say in terms of the business environment. So, that, I think is the next big event for the Indian markets.

Between now and early January unless we have some completely some unforeseen political event or something like that, I really see no significant event and I would agree with Adrian in saying that US Fed rate announcement will probably will be a non-event in that context.

The other big announcement that is probably due is if people start reading into what RBI’s next move might be on the local liquidity front. We have seen some softening of the data in terms of growth off late. There are some people out there saying that high interest rates are beginning to hurt demand. The Finance Ministry has always seemed to push for softer interest rates and the RBI rightly so has been concerned about asset prices in pursuing easier money policy. But if some of these factors were to change, surely you could paint a picture for a much better party early next year.

One of the things that I caught onto the newspapers today was, the Finance Minster’s comment that direct tax collections have fairly been robust, and I wonder if he is thinking about some tax breaks early on in the next year and in the run up to the budget those expectation will start playing. I think January is when a lot of these factors come into play. Over the next four weeks or so, I don’t really see any event out there positive or negative.

So, we will probably continue to trundle along the volumes and the breadth, to indicate that there is probably little bit of upside rather than downside. That’s what I would say.

Q: After a long time a stock like Infosys has moved up 5-6% in a session and it has given about a 10% plus bounce from the lows. Is it good for more, the way the rupee is going and the way the sector has got sold down?

Mowat: I think companies like Infosys and some of the major Indian IT companies are very well run. The management understands the adverse conditions in terms of the strengthening currency; local costs et cetera and tend to manage that pretty well. I would argue that it is little bit early to be buying direct US corporate exposure, particularly exposure to the financial services industry where numerous of the IT companies’ customers come from.

So, for now I would be reluctant to reentering the sector. But I do believe that your mindset should be when should I be buying these the companies that have traditionally been very well run, and have actually dealt very well with the cost pressures that have been evident in the industry for a period of time.

Q: You like technology though given valuations?

Agarwal: I have always said so over the last three months and that call has not been very rewarding. And Adrian spoke about the fact that the Indian technology companies have significant exposure to the United States, to the US dollar, and in particular to the financial services industry in the US which is the biggest point of pain at this time. So, all these factors haven’t helped.

I just wonder how much is the pain. When I was just speaking to a few people who have gone and met a whole bunch of technology companies in US over the last week and almost nobody seems to be seeing any signs of huge cutback in orders or slowdown in tech spending within the US.

It is possible that over the next couple of quarters you might see some bad news come in. I wouldn’t say that it is not possible at all. But also what I see is that the Indian companies are fairly cognisant of the fact that there might be bad news around the corner, they have been tightening their belts and looking for plan B. So, I’m hopeful that from a longer-term perspective you have probably seen the worst of the news behind us.

Will you make money in the next couple of quarters in techs stocks? I can’t really say. But will you make money over the next couple of years in tech stocks? My answer should be yes.

Q: What is your take on this whole financial services space now? We have seen a couple of very strong brokerage listings. That space seems to be getting good valuations and private sector banks as well. Would you buy them or do you find them expensive?

Agarwal: It is a mixed bag. Some of the banks are quite expensive. Some of them have bits and pieces that could actually throw out a lot of value. At this point in time, many of the financial services companies are sitting in a position where they are exploring new business opportunities, exploring new markets and how these turn out is anybody’s guess. You mentioned brokerages, but wealth management for instance, which is a business stream that a lot of brokerages are pursuing, can be a source of very steady income over a really long period of time.

So, today these stocks might look very expensive when you take valuation as a percentage of assets under management. But assets under management can grow very rapidly from where they are, and fees are fairly stable and very sticky. So, are you paying too much for them? I don’t know.

But I have to agree with you that the euphoria has been very strong. So, there could be some disappointments. I don’t want to get into specific names, but when you drill deeper down we do find some of the balance sheet and earnings models not very exciting. On the other hand, I would say that there are many financial services stocks, which still look quite interesting despite the very stretched valuations in the near-term.

Q: What do you think about this space, private banks, public sector banks and even some of the NBFCs, like we call them, the brokerages etc. – non bank institutions? Are you bullish or sceptical?

Mowat: I would concur with what Ashwini has been saying. We are moving more favourably towards the sector, particularly towards the public sector banks, which we think are offering better value than the private sector banks, which remain good stories, but perhaps more priced-in.

With regard to asset management businesses, wealth management etc, emerging market investors have made a lot of money in Korea in playing this theme. And so I think they would be very attuned to playing the theme in India. And perhaps you will see valuations get a little bit beyond where they should be, but that is just a genuine desire to play the wealth management theme around emerging markets.

Q: What is your call on metals now generally, looking at the US economic situation on one hand and the fact that the Fed is progressively cutting rates on the other? How would you play some of those steel, non-ferrous kind of stocks?

Mowat: Let’s talk about the steel sector. This year US steel demand fell by 10%. So, at the world’s biggest economy we saw a 10% decline in consumption of steel. The steel price rose. I think you need to understand what drives the steel price today. The US accounts for only 8% of global steel demand; China is some 32% of global steel demand. The recent revisions in terms of demand expectations for 2007 were driven by Russia, Brazil. And if you take fixed investment in Russia it is going from USD 220 billion this year to USD 440 billion in 2009, and with the oil price where it is at the moment, they have got the money to spend.

So, you are seeing commodity prices being driven by the emerging world. If you take the energy sector, YoY, there were some 600 million barrels of oil extra consumed in ’06 versus ’05. Some 450 million barrels of those extra consumption came out of the BRICs. This environment for basic commodities is very much an emerging world story as opposed to an OECD world story. So, ironically the activities of the Fed may not be particularly important in trying to predict where prices are going.

Source : MoneyControl