Nifty will trade in the 4000-5000 range in 2012: Nilesh Shah MD & CEO, Envision Capital in ET

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Nilesh Shah, MD & CEO, Envision Capital in an interview with ET Now talks about his outlook for the Sensex and Nifty for 2012 and his top stock picks. The story of how Indian markets have moved in the year 2011 was largely dominated by three factors currency, Europe, and inflation. What will influence the script for 2012? The single biggest factor which will drive 2012 is going to be deficit. The global community is going to eye how the government is going to tackle fiscal deficit. That is the single biggest factor and around it will revolve inflation, currency, outlook on markets and the governments resolve to take certain hard decisions. In addition to that factors which are there in the global environment, be it Euro, expectation of QE3. Those are variables which will come in, on and off but the common underlying threat for 2012 is basically going to be the fiscal deficit of the government. At 4500 on the Nifty and about 15000 on the Sensex, what is the fiscal deficit number markets are pricing in? Markets perhaps are pricing in something like 5.5%. That is not too way off from the estimates which have been put out by a lot of think tanks. The worry does not seem to be so much about FY12 but more about FY13. The kind of roadmap that the government lays out for FY13 in terms of the deficit number especially in the backdrop of an environment where commodity prices have not cooled off significantly. If the food security bill is passed then how is the government going to raise resources to keep the deficit under checks. It is going to be an acid test for the government. What are your views on the Food Security Bill? We as a nation do not seem to be yet fully prepared for it in terms of the delivery mechanism. The ability to fund that is still a secondary factor. The primary factor is the worry is that do we have the ability to implement the food security bill. That is something which most experts and common man believes, that we are still not fully ready to implement it on the scale on which it is envisaged. Do you think the budget will be a make or break event for Indian markets for 2012? The finance minister will indicate a fiscal deficit number... From all the local factors, that is going to be the single biggest event that we have to look for. This is not just because of how our last 6 or 12 months have been, but for the next 6 to 12 months post the budget. That means the period post February 2012. If you combine February and March, that is the time for the budget and elections in some of the most crucial states, the next 6 to 12 months will be the most critical period for the government to take whatever hard decisions it needs to take. It is the single solitary and the last window available to the government to take tough decisions and if the budget does not reflect that then according to me that will be an inflection point. You are not using the word interest rate at all... To me interest rates are a derivative of deficit. If the government ends up with a deficit which is much higher then what it can support, it would have to be funded by borrowings. One way to fund is through taxes but in an environment with the economy not doing too well your ability to increase taxes is not there. Your ability to collect more taxes from the same base is also limited. The only big option left is to fund it through borrowings. When that is done it has to result into higher interest rates. Inflation, interest rates etc. are all subsets or a result of the deficit. So macros will dominate Indian markets in 2012 not micros? Absolutely. At a particular level valuations will get attractive. Are they attractive? They are beginning to get attractive. They are in the value zone. We have probably just entered the fair value zone and if we head lower from the current levels then we would probably go towards those bedrock levels that were there over the last 10-15 years. What would be a bedrock level? 4000, 3500? Any levels below 4000 on the Nifty is a bedrock level. Even around 4000, sub 4000 is the kind of bedrock level because that would roughly translate into a Sensex of about 13000-14000. Assuming a Sensex earnings per share of 1100 or 1150 you are probably at about 11-12 times. Those are kind of levels or valuation range on a trailing earnings basis which have not been broken on a sustained basis no matter how big the event is. If you look at the last 10 to 15 years the markets have found it very difficult to break levels of 11-12. They could have temporarily broken it for a day or two, but 11-12 are fantastic levels. It has a very strong correlation with the yield on government securities. Assuming the yield on government securities to be about 8%-8.5% which is a risk free rate. If you were to take an inverse of that, you would end up with something which is called the PE multiple which is about say 11-12. At 11-12 PE multiple you will get Indian equities with all the future growth as a bonus. Now growth could be sluggish for may be a few quarters, may be for a year or two but over extended periods of time we know that this economy has the potential to grow and corporate earnings have the potential to grow in double digits. At 4000 Nifty, would you say it is time to go all in? Yes. It is definitely time to go all in. If you have been either cautious or neutral, at levels of 4000 and below you do not need to be neutral. You need to be cautious all along but you do not need to be neutral. At levels below 4000, valuations become so attractive that you should be bullish. Where are the bargains in this market? Where is the typical Buffett trade in this market, which is to buy fear and sell greed? Even without getting into individual stocks, a trade on the Nifty itself, when you get the large caps, as a basket at 11-12 PE multiple, that is a typical value trade. Wven if you were to do an analysis for the last 5, 10, 15 years, Sensex has not broken those levels. Even if it has, it has been temporary. You make serious amount of money at those kind of levels. Your ability to make good double digit returns increases significantly. You recommended HUL a year ago. Is it still a preferred buy for 2012? Defensives will continue to outperform because the macroeconomic outlook is still hazy. HUL as a franchise is a perfect hedge against a weak macro environment. However, that does not take away the fact that valuations are very rich. It is hard to make absolute returns from HUL. At a stock price of 400, you could end up with a 10% upside. It would still be able to outperform over may be a slightly a more longer time frame. It has the ability to outperform but would you make serious absolute returns from that, I am not too sure. Identify a large cap stock idea for us, where to your mind the downside is 10% and the upside could be 30% in next two years? If the markets were to correct 10%, most of the larger banks would also correct by about 10%. We have been cautious on the banking sector but if you look at State Bank of India, for example, the adjusted book value on a consolidated basis could be between 1200 to 1300. The stock is trading below 1600, 10% lower in that band of between 1300 to 1500, you can get State Bank of India around its book value. Are there concerns as yet in terms of asset quality, NIMs being under pressure and whether the entire banking cycle has turned, these are all the negatives that you may point out. However, there are absolute returns to be made from these ideas. What do you like in the midcap space? The environment is still not very conducive for midcaps. You may find a midcap stock which is at a 10 PE multiple and there is nothing which stops it from going down to an 8 or 7 PE multiple because of liquidity and not so much because of fundamental deterioration. When the environment is a lot more benign we see midcaps going up with very limited volumes. When the tide turns you definitely see midcaps getting hit on low volumes. When the tide turns for the positive, it is the large caps that lead first. Therefore a better trade sometime in 2012, when the valuations are attractive is to play the large caps first and then go about selecting your midcaps. The balance sheet related risks in midcaps are substantially higher compared to the large caps. You should not be watching out for midcaps. The three Ds which have worked for the year 2011 are dividend, defensives and diversification. What could work for 2012? I would not be surprised if it is again the three Ds which are at work. These three Ds by and large work when you are either in a sideways market or a bear market. For 2012, the trade could be large caps. Focus on those big names irrespective of the dividend yield or the diversification. I am not sure whether being too diversified also helps. You can probably afford to be diversified in a bull market but in a bear market you have to do your homework well. Have very limited number of positions which you can monitor even better. Globally when we started the year 2011 the top trade was to buy commodities. As you wrap the year pretty much the reverse has happened, commodities have cracked, EM equities not only India but other EM markets also have cracked and dollar is the best performing currency. Do you think by the end of 2012 this trade could reverse again in favour of EMs? I would certainly bet on that. May be the first few months the trade which you just mentioned could continue to play out and continue to extend itself which means that may be for the first few months of 2012 we could still see a fair bit of strength in the dollar and some amount of softness in EM equities as well as in commodities. But it is quite possible that sometime middle of 2012, the recession in Europe becomes even more evident and more visible and the fact that US continues to be in a sub power growth era, you are going to have elections towards the end of 2012 in the US, I would not be surprised if the Fed again opens the taps and March, April, May. You could basically see again some kind of a QE3 come in which could reverse the trade. You could again see emerging market equities, commodities, all do well more so in the second half of 2012. What could challenge your conviction? An equity investor has to be optimistic about the future and today one is far more optimistic that over the long term growth is going to be there. As valuations get more and more attractive, your conviction goes up. The biggest challenge to this conviction would be if the deficit number is completely out of whack and it looks that the government is perhaps not going to take some of the hard decisions for 2012, then I would say that we could probably remain in a very extended period. What will be your portfolio approach if that scenario pans? In a situation where the fisc is above 6.5%... You would then have bring down your perspective on the ceiling that this market could have for 2012. You will have to get a lot less optimistic about the prospects of 2012. You would probably push your bull case scenario more towards 2014 or 2015. 2012 is the last window for this government. Then you spill over to 2014, election time. Then one will see whichever government gets elected, what vision it has for India, what is the roadmap it lays down to get back India onto high growth path with a lot of fiscal discipline. 2012 is going to be basically a very critical year for India. What role do you think dollar will play for Indian equity markets in next one year and if your assumption is that dollar will remain weak, is it time to go and load Infosys? The dollar will remain strong for the next few months of 2012. That bodes pretty well for the entire technology pack. Infosys represents 2 opportunities. One is of course the strength of the dollar and two is, it is basically the best hedge against a weak macroeconomic backdrop in India. Technology as a sector can do extremely well. So let's nail it down to 1, 2, 3, HUL, Infosys and then State Bank of India. Yes, I would say that, the only thing is that in State Bank of India, probably your timing etc. has to be more better. You have got to be more clued on in terms of how the RBI is going to take a view on interest rates. They have hinted that we are going to probably start reversing the entire cycle, the question is when. The first two present the least downside from a macroeconomic perspective whereas in State Bank of India you could still have some kind of a macroeconomic downside. Everyone is trying to buy defensives so that they can hide under the desk. Is that trade getting slightly crowded? Yes. Something like an HUL is a defensive. It looks like it will outperform the market but it is going to be difficult to make double digit absolute return gains out of HUL. In the last one week, you have actually started to see a lot of consumer names particularly the tier 2 consumer names beginning to basically give off a lot of the strength. Why do you think if the world is chasing defensives, the VIP or Titan or the Jubilant Foodworks are correcting? It is quite possible that the outlook on their growth for the next maybe 3 to 4 quarters is now a lot more tempered and subdued. The margins for some of these companies could come under pressure which may not justify the higher valuations. This could also be reflective of the last phase of decline, when basically the pockets of strength start to give way. That normally begins to happen in that last leg of the decline and does not mean that we are done with the decline. In your personal portfolio, are you by and large invested? We are substantially in cash. We are underweight equities. If Nifty goes to 4000... If the trade becomes a lot more favourable for us, that is where we would want to basically try and get more invested than what we are today. So at 15000 on the Sensex and 4500 on the Nifty, you would say that market's risk and reward are on a neutral turf? I would say that. I would probably tend to believe that we are in a neutral turf and we believe that the range for the Nifty could be 4000 to 5000. That is the broad range, plus or minus 7-8%. Coal India has cracked. At these levels, is Coal India a good great long term buy? From a 5-year perspective, it still looks good. Given the kind of outperformance the stock has had over the last 1 year and particularly after its listing. The market is down 20%, Coal India is still up 20% from its listing price. So that is a huge outperformance even over the last one year. Maybe over the next 1 or 2 years, the environment could still remain challenging for Coal India but over a 5-year perspective, Coal India will still end up being a good place to be invested in. If State Bank of India is available at 1500, Coal India at 300 and Infosys at 2400, which is one stock you would go for? From a one to two-year horizon, it would be Infosys. The visibility of growth in case of Infosys is still high. So while they keep giving a guidance of 18-20%, even if that growth falls to 15%, I still think that is pretty good in this kind of an environment. In case of say something like SBI,issues and challenges about asset quality NIMs etc. continue to be there. On a risk adjusted basis, probably Infosys would stand out.