Markets to be in 'spot of trouble' if earnings don't recover in 2 quarters: Ramesh Damani

Earnings have to improve if it gets a boost from the government by way of the stimulus package, or disinvestment by the government. Investors have to watch out of macro data such as macro numbers.

Liquidity has been able to pull the market to record highs despite challenges of demonetisation and implementation of the goods & services tax (GST) which pulled down the economic growth rate to a certain extent.

Liquidity trumps valuations sometimes in the bull market. Valuations are excessive compared to their earnings but it was liquidity that held this market and closed at record highs in run-up this Diwali despite geopolitical concerns and earnings, said Ramesh Damani, Member BSE in an exclusive interview with CNBC-TV18.

We have always heard that liquidity is the mother’s milk of a bull market –feels like a good impression now. This bull market has climbed a lot of worries about earnings but we are coming close to the day of reckoning, said Damani.

“I don’t think earnings are too far away. The base effect of demonetisation is kicking in and GST is absorbed by the market. I think in the next couple of quarters if the earnings don’t improve, markets will be in a spot of trouble,” he said.

Earnings have to improve if it gets a boost from the government by way of the stimulus package, or disinvestment by the government. Investors have to watch out of macro data such as macro numbers.

There are some sectors which will continue to do well or deliver consistent earnings growth are autos and oil & gas companies.

Commenting on the specific sectors which will hog the limelight in the next six months include names like consumption. Hence, sectors such as property, affordable housing, airlines etc. among others.

Apart from this sector which is associated with gaming, casinos are available at cheap valuations relative to their potential should be under the spotlight.

Another theme which Damani has already discussed is quick service restaurants (QSR). I think in the next 4-5 years, these are bulletproof businesses not affected by technology etc. and incumbents will have a huge advantage in these businesses for next 5-10 years.

But, from Samvat to Samvat, OMCs will do well. They are on a high earnings trajectory.

Below is the transcript of the interview.

Latha: What does 2073 indicate to you? We were just discussing and Anuj was pointing out that it shows the return of the equity cult and maturity of the domestic investor. Is that going to be the hallmarks of 2074 as well?

Damani: Absolutely. That has been the bulwark of the market strength is this bull run, but also the fact that liquidity trumps valuations sometimes within a bull market. I think clearly as everyone argues that valuations are excessive compared to the earnings, but it is liquidity that held up this market. You had shocks in North Korea, you had problems of Fed raising the interest rate, you had problems of earnings and despite all of that, the market held up and in fact closed at the highs next to Diwali. So this gives me some thought that sometimes within the bull run, liquidity is of paramount importance. We have always heard that liquidity is the mother's milk of a bull market. I think we are seeing a good expression right now of that.

Anuj: You always say that bull market climbs wall of worry and this bull market has climbed a lot of walls. But, the earnings wall, do you think it is getting bigger and bigger for the market to climb or do you think eventually earnings will catch up this year? So far liquidity has helped us, but you will need earnings support at some point.

Damani: We are getting to what we call the day of reckoning. I do not think that is too far away. I think now the base effect of demonetisation is kicking in for the next quarter. I think GST has been absorbed by the market. So now, if say the next couple of quarters the earnings do not improve, this quarter is consensually expected to be a very poor quarter, so in the next two quarters if they do not improve, it could be high noon for the markets. So earnings will have to improve this quarter. Now whether there is a stimulus underway that will reinvigorate the economy, whether it will be disinvestment by the government that will send a lightning rod through the economy, I am not sure. But, I think six months from now, if we are still talking about poor earnings, I think the market would be in a spot of trouble.

Latha: But we are seeing some green shoots you think? Bajaj Auto numbers, export numbers for September, 26 percent higher, then all those Purchasing Managers' Index (PMI) and Index of Industrial Production (IIP) numbers, as well Reliance numbers. Are all these giving you the sense that we will not be worrying about earnings six months down the line?

Damani: Export numbers, I do not know, they were a flash in the pan. Before that they were poor. So we will have to watch them for a few months and see how they are doing. Some sectors of the economy are doing very well. We are shifting from a huge unorganised economy to an organised economy and it is a bit of la la land thinking to think that it would not cause trouble to the economy. So I think that is slowly getting ironed out. There are some sectors like auto, oil marketing companies (OMC) which continue to do well and continue to perform good earnings out there. The rest of the market will have to catch up and like I said, in the next six months, perhaps, a good litmus test whether market earnings are catching up with the valuations.

Anuj: Samvat is about investing, looking for investment ideas for next Samvat. I know you will not be talking stocks, but what would be the broad themes that you will be betting on for this Samvat or for that matter, for the next 3-4 years?

Damani: That is a question I always love to grapple with. I do not know if you know, but I had the good fortune of becoming a grandfather a month back. So I was thinking in my solitude is that what is the kind of investment portfolio I would like to leave as a legacy for my grandchild and what excites me about India is still the huge consumer market. And we need to look at it differently. So some of the sectors which will do well, which we have a lot liked in the past is property, affordable housing, airlines, but amongst the new sectors, if you look at the gaming casino stocks, they are at fairly cheap valuations relative to their potential. So they will do well.

And a theme that I have explored with you previously here, the quick service restaurants. I think for the next 4-5 years, these are almost bullet proof businesses. They are not affected by technology and I think the incumbents will have a huge advantage in these businesses because people will want better standards of living, better entertainment, better relaxation modes. Those look like good bets for the next 5-10 years which I would populate for a young person.

But if you want Samvat to Samvat, I think OMCs will probably do well. I think they are on a very high earnings trajectory, dividend payouts are very good. So I have all reason to believe and there has been a volume explosion in terms of petrol, diesel which has been missed by the markets. So on a Samvat to Samvat basis, OMCs look good to me, but on a longer 5-10 year basis, I would look at the sectors I mentioned earlier.

Latha: Year on year, your Jubilant Foodworks and Specialty Restaurants, your repeated reference to quick service restaurants, they have done very well. It is an 80 percent jump in Jubilant Food after going through a fairly rough patch. So both these stocks have actually shown that consumption has come back.

Damani: The net is bigger in quick service restaurants. I think there are other choices that investors would have and I would urge them to look at those businesses because I think one thing is entrenched and I think the demographics point to a huge sustainable upmove in dining out because of women working because of urbanisation, because of hygiene standards and these companies are trading at what I believe is the fraction of the valuations and you have got a billion people who will be hungry every day. So these seem like good places to be in.