Brexit has potential to lead to market turmoil: Nilesh Jasani, Jefferies & Company

The market reaction to Brexit has been very surprising, says Nilesh Jasani, head of research (Asia Pacific), Jefferies & Company. In an interview to ET NOW, Jasani states that Brexit has the potential to lead to some market turmoil globally. Edited excerpts:

ET Now: Are you surprised with the strength that markets have exhibited post the Brexit event?

Nilesh Jasani: It has to be admitted that the market reaction is, in a way, very surprising; we went through possibly one of the biggest events that we are likely to see in these years globally in developed markets, and for markets not just in India, but everywhere in the world to be higher than pre-Brexit level in such a short time, in three-four days, is quite astonishing.

In a way, it shows you the power of liquidity at the moment that we have been able to ignore some absolutely amazing things everywhere... Whether it is Dr Rajan’s departure in India, something that market almost never reacted to, or you think about the various worries in China, or you look at many other events in Japan, and so on and so forth.

Somehow, globally markets are able to overcome the events in a way positive, in a way very worrying.

ET Now: Are we going through the phase where in the short term everybody is chasing higher yields, better economies, but eventually global realities will haunt us?
Nilesh Jasani: To a degree, it could be true and to a degree, it is definitely very-very different. The way I see it is let us first start with the global events. The best example even better than 2007 is 1997. Roughly 19 years back on the same day, 2nd July 1997, the Thai baht collapsed.

If you look at the market reaction within few days after that or even weeks, it was reasonably okay. But what it led to over the next 18 months was massive. Brexit definitely has the potential to lead to some sort of market turmoil or more events globally.
Now for India, the positive is that alike in 2007 when we were hooked on to capital flows, like 2007 when our fundamental story, our economic growth was dependent on the market rising, all the money moving into the market perpetually, that is not the case at the moment.

At the moment, the economy story is much better insulated. It is never completely independent but much better insulated. If markets God forbid have to go down by 20-25% tomorrow, it should not really impact the economy much the way it created a vicious cycle back in 2008. I think fundamentally, insularity is there.

From that view point, I would concur with the decoupling argument now which I did not in 2007-2008. However, market correlations are very-very high. So if you look at the general regular statistical correlation between our stock market and global stock markets, it has gone back to roughly the highest level or close to the highest level we have seen in last 15 year.

This was not the case in 2014-2015 when we were going through our own political cycle, the confidence towards the central bank and so on and so forth. While at the moment, once again on daily and weekly basis, we seem to be taking far many more cues from global markets. What it means is that if unlike today you have tomorrow when the US markets or global markets are off again, then we again have the possibility of a correction, a bit like January.

ET Now: Is this fear that people have about IT companies or companies like Tata Motors, Motherson Sumi getting impacted because of Brexit real? or people are just being presumptuous?

Nilesh Jasani: I think it is the second one much more than the first one. As an economy we are generally be insulated but that does not mean that UK does not matter to us. We have obviously massive cultural and historical ties with them. It is almost like if UK really does not matter to India, then almost no other country in the world matters to India. We are that insulated.

So from that view point, definitely there is going to be some impact. Now whether the impact is going to be for a specific company A or B, frankly everyone is at a loss. It is not that anyone out there has a better idea on what this Brexit is going to lead to and that is why it is possibly a bit to early to ask for exact impact, maybe a bit of risk pricing is alright in the market place.

I think when corporate executives come on your channel and say that most likely there would not be any impact, they are also making a few assumptions which are the assumptions they can make based on the information available to them and similarly those who come your channel and say that it is all going to be hell, even they are making some other set of assumptions. But we will know. There will be some impact. What? Way too early to say.

ET Now: Where are you on this IT correlation with Brexit?

Nilesh Jasani: Three different ways in which IT companies could come under pressure. First of all, IT companies by a long mile is the sector in India and possibly across Asia that has the highest percentage of business coming from Europe. When you have 25% plus revenues coming from a sector, you always have to worry about the risk. The second thing is that from the currency side. We are talking about a sector where a minor disappointment can cause 8-10% price changes post earnings announcements. Most importantly and this is the point that has not been sufficiently out in the market is that most IT companies historically going back 20-25 years, have been doing most of their European business through operations in London or in UK.

ET Now: Let me just add more sectors to our discussion, Indian economy per se currently has two wheels; the consumption wheel and the investment wheel. The consumption wheel will look better because per capita consumption and rural demand will come back courtesy initiatives and monsoon and the investment wheel is starting to hum once again as we are getting some benefits of government spending. So as an investor, for someone who has to align with a theme, the consumption theme or the investment theme how should be the positioning?

Nilesh Jasani: I think the consumption theme definitely has far more positives when you are talking about listed companies than investment theme at the moment. The good thing about consumption is that at least a part of the two drivers that you talked about one of them is real and no longer hypothetical and that is the government.

Monsoon, there are far many more question marks than generally assumed but let us not get into that. So consumption theme appears definitely really-really solid, particularly after the announcement overnight.

Investment themes again have to different parts to it; one is government and the second one is the private sector. The government investments actually have been going up continuously for two years. They have had some positive impact on some companies but they are, I think, not have as much impact on profits and profitability of investment companies given the kind of buyer or purchaser the government generally is.

So as a result until you see private sector capex also picking up and there the signs are still not there, I would prefer consumption over investments.

ET Now: You were chatting about your opinion on IT and how the Brexit vote if it were to take place is likely to impact these businesses. From an Indian IT perspective do you think the world is now going to shift, even ahead of the elections, is going to get a sort of anti outsourcing, if I can use the term?

Nilesh Jasani: Risk are there, we hope not. We all have benefitted over the last 30 years from ever freer movements of product, capital and people and Brexit is symbolically the biggest sign of the times we are living in where people are sort of rebelling at least against freer movement of people as well as products. Capital, there is some sign but not as much and IT companies as you know very well have benefitted from that.

We all hope that these signs prove wrong but if not IT is obviously at risk.

ET Now: When you say you like consumption as a theme what about valuations there, I mean PE multiples for an HUL or for that matter Page Industries, I can throw in a Dabur, Marico, all the consumer stocks are priced to perfection, it is like saying that these are great businesses but prices are horrible. I mean, the line I use on television is that it is like silver is available at the price of gold?

Nilesh Jasani: Right. So I definitely like consumption as a theme relatively more than absolutely at the moment. I think that the market is mispricing risk and could definitely go down over the next six to nine months, in which case I think all sectors will take a hit. You are right that consumption is a well known story, definitely valuations are a concern, not across the board but on average that cannot be disputed.

The only think that optimists would argue against is or would say comment is the weight of liquidity that when you have so much liquidity, so much money trying to chase the same half safe, half growth sectors, valuations may not be a concern.

In a way you are seeing the same thing in global risky assets, government bonds, I mean look at the UK Gilt after Brexit. Look at what has happened to some of the AAA rated bonds or even AA rated bonds across Asia after Brexit. And valuations are a concern but they are a concern everywhere wherever there is some growth in some quality. So overall, yes valuations I cannot dispute that, you are absolutely right but relatively they look great.

ET Now: So besides consumption and IT, those are the pockets that we have talked about, what else is looking attractive when it comes to Indian stocks?

Nilesh Jasani: I think there are a lot of good stories in mid-cap segment and also in the occasional sectors like let us say apart from discretionary, pharmaceuticals but most of them are bottom up names. The reality of India all said and done, like you witnessed with the RBI report on Tuesday that you have 1800 to 2400 companies having sales growth of only 2% and we have been talking about this low base driven recovery for five years now.

The reality of our market is that we have market earnings growth of barely 2.5% average for the last five years. This used to be annual growth what we have got in the last five years in India.

So most of the stories are not really sector stories, they are mostly, I would say, bottom up stories. Public sector banks could prove and exception, I mean, if you look at the kind of things that have started happening since the departure of Dr. Rajan or the announcement of departure or Dr. Rajan is that the government suddenly has started doing things that it would have hesitated on if Dr. Rajan was going to be around. One of them was Pay Commission last evening and potential impact on fiscal deficit.

The second one of course is the recapitalisation stories that we are hearing at the moment, the possible use of the emergence fund. So if they actually go for public sector banks mega restructuring solutions that are not purist that would not have been approved by Dr. Rajan but solutions that the government would go for now, that could be a huge positive for the stock prices.

ET Now: One key thought you gave away is that a lot of these mid-caps are bottom up stories, but surely there is a pocket, a sector, which was small until then and then became very-very large. Which theme do you think has the potential to grow from where it is right now?

Nilesh Jasani: I think it would be non-banking finance companies. That is where I think you have more innovative use of technology and more innovative use of global financial revolutions, new products, and so on so forth.

ET Now: Do you think money will be made in PSU banks or it was a no earlier and it remain more like a big no still?

Nilesh Jasani: Look I have burnt my hand on recommending public sector banks once, I am very-very, you can say, once bitten twice shy. I think to be honest if I forget about that experience, out here out now public sector banks have a lot of value and lot of potential for reforms.

The fact of the matter is that if you have the RBI and the finance ministry working together on practical solutions a lot can happen, a lot can positively happen for the public sector banks over the next 12 months.

It does not mean that their ROE will definitely improve over a three-year period or it does not mean that they are going to have market share gains on a five year basis but given where the valuations are, I would say, it is worth thinking about.

ET Now: Where are you on this mid-cap versus large cap debate? In any market large cap they trade at a premium because they are better businesses, their cost of borrowing is lower and they have understanding of cycles, but India perhaps is the only market where majority of good quality mid-caps are trading at a significant premium to their counterparts or to their large cap peers.

Nilesh Jasani: Right. You absolutely said it right that if mid-cap versus large cap in a market like India at the moment is somewhat structural but a lot of that is momentum, a lot of that is fashion and you will have that issue over the next two, three, five years, if not much-much sooner, when particularly those mid-caps that are obviously commanding large cap like valuations that have become large cap like size in market cap, they will have a lot to prove and they do not have much room in the valuation for any bad news and mid-caps typically go through bad news, right, I mean, their businesses become famous, some other large players come in provide competition and so on so forth.

So mid-cap is a momentum sector, the last momentum sector that we have been having for last five years or six years is quality and quality has somehow it continues to command premium despite disappointing on growth. I would not give up on mid-cap easily, not that quickly, not yet but yes, valuations are a concern.