Mumbai: As 2009 winds to a close, the massive stock market rally since March seems to be losing steam. Jyotivardhan Jaipuria of DSP Merrill Lynch Ltd and Vetri Subramaniam of Religare Asset Management Co. Ltd speak on how 2010 will likely shape up for the markets. Edited excerpts:

How are you feeling going into 2010? You have been cautious for a while. Are you feeling even more circumspect than a month or two back?

Street signs: DSP Merrill Lynch’s Jyotivardhan Jaipuria (left) and Religare’s Vetri Subramaniam.

So there are a lot of challenges and the valuations do not leave too much on the table in terms of making the market attractive. So the next year is going to be challenging and it will be challenging not just for reasons particular to India but also the fact that we have been extremely correlated with trends overseas, directly correlated with equity markets and other risk assets and inversely correlated with the dollar.

I am not seeing those correlations or that kind of induced volatility go away in a hurry. So that’s going to be another challenging year next year as well.

What is your perspective getting into next year? Are you also circumspect or cautious or do you think the market will be able to climb these walls of worry that Vetri spoke about?

Jaipuria: This year has been one of the best years we have had in ages and if we see second half this year—I was just seeing some numbers now—this is turning out to be the best year for MSCI Asia pack since 1993.

So ...I think next year is going to be a year of consolidation where probably markets don’t do much... Having said that, we are expecting a first quarter correction in the markets.

That is an interesting perspective. In 2008 markets fell more than 60%, in 2009 we have more than doubled. You are saying that this kind of narrow range-bound trade that we have seen in the last quarter of this calendar year might actually be more like the picture we will see in 2010?

Jaipuria: Yes, I think after the last three years, after so great volatility, I think it seems very anti-consensus to believe that we will get into a narrow range market but typically if you see most years, markets are priced and they end up delivering something that no one expects. Like no one would have believed that this year would give 100% returns.

Because the issues are very clear, valuations are expensive, which everybody believes. Liquidity is not going to go in a hurry. From those base effects, the economies are recovering. So we will just get a year where markets end up may be not doing much for the year, there will probably be ups and downs...

Do you concur with that view or are you expecting more volatility in 2010 because of the global events which might come to the fore?

Subramaniam: My sense is that volatility might actually come back...definitely—may be in the Q1 or the first half of the year—and the reason for that is also because if you look at the typical volatility measures they seem to have come down pretty dramatically to levels which were almost prevailing more than (a) year-and-(a)-half ago when we were in far more sober times.

My sense is that you will most probably see a spike in volatility again. The other reason why I think volatility is here to perhaps stay is that increasingly over the last 18 months, we have just seen these correlations become tighter and tighter across the world.

It is almost like there is one orchestra conductor out there and all the markets are beating to the same tune and because of this you tend to find volatility (that’s) much higher than you would have found otherwise. So I think these are times we are living with, and it is something we will have to just put up with for the next, may be year or two.

You calling for a Q1 correction? Are you calling for a deep correction because we had one of them just a few weeks back, it was 10-12%, no more than that? Do you think liquidity still supports the markets at lower levels in case of a Q1 correction?

Jaipuria: It’s more like a 10-15% correction, liquidity (is) still going to be easy. I do not see the Fed tightening liquidity in any significant way till late into first half or probably second half of next year. So, to that extent, corrections will be narrow. But like in India per se, we are going to get negative news like Vetri pointed out: the exit policy comes through; inflation is high and bunching up of paper, which is waiting to come into the market.

I think a combination of all this will bring a correction. Globally also, there is too much faith in the dollar carry trade, which at some point probably we see a bit of dollar strengthening, which shakes up markets a bit.

Do you think there might be a deeper cut than the one we have seen over the last six months or so?

Subramaniam: Possibly, I don’t think one can rule that out any more. In fact, I felt that way even a month ago... I said market’s been trading in a tight range for a while and my sense is that we are building up to some sort of sharp move and frankly, about a month ago, I would have...put the odds at maybe 70% to the downside and 30% to the upside sort of move, more for the seasonal factors.

But the way the data points are playing out and the way the world markets have behaved over the last few weeks, increasingly, to my mind, suggests that the risk is more on the downside and my sense is that the next move that we are talking about is a 20-25% sort of move, I don’t think it will be small.

How would you approach corrections? If the Q1 correction does materialize, is it just a buying opportunity or you would want to reassess after examining the triggers which bring about the correction?

Subramaniam: I think there are two key things to look at and that is the way we look at portfolio strategy at this point of time. One is that the events of the last 18 months and again looking at how the domestic economy has responded, we feel far more strongly and far more convinced that we have the wind behind our backs when it comes to the more domestically oriented, consumption oriented stories. Where we tend to feel a little bit more circumspect is in more globally driven areas. So when it comes to the issue of dealing with a correction the sort of viewpoint that we are taking in our portfolios is that, over a three to five year period what are trends that we feel strongest about, and those trends are really the domestic trends.

Therefore, in terms of portfolio strategy, we would rather position ourselves where we think the structural tailwinds are in our favour even if valuations are really not all that attractive. But where we would rather stay away from is where we think the tailwinds are not really favourable and that is the global cyclical area.

So that is the way we are adjusting this in our portfolio strategy in terms of saying what trends are we most convinced about in a more medium-term basis and back those areas rather than areas which we are circumspect about.

Would a 10-15% kind of correction make you more optimistic about going out and buying stocks? Would it be a recommendation to buy the declines going into 2010?

Jaipuria: Yes, because markets are really going to be range bound. So if we get, let’s say, a 15% correction it gives you something on the upside for the rest of the year.

But I think it’s going to be the year of stock picking. It’s not going to be these great macro trends which really play out through the year. We are in portfolio positioning, very similar to Mr. Subramaniam; overweight the domestic plays and underweight global cyclicals.

How high would you rate the chances of the market surprising and coming back from an early correction in the year, eventually going on to take out the old highs of 21,000 Sensex?

Jaipuria: It is possible, like, if we go by past trends, every time when markets have had this V-shaped recovery then the longest time by which we should reach these old highs is probably middle of 2011. Most of the time, we would have probably around now been close to the highs.

So somewhere in the middle of next year, especially if Fed just keeps the policy very easy, it is possible that we go and touch the highs for some time. But the issue is whether we stay at those highs because every time, even if we go by the past history, every time that we hit these highs, we tend to get a 30% correction in the next six months. So we are not really going to sustain at the old highs next year.

Do we touch it during the year—yes possible sometime during the year we end up touching it.

How high do you rate the odds that even if the market corrects 20% going into 2010 it can make a strong comeback sometime later in the year and maybe even scale back to its old peaks?

Subramaniam: My sense, and that goes back to what I said earlier, that the market (has) sort of just been coiling up over the last two-three months for a big move. If a move like that were to happen it will be driven more by sort of seasonal trends, historically, at least December-January-February has been a good period for India and so too for some of the other emerging markets. It has typically tended to be a good time for flows.

So my sense is if you are going to see those old highs come through it will actually come through much faster and maybe come through in the next two-three months so it might come in the first quarter of the year itself.

But, as I said earlier, my own sense is that the sharp move is more likely to the downside and if that were to come through then I do not think 2010 is the year in which you will be challenging those old historical highs.

How do you see earnings shaping up over the next four quarters of calendar 2010? Do you think earnings will be such that the market may try to move up despite any kind of global headwinds and eventually even go on to see some kind of valuation expansion because earnings are growing at a faster pace?

Subramaniam: In fact, Mr Jaipuria wrote an excellent report in terms of analysing the earnings trajectory for 2011, so I should let him throw more light on that.

But, interestingly, just to sum it up there is very interesting dichotomy here that you actually look at where the earnings growth is coming through in 2011, it is actually getting driven by the global cyclicals, it is not being driven by the domestics.

The domestics are already having a reasonably good year in 2010 and they will continue or sort of maintain that momentum going into 2011.

But the big jump that you are seeing in earnings growth is coming from the global cyclical areas. So in a very perverse way what you need for those earnings growth numbers to come through is tremendous amount of follow through or at least sustenance of the current trends that (we) are seeing at the global cyclical areas in terms of prices.

One might argue that that is also divorced from the reality in terms of demand supply for commodities. But the fact remains that if you use those prices as a base number for your forecasts in 2011 that is what is driving the sharp earnings momentum in 2011.

So there is a huge dichotomy over here. If you feel strongly about the domestic economy then there really isn’t so much by way of acceleration for next year. It’s the global side of it which is driving the next year’s acceleration.

Take us through you report? Are we going to get 20% earnings growth in FY11 or are there risks attached to it?

Jaipuria: There are risks... A lot of it is dependent on the global cyclicals. So if the metals do not do—we have like 100-200% earnings growth in the metals and that if at some point metals start to come off then there will be risks to that earnings growth.

At the moment, most people are factoring in not just 20% coming but the general impression is there will be upgrades to that 20%. So that’s where the problem for the market is to get the market to rerate you need 22%, you need that to be beaten by quite a bit and you need the earnings growth to go to 30%.

And I think that’s where the risks to the market will come because even as domestics to do little better than what we have forecast. If there is any slippage in the global cyclical plays then the aggregate numbers won’t stack up.

That’s an interesting point, the global commodity contribution to earnings. What about the other big cluster which also contributes fairly meaningfully to earnings—banking. How much of a wildcard is that or swing factor is that for earnings growth in FY11?

Jaipuria: We have had a sharp earnings growth put in the banking stocks and I think even the consensus is quite optimistic. There, of course, one swing factors going to be the RBI (Reserve Bank of India) norms where the non-performing loans provisioning will have to go up.

What everyone is taking for granted today is that credit growth will pick up. So at some point if we do not see that credit growth pick-up happening then banking stocks will see some downgrades. But if those things play out then probably banking should do well over the course of the year.