Why Deven Choksey expects Q3 to be a challenging quarter

Metal consumption companies like automobile, automobile ancillary would be beneficiaries of the market condition but not in the immediate quarter. Things may improve there in the subsequent quarter, Deven Choksey, MD, KR Choksey Investment Managers, tells ET Now.

Edited excerpts:

At some point, markets will start losing patience. Every year, we start with lofty assumptions, then in the middle of the year the assumptions are challenged, then people come out with explanations and then we are ready to wrap the year with the same bullish assumptions.

That is what the market is all about. The market has to carry different views at different points of time and that is what it does most of the time. I feel that we have a huge potential on one side but at the same time, there are significant amount of headwinds which are not easily predictable.

We have a situation where America wants to increase the tariff on China imports of goods. On one side, Trump believes that America can easily handle such kind of increase in tariff and their cost structure will not go haywire. Neither will the demand slow down. On the other side, look at China factories. If they start getting overloaded with production, they would start dumping it elsewhere and there will be collateral damages. The kind of fall that we are experiencing in some of the commodities at this point of time, is driven by crude oil.

China factories are once again ramping up production to dump into the global markets. Such situations could definitely make for a scenario wherein if something great has been predicted, may not happen. We are in a similar kind of situation currently. We are seeing the benefit of the crude oil prices and the commodity prices coming down because we are a consuming country but we also have seen the collateral damages. When the crude oil and commodity prices come down, the global traders who have taken position in this particular commodities/asset class would be incurring losses. They would be selling off some other assets including the equities. We saw the selloff in American markets earlier. We are likely to see the same situation continuing. We are also keeping tight monetary policies as the result of which we are not growing at a faster pace, particularly in infrastructure. Forthcoming elections are also keeping our markets under check.

Market behaviour is going to be driven by all such factors. You will have a situation where you have to meet a kind of downside at that point of time. It is best to stick to good quality investments.

Would the third quarter be a washout for companies at least at the bottom line level?

Yes, Q3 will be a challenging quarter for sure. We are likely to see the commodity companies facing high input costs and lower selling price. Those supplies which are contract driven, may not immediately see the effect. But they will have to bring the market prices into account while they are building the future contracts. Commodity companies are going to be in some kind of trouble. Consumption companies are going to be beneficiaries. For example, metal consumption companies like automobile, automobile ancillary would be benefitting out of it but not in the immediate quarter. Maybe, in the subsequent quarter.

In the immediate quarter, their inventory levels are going to be effected by the high cost of the previous quarter. This quarter is not going to be helping them any which way. On top of it, there is a demand slowdown which in the passenger vehicle segment.

NBFCs are holding despite a tight lending policy. Those which have been languishing are those which have been growing aggressively without looking at the risk part of it. They are under check currently. There is not enough amount of credit in the market and that would affect the consumption pattern in the economy in this particular quarter.

A large company like Reliance is facing the headwinds in the form of GRM fall. Singapore GRM is quoting below $5 per barrel. Reliance could have a margin mark up on that because they have the complexity in the refinery to switch over to other products from the jet fuel. From that perspective, they will be relatively better off but in case of a fall, oil marketing companies would probably feel the impact.

How far is the IT trade going to take us? Traditionally, the next quarter is going to be a short one. Also, we have seen concerns around how long the IT story is going to play out along with the currency weakness.

Whenever we have seen the currency volatility, in a given quarter, it gets evened out. Probably in a rising or weakening rupee kind of situation, you end up getting the margin benefit of not more than half a per cent, even if it is a superlative quarter. The rupee has appreciated after declining for some time. So the margin advantage which IT had last quarter, would go away. What is more important is that frontline IT companies have already been working on some of the long-term contracts.

They have already got the clear visibility of billing on quarterly basis for the next few years. At the same time, they have moved the model into the digital space of development. All in all, put there is a fair bit of clarity as far as the growth going forward is concerned. We can expect 8% to 11-12% growth in IT sector, depending on the company in the next four to six quarters. Beyond that if any growth comes, it will be a pleasant surprise.

If that kind of situation is understood, then any fall in the stock price would demand buying and on the rise, you would be selling. Typically we are talking about the trading range of around 15% to 20% in a market like this where the IT companies have given around 8% to 12% guidance, would probably end up moving in the range of somewhere between 15% to 20%. We would probably take the opportunity on the downside to buy into some of the IT companies to get the trading gains of around 15-20% from the lows.