It has been good for India in the last 45 days. You cannot find a fault line. But is this as good as it gets?
For Sensex, 45,000 is a reasonable one-year forward target and that gives much more upside than we have for global emerging markets. So, a double digit upside more or less, whereas we have only 2% or 3% upside for global emerging markets. There is a number of things that India is going through. Obviously this government has come in for the second term. We have got an interest rate cutting cycle underway and we have got the oil price falling which is always helpful. I think the banking sector issues attract a lot of attention but we are getting closer to resolution on those and if that happens, we should hopefully start to see growth picking up which is a very important opportunity.
Indian markets got record flows especially in late March early April and mid May. What explains that kind of an inflow into Indian equities? Was that largely global positioning or something more India specific?
It was a confluence of factors, It is not the only market that benefited from resumption of flows in that period. What you are seeing is that investors are putting a question mark over the performance of some North Asian markets that are very trade sensitive and where also the stock markets cater to sectors that are in deep trouble globally — the auto sector and tech hardware, semiconductor memory stocks etc. and finance related. India has got the domestic drivers but it also benefited from the outflows that we have seen from other markets in the region.
When we started the year, the general view was India was almost neutral to mild overweight for global portfolio allocators. Is that still the position?
Yes. If you go back maybe 12-18 months into the first term of the Modi government, that was when foreign investor weightings in India peaked at almost double the benchmark at one point. The benchmark being 6% or 7%, we had clients who had mid teens exposure to India and that came all the way down and was only a very modest neutral to mild overweight by the turn of this year. Now people are starting to re-engage.
From global investor standpoint, MSCI is always an important benchmark in the China A Shares. The market share percentage is going higher given that Chinese stocks have not rewarded investors a lot. Is there a perceived fear in China slowdown?Even though MSCI weighting for China shares could be different, could markets like India actually benefit?
China A shares were the best performing market in the world by far in the first quarter but when as we went into the second quarter, it became obvious, policy stimulus was not really helping the economy recover for various reasons and then the trade and tariff issues resurfaced in early May. That was part of that rotation we were just talking about. The index inclusion was going on in late May. The first of the inclusion factor increases took place but it means that A shares will gain and the benchmark — it has become around 3% by the end of this year — is certainly something that active investors do not have to track. We are seeing that while foreigners were buying A shares very significantly in November through to the end of March, at the moment that is selling significantly through the connect programme and then reallocating to India, Brazil, Indonesia and also to Japan. So, that is an interesting reallocation going on.
Do you think the allocation which have comeback to India early or mid year, will remain firm and could accelerate as we move into the second half of this year?
That depends on the overall constellation and so it requires further interest rate cuts, long dated bond yields to continue to be stable if not down. The oil price will also remain well behaved and the new finance ministry team which is coming in, needs to start delivering particularly on the public sector bank recap, dealing with the issues in the shadow banking sector, which have been quite significant and those two issues are part of the reason why growth has been subdued. We need that growth rate to pick up.
If I do a score card of NDA-1, the mandate was strong, policy changes were quite robust but the net impact on the earnings really disappointed. Do you think investors are going to take the current mandate with a pinch of salt or are they convinced that some of the reforms may see benefit in terms of economic and earnings growth under NDA-2?
There were some considerable achievements in terms of bankruptcy law, in terms of the GST. I have covered India for over 20 years we have waited a long time for GST in terms of the actual digitalisation of government services and FDI moved significantly higher. Infrastructure delivery improved significantly on multiple fronts and quite a lot was achieved and so it has been a significant budget discipline but the overall growth environment has been somewhat disappointing,
Now, it is really time for the banking sector issue to be dealt with because aggregate demand is never going to be a problem in India at this stage of development. It is really a question of financing that in an appropriate manner with appropriate sweeter financial institutions and that is a problem that many emerging countries wrestle with. But I think it needs much more focus at the start of the second term.
Only the consumption engine has worked for India for the last couple of years. The high frequency data now seems to be telling us that we could be in for maybe not a deep rooted slowdown but a slowdown that is on our face now. Autos, airlines, movie tickets, two-wheeler sales or are seeing slowdowns. How does one use the current scenario to understand India and invest better in Indian stocks?
This slowdown that you are talking about is manifested on a worldwide basis and so we are very cautious about the global growth outlook. We are actually more concerned about countries in North Asia that are very exposed to the trade and tariff dispute between the US and China and have these complex supply chains with a lot of interconnectedness in manufacturing with US and China. That includes Korea and Taiwan. We are less concerned about India in that regard but we think there are important issues that need to be addressed here to get growth going again, particularly in terms of the key sectors in development like real estate and private corporate capex. Those have been weak and they need to be addressed.
The script of how Indian markets have moved in the last couple of years has been a function of largely PE re-rating and a lot of liquidity. What do you think could influence the script next three to five years?
From demographic perspective, India along with Indonesia is extremely interesting. When people are in there 30s or 40s, if you look at the domestic bit for equities and the growth of domestic mutual funds, that has been a key feature here because foreign investors reached their peak enthusiasm about India, 18 months into the first administration. I think they can turn around at the margins as they are but it is very important that the domestic mutual fund investor bit remains in place.
Where do you think markets are underestimating the growth? Do you think we are in for an earning surprise?
The overweights that we have in India include industrials, consumer, consumer discretionary and private sector financials. We are more cautious on some of the exporters, particularly because we think the rupee will be reasonably strong and again one of the interesting features of the last few weeks is that the rupee along with the Brazilian Real or the Indonesian Rupiah have been very strong versus north Asian currencies like the renminbi or the Taiwan dollar or Korea won. That is quite unusual. We have a bias for domestics and domestic demand players. We are basically arguing that this domestic orientation of the Indian market is an attractive feature right now.
But in terms of the earnings growth in the multiple, our Sensex target of 45,000 seems like 18.5 multiple, something like high teens to 20% earnings growth that earnings will bounce back and the growth will bounce back. If that does not come through, then that would be risk to that kind of target.
If I look at the regime of last five-seven years, especially post 2008, money was cheap, interest rates were low and that lead to big re-rating or PE re-rating for global financial assets. Especially markets like India saw a massive PE re-rating. Global central banks are likely to follow loose monetary policy. What happens to PE multiples because the cost of capital will automatically come down?
Yes I am not a huge fan of the Fed model that would relate the PE multiple to nominal yields. There is a better relationship with real yields and the PE multiple, PE being a real variable. What Fed was doing in 2018 was one of the reasons PE multiples fell so much in the US. That year, the real interest rates were starting to pick up. The Fed was not just raising nominal rates but were also shrinking the balance sheet.
Now you are right. The Fed is starting to change and other central banks’ margins including in China, the shifting is easy. You have to figure out though what actually happens to real interest rates in that environment, if inflation falls off very quickly. It is possible that real interest rates could go up. At the moment, in emerging markets, the multiple is reasonably close to the fair value. But the problem is that the growth environment is weak and for broad emerging markets, we only get the 2% or 3% upside particularly because of weakness in sectors like autos, tech hardware and the trade and tariff related sectors.
Potentially we are looking at a slowdown and a tough environment and what strategy would be the best in such an environment? Buy defensives which is a combination of high dividend yield stocks and consumer staples and autos or should one continue to buy risk when it comes to India?
India itself is a defensive market and it has proven that fairly spectacularly in the last four to six weeks. There have been periods when Indian equities were actually going up, when the S&P was going down, which is very unusual. It is anything but a high beta situation and it shares that defensive characteristic with some other markets. At a global level, we are not bullish on markets. Our S&P target is Rs 2,750 which is clearly below where the index is trading now but we think India can grind out outperformance in this environment and has this somewhat different characteristic whereas global growth is softening, significantly. We are pairing India and Brazil as our two favourite markets. They both have been in quite a depressed economic growth environment for a considerable time now and the play in both countries is in terms of solving the issues that lead to growth re-acceleration.
Why India and Brazil together — one is a commodity producer the other is a commodity consumer? History tells us they are inversely correlated?
Well they both are non-manufacturing in terms of the structure of their economy and in terms of structure of their stock markets. They both are slightly outside of if, not beneficiaries from the US-China trade tensions. If we look at India, the theme of manufacturing supply chain relocation into India is definitely appearing. We have been discussing that at this conference.
Brazil is an agriculture superpower and also within all of this, we are seeing reduced Chinese purchases from US and indeed Canadian agricultural products and all that is very bullish for Brazil. There is also an ongoing problem on swine fever throughout southeast Asia and China. Brazil is a big protein swing producer in terms of chicken production.
Both these countries have governments that hopefully will be energised around reform and they both have had quite depressed economic environments. But there is a possibility for growth to surprise on the upside in these countries. At this time, we think it is going to surprise on the downside, including in the US and elsewhere.
Since we are revisiting the whole issue of trade war, you have always expressed over the years that do not focus on the news but try and figure out how much of the news is in the price, How does one know whether the current trade war is a good template or a bad template and is something the markets are already pricing in?
We cut our target for broader emerging markets twice in May; once at the start and once at the end, as this issue resurfaced and growth data also came in somewhat weaker. We are trying to evaluate the situation. At the start of the year, when it looked like the trade and tariff situation was de-escalating and as the Fed surprised in January by pivoting to an easy stance and China surprised on the upside of the credit policy, that was good for the multiple and good for EMs. It is a very turbulent environment and it is something that we just have to give our best efforts to on a daily basis.
You have been tracking India for 20 years now. What is that one thing which has constantly surprised you about Indian markets and one thing which has constantly disappointed you?
Taking a step back, if you look at all the countries in the emerging index over the period that I have covered, there are two that have structurally outperformed over the cycle; one is China and one is India. So in fact the correct strategy if you had perfect foresight is to have been overweight those two markets and to have stuck with them.
In case of India, it is interesting in terms of disappointment that the overall growth rate in India has not achieved its potential. But the corporate performance has been very strong and the execution of certain business models both on the domestic and exporting side has been very strong. You probably characterised the micro execution as stronger than macro execution but then we went through the details. The first Modi administration changed a lot of things. There was a lot of structural reforms which should bear fruit longer term. The one element that was not dealt with aggressively enough is the banking sector and shadow banking issues.
Twenty years ago, if you bought into private banks it meant you have hit a home run — be it HDFC or ICICI or even IndusInd Bank. Ten years ago, if you bought into NBFCs you would have hit a home run. You have got a Bajaj Finance and several other NBFCs. Indian markets give you this periodic trends which are structural in nature. Is there any large mega trend which you are betting on? It could be a three-year, five-year trend or a 15-year trend.
Do not forget that in terms of historical performance, we have had a very strong performance from part of the contract outsourcing software sector and though the generic pharma producers have done less well recently, there was a period when they had done exceptionally well too.
It is not just the domestic plays that one has been able to tap into. Going forward, the really interesting thing will be to see the Make in India campaign can actually gain fruit in this turbulent environment where supply chain relocation is going to happen and as the domestic market develops here. Ween we do some of the survey works with multinationals about supply chain relocation in quite a wide range of sectors including auto components, handset assembly, parts of the chemical supply chain etc, India does get mentioned along with Vietnam and Indonesia as a credible destination. That will be very interesting to see.