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(Interview Transcript)
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Edward Pulling, MD, Pacific Regional Group, said too many people are hunting for the bottom rather than cashing in on the buying opportunity. "The next nine months is still a good time to start buying in India."
He said the quarterly earnings are likely to trough around 13-15% in Q4.
Pulling said the markets may have seen the worst, but may test it again in the future. "The Nifty may go down to 4500, and it’s likely to be a trading market for the next 8-10 months. The markets are likely to remain rangebound for the next few quarters and will eventually take another shot at making new highs."
Excerpts from CNBC-TV18’s exclusive interview with Edward Pulling:
Q: What is your sense to that trillion-dollar question, is the worst in place?
A: We have probably seen the worst but we might re-test the worst. By that I mean that for the next 1-3 quarters, the market will trade rangebound. If one is at 5,000 Nifty, one could probably oscillate 500 points either way from here. There are plenty of identifiable headwinds for the Indian stock market but there are also some positives out there.
It is going to be so for the next 8-10 months. It will probably be a trading market. Some time early next year we will have had four-quarters of decent earnings under the belt and the market won’t really have moved. We should be positioned in terms of valuations for the next move upwards. So, with a bit of patience and trading we will come through this intact and ready for the next move.
Q: In the larger scheme of things, do you think this is a one-year pause, if things pan out as you were expecting it after 4-5 years of table thumping bullishness or do you think we have ended one leg of the run and this is not just a cyclical pause but probably a global bear market we might have entered?
A: No, I don’t buy into the global bear market thesis. I don’t want to talk about the global bear market thesis because I don’t know too much about this. It’s my job to know about Asian and the Indian stock market in particular.
The biggest risk or hurdle out here facing India and the rest of Asia is inflation. This probably needs to be dealt with. It’s going to take a while and the tools used to tamp down inflation are generally bad for equities.
So, we have got higher interest rates, and reserve requirements. But we also have increased risk of policy mistake by governments. We are in an election-intensive period right now in India, elections and inflation don’t mix well for equities. I am not lying awake at night worrying about the global bear markets. In fact, I am not lying awake at all. But if I am losing sleep it’s because of inflation in India and across all of Asia.
Q: What you have seen so far in terms of the CRR response from RBI or in terms of the kind of clampdowns on price which the policymakers are trying to affect on some sectors like steel, would those qualify as the beginning of policy errors in your eyes or not quite yet?
A: Raising the reserve requirements is not a policy error. I don’t think raising interest rates is a policy error. RBI has got out in front of inflation pretty well about a year-and-a-half ago. The food price inflation has occurred since then and not too many people saw that coming.
As to price controls and things like steel and cement, I can understand why those price controls have been put in, but they don’t address the root causes of inflation, certainly not in this country. India needs to improve its supply-side dynamics. To improve the supply-side, requires more investment and to attract more investment, one has to have a free pricing environment.
Q: What leads you to believe that we might have a re-test of those lows because inflation is a known devil now, it might persist longer than people believe? Do you think there is something lurking out there, globally or locally, which is not manifest to the market yet but might cause it to fall and go back and re-test those lows?
A: The trigger for a downward move in a trading range would probably be earnings. If you dial back a little bit, this earnings cycle peaked in December 2006 that quarter when earnings grew at around 45-50%. Earnings this quarter is going to come in at around 17-18%. can see quarterly earnings growth on a YoY basis troughing at somewhere between 13-15%. So, it is not necessarily lurking. I don’t think that we are through the earnings deceleration yet.
Equally, analysts need to cut their earnings forecast some more. That is not unique to India. It is all over Asia, and probably all over the world. So, you are looking at an earnings deceleration, although we are most of the way through it. We need to see earnings forecast get cut a little bit more. You have an election intensive calendar. There is potential for policy risk due to inflation. So, nothing is lurking. But, it is going to be a rocky road through the next nine months.
So, could we go back down to 4500? Sure. Is that the end of the world? Absolutely not. If you accept that we are in a trading range - you may not, but if you do - then you need to be buying the right stocks at the lower end of that range and concentrating not on the short-term negative news flows, but how you want to be positioned before the next big move up.
Too many people are going to be hunting for their bottoms and actually miss one of the great buying opportunities in the Indian stock market.
Q: By which quarter in India do you think we will get around to that earnings trough of 13-15% that you spoke about? Do you think in the next quarter or towards the end of the year, maybe the last quarter?
A: It is going to be one of the next three quarters. Probably it would be the September or maybe the December quarter.
Q: Do you think that 2008 could actually turnout to be a down year for the market after 4-5 up years?
A: If it is plus or minus 10% then it’s a non-event year. If it is down 2% then it is down 2%. In the context of what we have done over the last five-years, and what this market will do over the next 10-years, I don’t think a plus or minus 10% move in calendar 2008 it’s a big deal.
Q: How are you reading this current upmove in most Asian markets? From their recent lows, not the January lows, most markets are up between 18-20%. Do you believe that most Asian markets might suffer from a risk of a re-test of those lows and this is just an intermediate rally then?
A: The genesis of this rally has been an improvement in the functioning of the credit markets. It is difficult for me as an equity investor to have a day-to-day handle on what's going on in the credit markets, but my colleagues who manage fixed income tell me that things are improving there and that’s generally had a tonic effect on risk appetite. For other reasons, this move probably isn’t justified. I don’t think that the valuations are compelling yet and I do see earnings forecast getting cut.
Q: The interesting thing in this rally has been that the two biggest outperformers last year -- India and China -- have been the biggest dogs. China the bigger dog and India has done far less than many of its other Asian peers. Do you think it is a function of inflation or our relative outperformance in the previous years?
A: Let’s talk about India first. If you cycle back to the end of last year, India was about 21 times forward earnings and MSCI India in dollar terms was up around 70% in CY07. The rest of Asia was around 16-17 times forward earnings, and had delivered region wide returns of between 40-45%. So, India, both valuation and performance wise on a relative basis, was looking overstretched and probably needed to normalize.
As for China, the H-shares in Hong Kong actually started their decline in early October. India topped out in early January, so they weren’t necessarily more expensive. It’s just that inflation cropped up as a big problem in China earlier than it did in India. The H-share market had provided a pretty negative backdrop for the better part of this year. Now, they are rallying today but besides that they were down 40% year-to-date. So, it stands to reason that last year stars are going to be the dogs of the first half of this year but things will normalize. Going forward, I would still want to be overweight on China and India in an Asian context.
Q: What's the central risk to this hypothesis that we may at best re-test those lows of 4,500 but not go significantly below that? What could go wrong which might take us lower?
A: The biggest risk out there is inflation and then the secondary risks created by inflation. Policy risk is one of them. The last thing we want is any kind of capital controls or uneven playing ground in capital markets to come out of this inflation problem. If inflation is not dealt with, then the risk to earnings increases materially, in particular the risk to margins. Inflation is the most important problem that I can identify. Then, the other problems that I can identify probably would originate from inflation.
Q: What about relative valuations? How much have they adjusted after this relative underperformance of India, relative to other Asian markets? Do you think most valuation froth has been skimmed off or do we need to adjust more?
A: Yes. For China, H-shares adjusted in Hong Kong. They were probably down to around 14 times forward earnings, with forward earnings growing at 23-25% for calendar 2008. So, they were definitely cheap. They were definitely a buy couple of weeks ago. They probably still are now. In India, investors can afford to be a little bit greedy and wait for a better buying moment, probably on a slightly better valuation then where we are right now. If one is a medium- to longer-term investor, then one probably doesn’t really want to fine-tune things. This is a pretty good opportunity to get started on your buying of Indian equities and you can consistently do it for the next nine-months. You would have bought somewhere along the bottom if you do that.
Q: Let me talk about a few of the risks that you spoke about earlier. You spoke about politics a couple of times. What exactly are those policy errors that you had in mind and does politics or elections generally present any kind of an India specific risk to you?
A: I don’t want to dwell too deeply into politics were there are potential policy risks. Suffice to say that politics and inflation don’t work well and that’s not unique to India, that’s a global phenomenon. Politicians want to get re-elected and it’s a very hard to get re-elected in an inflationary environment. Consequently, people say and do things that can be negative for equities and again that’s India and anywhere else in the world. If you listen to some of the rhetoric that came out of Pennsylvania in the past two to three-weeks, one would be pretty concerned also.
So, when you talk about risks, don’t forget there are risks on the upside. Mutual funds in India are holding about 12% cash. India funds overseas have cash also, not 12% but generally higher cash levels than they normally would. Regional and hedge funds and global emerging market funds are no longer overweight on India. They are probably neutral to underweight on India. Risk appetite all over the world is very low and is more likely to go up than down over the medium- to longer-term. Indian economy is going to decelerate from say 8.5-9% growth to may be 7.5% growth.
Earnings growth will trough at around 13% and then start re-accelerating. There are a lot of risks on the upside and we shouldn’t spend our entire time on your show talking about negatives. We are going to talk about the positives. A lot of your guests, whose track records are fantastic, are generally cautious right now with one notable exception in Singapore to whom I always doff my hat. But this is not a market that you want to bet against in the medium- to longer-term. If you bet against India in the -medium to longer-term, you lose.
Q: The point of me bringing out the negatives in this interview is with this specific intention so that you can trash all of them for our viewers and they go out feeling bullish, not feeling extra bearish. I am quite sure that you’ve managed to do a bit of it. I am hoping you will do a bit more over the next few minutes. But let me bring out one of those issues which has had the market concerned, all those mark-to-market derivative losses which people think are a real threat to earnings. Is it or is it just over-hyped?
A: It is not over-hyped. They are threats to earnings or balance sheets depending on what accounting methods corporates choose to follow. The good news about these MTM losses, FX contracts, and other attempts at hedging is if management comes out and bites the bullet, takes the hit and comes clean with a mistake, the market tends to price-in the mistake and move ahead very quickly.
What you don’t want to do in times like this is prevaricate or obfuscate. It is important for people to know also that these forex hedges, other forms of hedges, and MTMs and all of that we are talking in India are also been seen in other parts of Asia also. This is not India specific.
Currency markets have been pretty crazy this year. Commodity markets have been extremely difficult for people who have them for raw materials. So, mistakes are going to get made. Deal with the mistakes and move on. Will all this affect quarterly earnings? Yes it will. This will be for the next 2-3 quarters. I hope it doesn’t go longer than 2-3 quarters. It shouldn’t. You come out and you take the hit and move on.
Q: You spoke about risk appetite and the possibility of it improving. By when do you think risk appetite improves a little bit for Asian and Indian markets and can we get a bit more by way of liquidity support?
A: I think risk appetite has already bumped off the bottom. We need to see continued stabilization in credit markets for risk appetite to improve and probably need to get through difficult news patches.
You are going to continue to see negative earnings surprises and announcements from companies over the next two to three quarters. The genesis of most of these announcements is going to be margin pressure. It is going to be people who are buying copper or labour intensive in Southern China. There is going to be margin pressure and this is going to keep a lid on risk appetite going forward. Until people are more confident about corporate earnings in India and the rest of Asia, risk appetite will be sedate. But clearly it has already bounced off the bottom.
Q: The two big themes over the last couple of years that led our markets up were infrastructure, which includes a lot of sectors and financials. Both those sectors have suffered quite a bit in this fall. Do you think something has gone wrong with these two basic core themes in India or they will bounce back with a vengeance once this phase is done?
A: The only thing wrong with infrastructure in India is there is not enough of it. The long-term fundamentals of the infrastructure in India are 100% intact. So, some of the stocks probably achieved the top end of their valuations, other companies are experiencing delays for a variety of reasons. But over the longer-term, infrastructure is an undeniably strong story in this country.
Ditto for financial services. I maintain that financial services in India are extremely under-penetrated and structurally it is going to be a very high growth sector going forward. Again, some of the valuations got ahead of themselves and that has corrected. Some companies have made some lending mistakes over the past years that they need to air out so that the stocks can move forward. But those two sectors look very good.
Another sector that looks very good, where it is difficult to invest in India, are resources. There are not a lot of pure resource plays in this country. In fact, India is a taker of resources as opposed to a maker of resources and that will have an effect on margins. But there are a couple of resource stocks in this country that you can play. In fact, the largest company in the country, Reliance is a pretty good resource story.
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- Jul 08, 17:31
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