The European crisis have weighed over global markets for quite some time but, Adrian Mowat, Chief Asian & Emerging Equity Strategist at JPMorgan believes China is more concerned about earnings. He also added that Japan is outperforming due to the encouraging statements made by Bank of Japan. Going forward, he expects this outperformance to continue.
Mowat told CNBC-TV18 that the Indian market is performing in line with other emerging market economies. But, it will be difficult for the government to meet its divestment target, he opined.
At the moment, Mowat is overweight on India and sees good returns over the next twelve months. According to him, policy and governance issues are likely to be key risks for the Indian market.
Here is the edited transcript of the interview on CNBC-TV18.
Q: Market seemed quite nervous about the news flow that might come through from Cyprus as also the political noise one has been hearing from Italy since last evening. Are you getting the sense that we could be headed for a sharp cut around these news events?
A: I do not think so. I would argue that the market in China is more concerned about the end of the results season. They are not really sure what to look forward to. The banks came out with good full year results, but it is quite likely that Net Interest Margins (NIM) and credit costs are going to be in the wrong direction in the first quarter results, which will be out within a month.
With regards to Japan, it is a market that has had an extremely powerful rally. The Topix was up 22 percent quarter-to-date when we started this morning. So a little bit of profit taking cannot be ruled out as we run into the Easter holidays. It seems quite reasonable. I am actually surprised how little discussion I am having with clients, with regards to Cyprus.
Q: How do you read all these moving elements? This year has been extremely different from equities than what we have seen in the past. There is the US and Japan which seem on track to making new highs for themselves. The eurozone is in a mess and Asia has been quite disparate as have been emerging markets. Is that the trend you think we are going to live with this year that no two markets will move in the same direction?
A: The environment is beta poor in emerging markets, but alpha rich. It is important to understand what exactly is going on here in these major markets. In the US market, we are seeing a high level of buybacks. It tends to favour companies with more stable earnings and that is why staples have been outperforming.
We are also seeing leverage buyout transactions such as what is going with Buffet buying into a large soup company. He is borrowing at 3 percent, buying a company with steady earnings and an 8.5 percent pre-tax earnings yield. That is the support for the US market. With us likely to have zero interest rates well through 2015, I see no reason why that should change.
We were optimistic about what is going on in Japan. I would expect Japan's outperformance to continue and what we are finding in the large emerging markets is that people are confused by policy in Brazil, Russia. Sentiment on Russia is particularly low and maybe that is more directly affected by what is happening in Cyprus. They are confused by policy in Brazil. They are looking at Korea and Taiwan and saying these are the countries that suffer as the Yen weakens.
Hence, large cap EM is out of favour but smaller EMs like Thailand and Philippines are outperforming the US and Japan. That is because they have got a very good economic momentum. We have just upgraded Malaysia at the beginning of the week. We like that story with healthy domestic growth, both for capex as well as consumption. So there are things to do here, but they tend to be in the smaller parts of the benchmark.
Q: The Indian market has underperformed and delivered negative returns from the start of the year, but the money has not given up on India yet. At the close of this month we have got another Rs 9,000-10,000 crore from the Foreign Institutional Investors (FII). Are they being patient? Is it a tactical move? How do you read it?
A: India has performed in line with the emerging markets. Judging by the moves today, it may actually finish the quarter a little bit ahead of the emerging market indices. The market is down, but EM is down as well. So it is not an underperforming market.
The way we look at it is we see India as having a very tough start to the year for the economy. The consumers are dealing with higher diesel prices. Petrol prices have moved up quite a lot in the last six months. We have a relatively austere Budget. All of that argues for disappointing economic data and disappointing earnings.
We would view any weakness as a great buying opportunity. India’s risk premium is going to fall a lot over the next 12 months. The current account and the fiscal deficit is moving in the right direction. The central bank is cutting interest rates and maybe they will continue to lean against this fiscal discipline, fiscal austerity. If we look at governance, the cabinet’s board on investment could be very important in kick-starting capex.
They have already approved a couple of projects. There are still many more that they can get their teeth into. The final thing we would highlight is technical. We have seen a lot of insurance companies selling the equity market. We think that will probably dry up in the first half of this year.
Q: Part of that is to raise capital in order to provide capital again for the government's divestment process. How have you read that? Do you think that is sucking out some momentum from the secondary market itself?
A: People are very cynical about divestment plans. In the 20 odd years I have been looking at India, I struggle to remember a year where they have ever got anywhere near their divestment plan. If they get near their divestment plan the market would be positively surprise. It would help the fiscal deficit and in helping the fiscal deficit it would help the risk premium.
Q: The problem with India is that it is tough to see where all these negatives trough out. We are headed into April which is likely to be as ugly an earnings season as we have put behind us the last quarter around. We are due to get a Current Account Deficit (CAD) figure today that is probably going to be upwards of 6 percent. At what point would you say the market or the economy is primed for that trough after which or around which the equity market can begin to make some kind of upmove as well?
A: Investors should look ahead and think about how this economy is going to feel in 12 months time. If the data is poor then that provides you with a buying opportunity. We are not about pricing in history. We are thinking about pricing in the future. The history is bad in India, but the future is definitely looking brighter.
Q: Tactically, would this be the point where you start buying into the market?
A: Absolutely. We are overweight India. We think India is going to give us a very nice return over the next 12 months, but we would like to buy into markets when they have weakness, so we can get a better book cost and we would like to think about how the conditions are going to change and they are going to change very favourably in India.
Q: Are you working with a target for this market that has gone undone in the first few months compared to what targets people had set for India?
A: My general view is index targets are pretty pointless. They are not very helpful in making good investment decisions. They tell you more about people’s assumptions on discount rates. My view is the economic conditions in India are going to move from being very poor to improving throughout the next 12 months.
As that happens, the Indian equity market is going to move higher. If US equities are doing as well as they are, then perhaps the upside will be even greater.
Q: What remains the central risk to performance in that case? Is it something going wrong with the global environment and hence a sucking out or a halt in terms of flows? Is it political development, something that has seen a flux these last few weeks or do you think it still boils down to the macros and disappointment on that front?
A: There is a very clear message throughout the emerging markets. It is all about local fundamentals. The underperformance of the large EMs is because of a deterioration in local fundamentals, earnings revisions. Within India, I would view the risk to this is if the governance environment fails to improve, there is a very narrow window for the cabinet board on investment to act to push forward these projects.
We need to get the Land Acquisition Act passed within the current Budget session of parliament. I see it as politics and the effectiveness of the government as the biggest risk to our view.
Q: Two sectors have traditionally had extremely high FII exposure. One is the banks which have been through a bit of a confidence crisis in the course of the last month and the other is IT where exposure and weightage is quite high. But, there is some nervousness about earnings bearing through.
A: What we are seeing out of US is pretty decent, durable and goods numbers. The consumers are holding up much better. Indian IT companies are primarily exposed to the US economy. At a macro level, I am reasonably comfortable with the story.
With regards to the banks, if we are right about the Cabinet Committee on Investment (CCI) working, then that should stimulate the amount of capital that is needed in this economy. It should be good for the banks and maybe help them trade away from the stigma that they have been caught up with regards to these accusations on money laundering.
Q: The one thing that has held this market out so far this year is the support we have got from flows as we have discussed earlier. What do you hear from that front? Most of the money seems to be routed through Exchange-Traded Funds (ETF). They are emerging market specific, not so much country specific. Is there still money coming in there? Are people beginning to lose patience with markets like India?
A: I am a great believer that flows follow fundamentals. I am confident that the fundamentals have been moving in the right direction. As a broad statement, we are seeing inflows into both developed and emerging market equities and typically into actively managed funds rather than ETFs.