India's growth supports current valuations: JPMorgan

Excerpts from Your Stocks on CNBC-TV18 Watch the full show » RELATED NEWS Mkts may dip in Oct, rally again at yr-end: Marc Faber Volatility will be the theme for next 2-3 yrs: Religare Cap Mkts may pause on soft global cues ALSO READ See what other FIIs are saying about the markets See what other experts are saying about markets See what Udayan Mukherjee is saying about the markets

The US markets are far from encouraging and global economic data is expected to be very mixed, probably on the softer side, says Adrian Mowat of JPMorgan. Speaking about the US concerns, he said the S&P 500 is likely to stay in the 1000-1200 range and US's reluctance to create new jobs is worrisome. An improvement in the US employment data will lead markets higher, he said.

Among the emerging markets, India offers a good growth story. When asked if stretched valuations are a concern, he said, one needs to look at a market vis-a-vis its growth and "Indian valuations are appropriate relative to its growth." Mowat expects a 25 bps repo rate hike in the next RBI policy.

Below is a verbatim transcript of his interview with CNBC-TV18's Sonia Shenoy. Also watch the accompanying video.

Q: After the kind of global economic data that we have seen in the last couple of weeks, how do you think market like ours should react to that?

A: Unfortunately we are going to be in a period of time when economic data is going to be very mixed probably on the soft side. We are expecting the S&P to still be stuck in this range between 1,000 and 1,200. Market will be very focused on the employment data and we are concerned that despite quite high profitability in the US, the US businesses are very reluctant to create new jobs.

If we see an improvement in the employment data that will help the market to move higher, if that deteriorates, the market will move lower, although we doubt it drops below a 1,000. If you look at the spread between the yields on investment grade bonds versus the earnings yield on the market, it is a record high and that is leading to M&A activity and it is also leading to share buybacks.

The message from the developed world is we have bounced in, we have got relatively lower growth, declining core inflation and that is difficult for the developed market. I don't think it is a particular threat for emerging markets, particularly India which offers both growth and inflation.

Q: The issue that the Indian markets have been dealing with for a while now has been stretched valuations. Nevertheless we have seen that rallying in the last couple of trading sessions belying all of that. Do you think we will carry forth this kind of move of a slow and steady upgrade despite the kind of valuations that we are dealing with?

A: We need to put India's valuations into a global context. We have record low risk free rates and we have a chronic shortage of growth. When I look at emerging markets, where I can find growth, I am paying high valuations. The types of stocks that we are recommending in China are in the mid to high 20s. I find Indian valuations look perfectly appropriate relative to the growth opportunities within the markets.

There is always a danger if you think about the market from a country perspective that you miss the relative opportunity, you miss the fact that we are seeing strong foreign institutional inflows (FII) inflows because they find this market offers good growth and the valuations are acceptable.

Q: Apart from that there is a huge supply of paper as well that is expected into markets like ours in the next six-seven months time. How much of a hindrance do you see that to the way our markets are moving or rather the trajectory that our markets will see from here?

A: If you do a back testing of which markets performed well when you are seeing large levels of equity issuance, you often find that the best performing markets are those with significant amount of equity issuance. You cannot simply say that we are going to get lots of capital calls and the market is going to do badly.

What matters is do the macroeconomic fundamentals continue to track, is people's appetite of risk still on track and are we being offered attractive investment opportunities. If those conditions are in place then I wouldn't worry too much about capital calls for the next twelve months in the Indian equity market.

Q: A lot of people are talking about how domestic growth would be a marker for us in terms of outperformance in the entire emerging markets or even the developed markets lot. How are you reading into the consumption sector in our markets and how much of that would contribute to an uptrend from here?

A: Consumption is already robust in India. The question is are we going to see a big pickup in companies investing, in acceleration, infrastructure activity, Judging by the anecdotal feedback from companies, they had been reluctant in 2010 to add capacity because of their concerns about the global outlook. But we are now seeing the capacity shortages in India and so we would expect businesses start to accelerate investment going into 2011.

If we look at the leading indicators for infrastructure such as the order backlog at the major engineering companies, those would also indicate that we will see an acceleration and investment as we go into 2011. The final factor I would look at is global bond markets. We are seeing record low borrowing cost for emerging market companies in the US dollar bond markets. That should also be good leading indicators of capex. India has an accelerating economy going into 2011 and we may see in 2011 that the Indian economy grows faster than the Chinese economy for the first time.

Q: You have been a little cautious about the way the commodity sectors are shaping up, not just globally but in India as well. How much of a correction if at all do you anticipate in the commodity sector now in the BRICs (Brazil, Russia, India, China) economies as well as in developed markets and how much do you see us pegged that by?

A: What we have got in the commodities space is a rather unusual price movements occurring. We are seeing global leading indicators rolling over. Chinese steel production is falling month over month, yet commodity prices have held up reasonably well and that seems to be because of the bid from the financial investor. If the financial investor starts to reflect on the Chinese economic data on how the Chinese economy is rebalancing that could cause them to start to redeem their positions in commodity exchange-traded funds (ETFs).

If that was to occur, I think the correction could be very sharp in commodities. It could be quite deep. Let us not forget that in 2008, we watched the oil price move from USD 140 per barrel down to the mid 30s in a two month period. If you have the financial leverage in these commodity markets, you can see some very deep, rapid moves.

That would lead Indian equities lower as with other equities, it would be fundamentally a very bullish event for India. We would worry less about inflation, about the current account deficits and India would be in a better position to add more infrastructure at a more attractive price.

Q: What would be a defensive bet then if such a correction does occur in the commodity space?

A: I think long India, short emerging markets or short the BRIC index would work well because Brazil and Russia would clearly underperform in these types of environments. You may also want to be long Indian IT companies because if we were to see short-term capital outflows as you saw redemptions in BRIC funds, then the rupee might weaken a bit and the Indian IT companies would be well positioned for that. On a fundamental basis, being long manufacturing companies would see an improvement in margins as their raw material cost fell, those should relatively outperform as well.