Morgan Stanley bullish on India growth story in long-term

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Inflationary pressures seem to be affecting the performance of almost all emerging markets. According to Morgan Stanley Smith Barney's David Darst, the second half of the year will be driven by inflationary concerns. While interest rate increases by many central banks has left investors not too confident, there does seem to be considerable amount of interest emerging in these economies, he says.

Morgan Stanley Smith Barney has been underweight on India in the short-term for a couple of reasons. "One is the monetary tightening while the other is the price to book value versus the price to book ratio in India is 3.3 times which is a little on the expensive side."

However, the India growth story in the longer-term is very attractive, placing India in a very sweet spot, according to him. The service economy, the infrastructure story and the incredible demographic and structural positioning of India is positive. We view India as an investment opportunity," he adds.

Below is the verbatim transcript of the interview. Also watch the accompanying video.

Q: What is India looking like from your perch at Morgan Stanley Smith Barney?

A: Right now, we have been underweight India because of two reasons. One is the monetary tightening and second is the price to book value versus price to book ratio is 3.3 times is on an expensive side in India. India on a short-term basis would be underweight.

We still have exposure, but we would be underweight versus a normal market rating. We are overweight in China, and underweight in Mexico, India and several other countries. India can eek out as the stock market is not expensive on a price to earnings basis.

The earnings growth is about 20% this year and will be another 12-15% next year. We like those earnings dynamics. In longer-term, we see a tremendously attractive growth story for India. Consumer markets, service economy, infrastructure developments, incredible demographic dynamic and structural positioning of India is in a very sweet spot.

In longer-term, Morgan Stanley has a tremendously positive view of India as an investment opportunity. There is a lot of good feeling, grasp and engagement by our investor base of India as a growth story in the intermediate and longer-term.

Our view on RBI's rates hike by 50 bps is that it is putting them ahead of the curve which is much better than being behind the curve. The markets didn't like going down 463 points on Tuesday due to the rate increase by RBI on repo rate. In our view, it was like taking a strong medicine in the short-term so that we don't have to take stronger medicine in the intermediate and longer-term.

Q: How do you see emerging markets performing in the second half of the year? For last few weeks, emerging market performance has been slightly tricky?

A: Emerging markets performance in the second half of this year will be determined by the ability of the authorities to get inflation under control. This will allow them to begin drawing to close the interest rate increases.

The RBI raised rates by 50 bps a couple of days ago to 7.25%. Brazil is at 11.25% and Russia is at 8%. China has raised interest rates four times since October 2010.

Inflation situation is very much driven in EMs by energy prices and food prices. Some early signs which are beginning to moderate will allow the monetary authorities to begin a process of slowing down the tightening to get inflation under control.

If that happens, we have a significant overweight in EM equities relative to a normal weight. We have over double weighting in our portfolios in the US and globally.

We anticipate the growth story, attractive demographics and dynamic opportunities in EMs to continue to offer investment opportunities. It will be very dependent on the ability to get inflation under control.

Q: In the near-term, how are you tactically positioned now in the next three-four months as QE2 draws to a clause? Is there a possibility of a sharp correction in global equities and commodities? Could that happen according to you?

A: The likelihood of a sharp correction over the next few months is very possible, while the volatility is towards the lower end of the range. Volatility to us indicates a fair degree of investor complacency. The month of April was a very good month for the stock market in the US and was up by 2.8%.

January and February was positive. March was not positive and had great worries about Portugal and European debt situation including troubles in the Middle East, oil prices going up, earthquake and tsunami in Northern Japan and the Fukushima reactor.

April was very positive for the stock market. The stock market was up 2.8% in the US. Groups like real estate investment trust were up 6% in the month of April. The market is probably coming in for some kind of a breather.

In the S&P 500, it closed last night at 1,357 which is well above this resistance level of 1,340. The market has been able to penetrate on the upside and at a resistance level of 1,340. This correction can be bought appropriately as the market sells off.

Midcap stocks have done better than the US stock market. The US stock market is up 7.9% so far this year, and the small and midcap are up about 10-11% so far this year, the S&P 400 and the S&P 600. It would not be moving straight up. We have had three out of four months positive and there would be something ahead of us.

The dollar is very near its low on a trade. The dollar index includes six major currencies like the euro, Swedish kroner, British pound, Japanese yen and Swiss franc and dollar. The dollar is tempting.

Any kind of currency crises or scare would be similar to an oil shock that would cause investor psychology to create market turbulence and weakness. We would use this opportunity to buy stocks again, given the lack of any of these three conditions that would cause us to turn negative on stocks on a cyclical basis.

Q: We have not had great FII support into this market. We just got a dollop of money in the month of March. Ever since then, it has been looking quite tepid. How are you mapping the second half of the year in terms of global money flows into emerging markets including India?

A: There is a considerable amount of investor interest in emerging market. They have received a tremendous amount of positive publicity.

People are very aware due to the efforts of many investment firms in US and North America that the dynamics of the demographics and growth, banks are reasonably strong in the emerging markets.

They have reasonably good debt situations from a central government standpoint from the household debt situations. All these things are driving a greater embrace of emerging markets by the individual investors in the US.

A lot of money like USD 37 billion went into emerging market equities last year at the beginning of this year. There was some concern about interest rate increases and political developments in North Africa and Middle East.

There was concern about inflation in the EMs. Investors reduced the flows and this it is a much broader embrace of EMs than in 30 years.

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