Earnings at risk from slower GDP growth: Morgan Stanley

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Q: How do you read the whole emerging markets situation right now?

 

A: Global risk appetite has been tested very severely in February and we did see markets kind of getting sold off, various issues happened on subprime mortgages in America on the growth data in the US, on the Yen carry trade, Shanghai Stock Exchange. A lot of it is behind us right now, but to me it appears like kind of a lull before the storm because we have still not settled some of these core issues.

 

We have not settled the issue on growth in the US, I don't think we are done with possible inflation risk in the US and the Fed Chairman has been trying to warn the market about this. The market seems a bit more complacent than it should be. We are also not done with the possible slowdown of growth in China.

 

So these issues looming large and will have impact on these risky assets as you go forward. 

 

Q: What about flows? There doesn't seem to be any great desertion of India though from the global funds after this fall?

 

A: In fact, we have seen a big reversal of flows even in the emerging markets universe. Emerging markets did go through three-four weeks of outflows and it was all back up again last week.

 

India has been quite favoured, I have to put this into context just before the February 8 peaking of the market, in the 19-20 weeks prior to that emerging markets has received record inflows. India actually did not receive its proportionate share; very different from the way it was happening two-three years prior to that.

 

So there was clearly a slowdown just from an EM perspective and I will not bring in the structural change discussion here. The composition of flows India has seen because we see a lot of dedicated money that's coming into India, a lot of global money that's coming to India and therefore EM money per se is losing its significance.

 

But the point to note is that India did not receive its fair share of EM flows and what it has received since February 8 is far in excess of what emerging markets has received. So one takeaway is that there is a change in terms of India's dependent on pure emerging market flows.

 

The second is my conclusion is that investors appeared to be a bit complacent about the risk that are there in India. So the markets corrected and they have come back to buy the markets right away, very different from May '06 because in the sixth week after the May '06 correction which is where we are with respect to the Feb '08 peaked. This time around investors actually had purchased and I am referring to foreign investors, who purchased on USD 200 million of stocks net including cash in futures. This time around the number is around USD 2 billion.

 

So investors, I think are being a bit more complacent this time around about the risk factors that India faces.

 

Q: What's your assessment of fair value and where do you see this market trading?

 

A: Fundamentally on residual income model, the fair value is around 11,500, which is really a December '07 target that we have. In the meanwhile, it's quite possible that the market goes below the fair value. The fact is that it has traded above the fair value for several months, so there is no reason not to believe that  it can trade below fair value.

 

I don't think it's getting there tomorrow morning though. I think the market will go up and down; my view is that volatility is going to be a lot higher and buying volatility should be a good trade for investors generally speaking. But we are basically heading lower rather than higher in the coming months.