Credit Suisse underweight on India, but remains constructive on RoE perspective

“If we look at the Asia-pacific region for the whole, the consensus has picked up to 15 percent growth in the region. The last time we had double digit earnings growth for the region was back in 2010,” explains Siva.

Commenting on global markets, Siva said US President Donald Trump is a major risk factor and if there is any correction due to his policies in the region, it could be an excellent opportunity to buy.

“What drives markets is RoE and in our view, this has been the best fundamentals in 6 years. For 6 years RoE in Asia pacific has been coming down and thus time we have seen first signs of improvement,” said Siva.

She further highlighted that we are starting the year with earnings upgrades after 6 years which also makes us confident on the Asia Pacific region.

Commenting on US Federal Reserve stance on the rate hike, Siva said that any hike by the US central bank is not good for emerging markets. “There will be a correction after US Fed hike, but you should buy on dips,” she said.

“The other phase when the Fed hikes but the real fund rates are actually negative. This is when the policy is accommodative and becoming less accommodative and this is the period which I think is good for EMs and we are currently in that phase, added Siva.

Below is the verbatim transcript of the interview.

Q: I do not know how much you know, but there is a huge fan following for your calls as far as emerging markets and India is concerned. First question which probably even your investors have been asking you off late, why underweight India?

A: I would think for the region, it is actually the best return on equity (RoE) fundamentals in 6 years and India actually does have improving RoE, so we are constructive on India from an RoE perspective, but the reason for our caution and the reason for our underweight in India is we think a lot of this is already priced in. So, if you look at India RoE has actually risen by above 1-2 percentage points from the low and that is as I said our theme for the year. But unfortunately, what we think is already being priced in is something like a 19 percent recovery in RoE so what I emphasise is really a valuation call so it is not that we don’t agree with RoE improvement and whatever, it is very much a valuation call.

Q: While everybody debates that valuation for India at 17-18 times forward earnings look expensive, but the flip side to this is there is an argument that the earnings are going to pick up in the second half of this financial year is that something which you are of doubt that earnings will not actually come up for India?

A: We think earnings will improve, but our argument is earnings are improving across the region as well and there are markets that are not pricing is as much of an improvement in earnings. So, if we look at Asia Pacific region as a whole the consensus has now picked up to a 15 percent earnings growth for the region. Remember for the last three years earnings have only averaged around 2 percent. So, 15 is a huge improvement and the last time we had double digit earnings growth was back in 2010.

So, again it is not that we are not positive on Indian earnings it is just that we think that a lot of other markets are also seeing improvements in earnings. So, India’s RoE is rising but so is Korea’s RoE, so is RoE in Australia, Taiwan and even if we look at MSCI China if we exclude the financials RoE also starting to pick up.

Q: The big sector call that I read in your report off late is that you are looking to advise clients to buy the cyclicals especially in Asia, what is the view there and probably what are the key themes that you think investors should look at?

A: We are still keen on cyclicals; a lot of clients have been worried that rally in cyclicals has been quite a lot, has been quite large, cyclicals have outperformed defensives by over 20 percent over the last 18 months. So, some clients are saying maybe there is lot of optimism about Trump and his policies already being baked into the cyclical prices.

Our argument is that if you feel that the cyclicals have run high instead of buying defensives maybe look at a switch from some of the North Asian cyclicals which have done particularly well to some of ASEAN cyclicals which have actually been kind of laggards. So if you look at North Asia, cyclicals have actually outperformed defensives by as much as 35 percent. In ASEAN the outperformance is only around 10 percent.

So, in December last year one of the big changes we did was to take a little bit of profits in some of the tech stocks, we are still overweight but we took a bit of profits in some of the North Asian tech stocks and we have actually been adding some ASEAN cyclicals which haven’t done at least as well as the North Asian ones.

Q: A word on the Trump policies and the global markets because last year they saw two unprecedented events in terms of Brexit in terms of Trump victory and still the global markets have rallied pretty hard. In that context how are you mapping up the global set up and what this could mean for emerging markets like India?

A: I still consider Trump as a set of major risk factor, obviously the border tax which we have heard a lot about is a source of concern. But we are also saying on the other side as I said domestic fundamentals and our view is what drives market is actually RoE or return on equity and in our view this is the best RoE fundamentals in 6 years. For 6 years RoE in Asia pack has been coming down and we are now seeing the first signs of what we call an inflection or turning point.

So, we are kind of trying to advise the investors that we get a pullback because of Trump’s policy whether it is a border tax, or tariff or protectionism then also focus on the fact that it could be a buying opportunity given that we are seeing this inflection point and as an Asia Pacific strategist we have been waiting for 6 years to see this inflection point. So, we are highlighting best earnings growth since 2010. First pick up in RoE since 2010 and the other real surprise has been this year we are staring the year with earnings upgrades. Again the last time we saw that was 2010.

Q: Even last time when I met you at this conference and we spoke about the markets and all the one big theme you had was some sort of global commodities cycle and the commodity plays. I guess one of the big call last year for you in that model portfolio is Hindalco and that has actually given 4x return in the last one year itself. From a global commodities point of view what is your view there and you think there is still money to be made in some of the global commodity plays?

A: The commodity stocks have done very well, so potentially going forward the upside may not be as large as last year. We have been a bit more kind of saying buy the pullbacks, buy the dips rather than just buy the cyclicals. Our argument on commodities and the reason we like commodity stocks was not actually because of Trump. If you remember last year my argument was that we are seeing supply cuts so our argument has not been focused on demand rising our focus has always been that because of pollution because of policy and because of I guess funding, China is actually kind of cutting back on supply. So we are still of that view. We are happy to buyers of the dips.

Q: Big call from the whole Credit Suisse, whether it is Neelkanth Mishra or whether it is you, you all predicted the big slowdown in terms of supply from China and that actually helped a lot of the commodity stocks. In fact Neelkanth tracks commodity stocks very closely, he has been bang on as far his calls in the Indian commodity stocks. The other interesting part of your report was that typically you have seen when Fed rates hikes it helps emerging market sentiments and in terms of flows as well. Will you just explain that rationale ones?

A: The question is you need to break up the Fed hike actually into what I call three phases actually. So, going into the Fed hike is actually not positive for emerging markets, we tend to normally see a correction in markets going into the Fed hike and if you recall going into the first hike in December of 2015 we did get a correction. So, the first part I always say there is a correction but we should buy the dip. Then there is a second phase when the Fed hikes which is when we call it the real Fed fund rate is actually negative. So, this is when policy is accommodative and becoming less accommodative, this is the period where I think is actually very good for emerging markets and this is the period that we are currently in.

So, if you look at the real Fed fund rate today, it is about minus 0.5 percent. So, we are still in negative rates, we still have policy that is accommodative. The part that is very negative for emerging markets is when the real Fed fund rate is above 2 percent. Depends on when we think we are getting towards restrictive policy. So, as I said, we are still at minus 0.5 percent so we still thing there is upside, there is still room for markets to go up.

Q: What, to your mind, could be the key risk for emerging markets equities in 2017 because India has rallied pretty hard, some of the emerging markets have rallied pretty hard in the last 2-3 months, in the last few months? Broadly, what to your mind are the key risks that investors should watch out for?

A: The key risk still in the short-term is still with Trump now saying after healthcare has not done well, he is going to focus on tax. I still think less over India, because India is more domestically driven, but some of the more export driven markets like Korea which and Taiwan which we are overweight, that is still the key risk. And obviously, I guess beyond November after the politics, the congress in China, then there is also a risk on China, but at the moment, the Chinese numbers are looking good. So, that is not so big a risk at this point. But that could obviously change as well down the track. So, shorter-term, we think is actually not the Fed because the real Fed fund rate is still negative. So, shorter term, we think the key risk is still Trump and any protectionist policies that come out as a result of that.

Q: In that four expensive basket, you classify the two baskets, the four cheap and the four expensive, in that four expensive, India is probably at the top of the four countries that you identified. Still you have got some exposure in the model portfolio of some of the cyclical Indian stocks. So, two part question. How much downside risk do you see for the Indian equities given that it is so expensive and there is a risk of earnings not coming through and how are you tactically positioned in terms of individual stocks in the model portfolio, as far as India is concerned.

A: We are underweight India, so that means, because we are constructive on markets, it is not that we think India is going to fall. Actually our view is that India is likely to rise by less than the other markets. So, if you look at the expensive four basket, India has done well, but we look at the basket and the other three markets which are in the expensive four, Indonesia, Philippines and Australia have underperformed. So, the basket as a whole has actually underperformed by around 3 percent and the cheapest four which is Korea, China, Hong Kong and Singapore has actually outperformed. So again it is difficult to get every market right, but our argument is that if you overweight the cheapest four and you underweight the expensive four, you have pretty much consistently added alpha over the time period.

Q: I know within the cyclicals you have tried to play some of the IT stocks and some of the commodity stocks in India. Has that been pretty much the portfolio construction in the last one year or have you looked to change a little bit after a big rally especially in commodity stocks in India.

A: In terms of the regional portfolio as well as in India, our focus has actually been on cyclicals and within cyclicals actually on tech and materials, that has been our two big overweights. The other sector that we also like is actually financials. So we also have a fairly big overweight within financials in the region. The only real big change as I mentioned, that we have done over the last three to four months is to take a little bit of profit in the North Asian cyclicals and to add a bit of the ASEAN cyclicals. So, not many changes beyond that actually.

Q: When you spoke about financials and India has a very large share of financials in the index as well. And that is one big barometer of how the economy is performing. Anything that stands out within the Indian financials that you probably have in the model portfolio.

A: I think because the Credit Suisse team is still fairly cautious on the Indian financials, we actually do not have, we are not recommending Indian financials, but we like financials in Korea, in China even in Indonesia, Singapore and so on.

Q: The one big call that I got from Neelkanth last week is that he has turned bullish on the Indian technology stocks. I know there are a couple of stocks that you hold in your model portfolio as well, but broadly, from an Indian tech point of view, is there a view that you hold which probably is pretty much in line with what Neelkanth's view is?

A: We both feel that with a pullback in Indian IT, it looks interesting, but we are overweight tech. And it is not just Indian IT, we also like a lot of Korean tech stocks, Taiwan tech stocks as well which actually the problem is the other side. They have actually done so well that, as I said, we have been taking some profits in some of those names.

Q: I asked you this question last year as well. What will make you bullish on India? I know you are underweight India, but what will make you overweight India in the medium to near-term?

A: As I said, the reason for the underweight call is valuations. So if valuations correct, we are happy to overweight. People forget that India was one of our biggest overweights after the taper in 2013. Certainly was a big overweight. Asia was our biggest overweight market in 2014 prior to the election. And as I said, Indian ROE is picking up nicely, so the fundamentals are good. It is just a question of valuations.