Value alone is not a case to invest in India: Alok Sama

Alok Sama of Baer Capital Partners feels that while Indian equities certainly shone at the beginning of the year, even going ahead and outperforming many emerging markets, it is still not a base case for many global investors.

The euro region continues to be in the eye of the storm where a ton of uncertain tailwinds exist, from the Spanish and Italian bond yields, to the contagion of the Greece debt crisis spreading to peripheral nations.
His view is, if you are a global investor - the place to look for, for truly compelling valuations is actually not EMs, it’s not India, it’s actually Western Europe where you could buy high quality global companies
“If you are value oriented with a global perspective, I think there are better bargains than India. So value alone is not a case to invest in India,” says Sama. With Indian policymakers signalling a lack of leadership in the current turbulent environment, he finds investors hesitant about India as an investment safehouse. Below is an edited transcript of his interview to CNBC-TV18. Watch the accompanying video for more. Q: We have seen couple of poor reactions to the Fed statement. Do you think the summer rally is fading or do you think we can build on that as more news from Europe comes in over the next few days?
A: The FOMC seems to have mastered the art of not surprising the market perhaps on the theory that there are enough sources of volatility elsewhere. There is very little by way of surprise. The Fed's intentions have been signaled well in advance. The initial reaction was somewhat muted.
Perhaps people expected that they would announce an outright QE3 or another bond buying program, instead all they said was extending Operation Twist. But importantly they changed their language to signal that they are still on standby and they are concerned about the state of affairs in the US, the global economy and that QE3 is a possibility and the markets seem to have concluded that it’s a likelihood.
Many investment houses are handicapping the probability of QE3 in the region of 75-80%. With respect to a rally in risk assets that’s already happened. If I had to hazard a guess, the S&P would probably be a minimum 5% lower than it is today. Risk assets across the board have rallied over the last week to 10 days.
If you look at what is happening in Western Europe, with the Spanish and Italian yields which the world has been fixated on, the news there is not positive, a ton of uncertainty, tail risks out there. I would attribute the recent rally in risk assets in the eyes of market participants to the likelihood of QE3. So I think the rally is actually behind us. Q: There has been relative outperformance from India as a market compared to a couple of other sets. How are you feeling about India?
A: On India - we are up since the beginning of the year. Certainly very substantially outperformed Western Europe, outperform many emerging markets (EMs), Brazil, China etc. I don’t think India has dramatically underperformed. There have been concerns with respect to the rupee.
On the dollar basis it looks a lot worse. Talking about compelling valuations, if you are a global investor - the place to look for, for truly compelling valuations is actually not EMs, it’s not India, it’s actually Western Europe where you could buy high quality global companies, frequently very high dividend yields, discounts to book value.
There are some screamingly cheap valuations because people are struggling to come to grips with what might happen with a company like a Telefónica or Santander or Repsol, if there is a Euro break up and Spain leaves the Euro. These are global companies with minority of their assets in Spain. There is a big issue out there. If you are value oriented with a global perspective, I think there are better bargains than India. So value alone is not a case to invest in India. Q: What do you hear about the money interest because this market hasn’t seen that much in terms of outflows? Yesterday was the first day in many when there was a small negative tick on our cash market.
A: The elephant in the room is Europe and how the story with respect to Europe unfolds and the changes, volatility in risk appetite, that’s what drives flows in and out of all risk assets including but not limited to EMs and certainly to India. That’s what one needs to keep an eye on. My own views on Europe, I along with many others believe that we are at the tipping point right now.
The move towards an outright fiscal union, banking union with a very clear time table needs to be articulated to the market with a lot of conviction. I think the announcements with respect to what was done with Spain - the markets reactions are interesting. People saw through that very quickly and it’s very obvious what the markets are looking for, what the world is looking for is some very concrete moves with a specific timetable towards fiscal union.
To the degree that the market gets satisfaction on that front in the near-term, you could see a very substantial rally in all risk assets and that will extend to India. If I may draw a football analogy, which is probably appropriate in the light of what's going on in Europe right now, with India its a case of a series of own goals. The announcements with respect to GAAR, the flip flopping, going back and forth, it’s a bit of a circus to be honest. There are elements of it which are laughable and the signal to the world is that nobody is in charge.
_PAGEBREAK_
The government needs to wake up to the message in an environment where people have options. The growth picture is not as robust as it used to be. From a value perspective there are better bargains to be had elsewhere. The Indian government needs to be on top of its game in terms of coming across as investor friendly from a policy perspective, be seen as doing the right thing, to reinvigorate the investment cycle which is really the heart of the issue with respect to India.
If that happens, you have the potential for an extraordinarily powerful rally because the growth picture may not be as robust as it used to be, but it’s still out there. So there are enough reasons to invest in India, but at this point there are probably more reasons not to invest in India than the other way. Q: If you were to talk about what could go wrong, what is the extent of the downside?
A: If you want to talk about the downside scenario with respect to India and to equities and risk assets across the board, in a probabilistic scenario, the likelihood of an outright break up of the euro zone say Spain or Italy leaving the euro zone, an outright banking crisis, things being somewhat out of control, people would handicap that right now.
It’s somewhere between the optimistic outlook would be 10%, the more pessimist outlook would be 50% and most people are somewhere in the middle. I would handicap that as a 20% outcome. If that happens, then you are talking about a 25-30% decline in markets across the board including India. Nobody is going to escape that as it is a truly dire scenario. That will make the Lehman crisis look like a side joke.
That is a truly cataclysmic event and that is part of the reason we have tended to be defensive and that’s part of the reason you see risk aversion. You have had a nice little boost in expectations of QE etc but that tail risk is still out there. I think the consequences of that for equity markets could be dire.
I don’t think it's going to happen, I think that’s a low probability outcome, say 20-25%, but 20-25% risk of a 20-25% decline in equity markets that’s not a trivial risk but a very big deal. I would be very cautious right now. Q: Any thoughts on the rupee which has hit a fresh all time low this morning? How is it going down with global investors like you?
A: I thought 56 was a reasonable level for the rupee at this point in time and I still think it's a reasonable level for the rupee. Other EM currencies have actually rallied by 2-3% over the last week, again, a function of expectations on QE3. The rupee is actually going the other way, immediately following the announcement on the part of the RBI not seen easing the monetary policy. It's all a function of people's attitude towards India and that's where the issue lies.
I think the country has serious PR issues and it's not just as shallow as that. People would like to see some concrete steps that demonstrate that there is a centre that's in charge, that’s business, investors friendly and until we see that, there are real issues with respect to inflows into India. Q: On that RBI issue were you surprised by the fact that they didn’t choose to move and has that changed the way you are approaching rate sensitives?
A: I would say we were modestly surprised not shocked because the RBI has been doing its bit, they were ahead of the curve in terms if cutting rates earlier in the year. I think what people haven’t focused on is the magnitude of QE in India.
The RBI has been actually if you look at the quantum of bond buying by the RBI, for the first 2.5-3 months of current fiscal year is equal to 3.4% of GDP and if you compare that to QE2, the Fed in the entire calendar year 2011, bond purchases were equal to 3.8% of GDP. So RBI has been doing its bit in terms of benchmark rates and QE, in terms of impact they have had on interest rates. And inflation is still out there. It’s a classic stagflation kind of environment.
You have a growth recession, you have inflation that’s out there. There is a good parallel in terms of the ECBs announcement where a lot of people expected the ECB to ease lower rates but it didn’t. The point that Draghi made, which I think is the same point the RBI is making, is - look, we have got issues but there is only so much monetary policy can do. The initiatives that need to be taken, the responsibility lies elsewhere with the centre. Q: Crude has really been the single best factor for the Indian markets over the last month and a half.
A: Crude is going to be the function of three issues, one is what's happening with the dollar, since it's in dollar term so more QE3, massive QE3 means that it has an impact on oil, oil become expensive. It is very much a function of the global growth picture.
To adegree you have seen moderation in oil prices which is a function of people moderating their expectations with respect to growth and the third piece which is much more complicated is supply bottlenecks and there's a fourth which is the geopolitical damage of what's happening with Iran.
So it's a fairly complex calculus with a lot of sources of volatility. I think oil if you had to reasonably assume, if you had to balance all these, something in the area of USD 110 is a reasonable level which is not the greatest outcome from an India perspective because the pressure on the Balance of Payment (BoP) is here to stay.