See earnings downgrade; multiples need to fall more: HSBC

Valuation for Asian markets should be lower than what they were in the past, says Herald Van Der Linde, Head of Equity Strategy, Asia-Pacific, HSBC. Price-to-book multiples need to further contract, he says.

Over the last couple of months, India was the biggest overweight in mutual fund positionings across Asia, he says. That situation has changed. Now there is an overhang on Indian positioning which needs to be washed through the system, he adds.
He feels earnings will be downgraded soon and even though right now India is trading at fair multiples, these need to come down further before India starts to look very cheap.
Van Der Linde is more concerned about the downtick in growth in India, than a  sovereign downgrade. He feels China can provide some support, especially to countries from where it imports the most. But unfortunately for India, it does not export much to China, he adds. Below is the verbatim transcript of Herald Van Der Linde's interview on CNBC-TV18 Q: We have seen significant reduction in stock prices, you have spoken about the rise in the cost of capital coming at a time when Asia’s return on equities are getting compressed or in a structural decline but have values compressed enough or do you think that you are going to see much more seminal fall?
A: You are right. The rise in cost of capital, which of course is very visible for India demand, comes at a time when across the whole region India is not an exception to that return on capital comes down. So that means that in the future, valuations for Asian markets should be lower than what they were in the past. Price to book multiples need to further contract.
So structurally that puts Asia in a very difficult situation. In the near-term also a bit of an overhang maybe for India if that - we do some detailed work on mutual funds holding and we see how mutual funds have positioned their money across the different countries and market.
India has been an overweight over the last couple of months and quite a big overweight until the beginning of August, I think with the exception of Philippines which is a relatively small market, India was the biggest overweight in mutual fund positionings across the region. That was to a certain extent a reflection of worries in China and Korea.
Therefore India although it didn’t do as well and the domestic growth environment looked like weakening, it wasn’t that bad for example China and Korea. That situation has changed or in the near-term, you have this overhang on Indian positioning as well which needs to be washed through the system as well. Q: You were speaking about valuations, 14.5 times is the average valuations, what might they get compressed to, 11-12 or sharp buying sometimes in a swing happens only when it goes to even as bad as 11-10, do you think it can get that bad?
A: It doesn’t have to be that bad but I cannot rule out that particular possibility. We have to see how things work out. I suspect that across the region - and India is no exception to that – we are going to see downgrades in both those from economists and later from corporates and I think Vineet Bhatnagar was talking about IT sector that even the export sector there should see probably some pressure from contract renegotiations there.
So we are going to see earnings to be downgraded. So the strength of falling probability will further accelerate. I think that India started trading at fair multiples quite recently and we need to see multiples come down much further before we can say that India starts to look very cheap. Q: How high is the possibility of a sovereign downgrade coming in for India very soon because persistent talks of that has spooked investors in the last couple of days?
A: I am not 100 percent sure about this to be extremely frank but from an equity’s point of view, I am not quite sure how extremely relevant that is. I think it is a credit market situation. What I am a little bit more worried about is the downtick in growth in India. Across all Asian region, one sector we haven’t looked at, that markets haven’t been focusing on is China.
We have seen very early pick up in economic momentum in China, the IIP numbers came out a little bit better, PMI came out a little bit better quite recently and China could act as a bit of a stabilising factor in these Asian markets in particular to the countries that export a lot to China if this continues over the next couple of months and that would be Korea, that would be Taiwan. Unfortunately for India, India doesn’t export a lot to China, much more to the Europe. So I think they are still putting it to be a downside risk to growth and that needs to be factored into the equity markets. Q: In your note you say that Fed tapering has been a sell trigger across Asian equities but policymakers' response is important. What would you want to see in terms of policymaker's response in India?
A: We can go in detail about what we need to see. I can give you a couple of examples for that. But I think the difference between what economists would argue is an appropriate response and let us put a group of policy measures, a country like India could make.
Then on the other hand you have the politicians who have to decide what they would like to see is not necessary overlapping of what the economists would propose. India could propose broadly speaking I would say measures that would stem the outflows and increase inflows of capital in FDI opening up markets etc but it needs to be doing in such a way that it is very credible that this will continue also if you have new government after your elections next year.
So even if they would announce something like that, it might be very difficult for markets to see how that would be implemented because you have a new government next year and we have to see what they think about these proposed measures as well. Broadly speaking these measures need to attract more capital.