Bonds mkt more attractive than equity at this point: HSBC

In a scenario where bond yields are moving higher and currency is weak, foreign investors have a great opportunity to enter the debt market, points Philip Poole, Global Head of Macro and Investment Strategy, HSBC Global AMC.

"It is a bit more problematic from an equity perspective because equity markets, not just in India but in emerging markets generally been suffering because of some weakness to growth," Poole said. In addition tightening monetary policy is also not in favour of equity markets. Calling RBI's measures to curb a voltality in rupee a step in a right direction, Poole said that the central bank is being forced to tighten liquidity on currency pressure. On late Monday evening, RBI released series of liquidity measures to clamp further decline of rupee. "I think it is the right thing for the RBI to be doing because otherwise the inflation risk will be rising," he said. He further added that market expectation of interest rates eventually coming down has now vanished. "Even though the entry point from a currency point of view is interesting, it is less of a straight forward story for equity markets, much more of a bonds story," he concludes. Below is the edited transcript of his interview with CNBC-TV18: Q: How are you reading these measures? You will now rethink brining money into Indian equities; you were expecting earnings per share (EPS) downgrades? A: The reality is the Reserve Bank of India (RBI) is being forced in a sense to tighten policy because of pressure on the currency. We have seen a lot of money flowing out of India and in bonds in particular. This is not the only market where it has happened because when Bernanke triggered this tapering concern, we have seen money flowing out of emerging markets (EMs) bond funds and India of course has suffered from that. On top of which India has a size of a current account deficit so that needs to be financed and in this environment we have ended up with tighter policy. I think it is the right thing for the RBI to be doing because otherwise the inflation risk will be rising. We have already seen the impact on fuel prices, on inflation and so it is exactly the right thing to do, exactly in a way what Brazil is being forced to do, what Indonesia has been forced to do, where pressure on the currency is a threat from inflation perspective. But of course it is going to take its toll, there is always going to be an impact and its going to be an activity, if anything it will be weaker in the short-term rather than stronger. Q: Therefore how will you respond as an investor or how do you foresee investors responding. Do you think foreign institutional investors (FIIs) equity funds are going to see outflows or at least a stoppage of inflows or do you think FII debt funds could see sizeable inflows? A: Considering the fact that bond yields have moved up and the currency is weak, this is an interesting entry opportunity for foreign investors to enter into the debt market. It is a bit more problematic from an equity perspective because equity markets, not just in India but in emerging markets generally been suffering because of some weakness to growth and if monetary policy is being tightened, it is not going to help.  The market had an expectation that interest rates eventually will be coming down maybe even in the next couple of months. I think that was overdone in the case of India but now expectations off the table. So, short-term even though the valuations are relatively attractive, even though the entry point from a currency point of view is interesting, it is less of a straight forward story for equity markets, much more of a bonds story. Q: If the move taken by the RBI similar to what we have seen by Brazil, Indonesia. How does India compared with its peers with respect to your investment strategy now? A: If we look at the way the equity market have performed, Brazil has been a massive underperformer year to date; it’s a combination of certainly weak growth; policy concerns obviously social tensions rioting on the streets, central banks raising interest rates because of inflation and whole series of things. But it was also the case that the equity market was relatively expensive before this correction. That equity market is now down close to its five year average on a forward multiple bases. India has performed better than Brazil certainly, it has not been a stellar performer but in an emerging market context it has not performed badly year to date and it’s broadly also inline with five year average. The cheaper market in emerging market world, in fact would be markets like Russia or China. So, these are trading pretty cheap to whether you have traded in the past and that trading cheap on peer group basis. In terms of how India fits in to that - it is not expensive relative to where it traded in the past but we see value very much in the cyclical sectors in the financials and things like materials, some consumer discretionary stocks and we see that the defensive sectors are very expensive. So, the value in an Indian context is particularly skewed in that direction. _PAGEBREAK_ Q: You spoke about the stock market impact being fairly complicated as compared to the debt market but if you had to hazard a guess, what is your expectation of the kind of return that the Indian market could throw up. How much more pain in the near term? A: It is very difficult to know at this stage. It is a very fluid situation. The answer to the question has more to do with global risk appetite than it does with what happens in Indian context. I think this whole debate around tapering from the Fed, the extent to which that changes global risk appetite. That will be the key driver for India. I think we are in a situation where the market is starting to take more balanced view on this tapering issue that is very conditional, that it won’t come through unless the US economy is doing pretty well and if that is the case then we will see risk appetite perhaps picking up. That could lead to some inflows into the Indian market because there is no doubt that the currency certainly represents an interesting entry point and as I have argued certain sectors anyway look quite cheap. Q: Do you think the currency is about at its worst at this point in time barring temporary overshoots? A: I think the action here should help to stabilise the currency. It has been clearly very weak and a part of the issue is to catch up with inflation; inflation has been running at a high level. The currency is now catching up with that inflation or it has probably caught up. If you look at medium to long-term value, if you look at things like purchasing power parity, the currency looks very cheap. On the short-term of course the drivers are much more dynamic than that. But my guess would be that the currency can stabilise and potentially strengthen a little bit from here but I wouldn’t expect to see a dramatic move because there is still a lot of uncertainty, current account issues not been resolved, policy issues, heading into elections, all of these uncertainties is not generally good from an investment perspective. Q: You would consider all falls of the 60/USD as attractive at this point in time? A: Yes, attractive entry points particularly as I mentioned with the bond market having reprised, it may need to reprise a little bit more but in a relative to where bond yields have been and relative to where the currency was certainly several months ago, this is a much more interesting entry point. Q: There is a food subsidy bill which is now been passed as an ordinance and that is an entitlement, it cannot be rolled back, there is no exit. Would you worry about that from FY14-15 onwards as a potential destabiliser? A: Subsidy is just not a good thing in any form and what we need to see is a consistent line, policy line from the government, not just in India but in dealing with these sort of issues because subsidies are distortions, they lead to all sort of negative economic consequences. There are better ways of protecting people than using subsidies. So, I think it is something to be aware of. What needs to happen to change investor sentiment is we need to see the government getting a grip of these bigger issues. We have seen some progress on that front, absolutely but we need to see implementation now and foreign investors are perhaps little bit concerned that progress can stall because of the election process. Q: You mean like power projects and coal supply? A: Yes. There is huge need for infrastructure spending in this country. There is a lot that needs to be done from an infrastructure perspective and the government needs to push on that. Q: All these measures are negative for Indian banking system but do you still see some value in the financial space. What is the call for the Indian banking stocks? A: From the perspective of the way we have managed funds, we tend to look for things that are cheap in the valuation cycle. As a result of some of these pressures, they may get cheaper in the short-term but we take a call that over time stocks may revert to some kind of equilibrium level. So, we try to belong to things that are cheap and underweight if you like, things that are expensive. That’s the philosophy that we have and over the medium-term it tends to work quite well. In the short-term of course nobody can make a good call on market particularly when there is volatility and they currently are. Q: HSBC recently lowered India’s gross domestic product (GDP) forecast to 5.5 percent from an earlier 6 percent. Do you see downside risk to the 5.5 percent GDP estimate? A: That was before the move so it is quite possible that could be changed. That was HSBC Global Markets. We are Asset Management so we are separate part of the group. But we will probably see a number of forecasters lowering their GDP forecast. In reality if you want to correct a current account deficit, more often you will have to squeeze domestic demand because the current account deficit is a reflection of demand which is bigger than production. So, that is potentially part of the story.