Remain bullish on Indian equity markets: Credit Suisse

Sakthi Siva of Credit Suisse continues to be bullish on the Indian equity markets and expects strong fund inflows into equities. “We believe there is still rather large gap between the equity market price index and the level of earnings. For the Asian region as a whole, that gap is north of 20 percent,” she said in an interview to CNBC-TV18.

Foreign Institutional Investors (FIIs) pumped in more than Rs 1 lakh crore in 2012, marking a huge turnaround from net outflows reported in 2011. Siva added that large investors continue to be cautiously optimistic on emerging markets like India and China. So, both these markets are poised to get foreign inflows this year. Also read: Bullish UBS Sec's top recommendations for 2013 "The bigger theme for 2013 could be a switch out of bond funds into equity funds and that may help to achieve our 20 percent return for the second consecutive year," she elaborated. Meanwhile, Tata Motors and Reliance Industries are among her top cyclical picks and advices switching out of ITC, TCS, HDFC Bank. Below is the edited transcript of his interview on CNBC-TV18 Q: A lot of people believe that maybe after seeing alternate good and bad years, 2013 may find it difficult to repeat the cheer of 2012. But you believe that it could be an encore? A: Yes, we retain our bullish bias. In fact, the heading for our 2013 outlook report is second consecutive year of 20 percent returns. Maybe we are being a bit too bullish. However, our theme is whether equities could potentially catch up with earnings. We believe there is still a rather large gap between the equity market price index and the level of earnings and in fact for the Asian region as a whole that gap is actually north of 20 percent. Q: So are you saying that earnings will start picking up or do you think the current rate of earnings growth that you are seeing in markets like India would be enough to justify 20 percent upside. A: We actually think that even the current rate of earnings; if you look at earnings versus market indices over long periods of time they do tend to move together. There are periods when they diverged; 2007 was one such period was the opposite situation, where the index was some 40 percent above the level of earnings and this was particularly true for both China as well as India. Whereas, today we have actually got the opposite situation, where the equity market price index is actually below earnings for the region by around 20 percent and for markets like China and India by as much as 40 percent. We think that the reason for this investor scepticism has been the persistent earnings downgrades that we have seen since about 2008. However, if we look at the month of December, the rate of earnings downgrades has actually slowed in the region to just minus 0.3 percent. Even in India, the rate of earnings downgrades has also slowed to minus 0.3 percent. We believe that if these downgrades continue to slow, it may give investors more confidence in the actual earnings that have actually already been delivered so far. Q: What kind of positioning do you see amongst your large investors that you speak to? At the start of 2012, they were terribly underweight but it seemed like they had been raising their weightages to equities, and emerging markets in particular through this year. Right now would you qualify it as cautious positioning, sceptical positioning or almost bullish? A: I would still characterise it as cautious optimism. You are certainly right. Last year there was almost USD 51 billion of inflows into emerging Asia excluding China and half of that came into India. So, India certainly did get quite a large chunk of those inflows. Our big call is potentially an asset allocation shift out of bonds into equities. So if you take in the US for example last year there was about USD 300 billion of inflows into bond funds and USD 150 billion of outflows from equity funds. We believe that while we have seen some inflows into emerging markets, the bigger theme for 2013 could be a switch out of bond funds into equity funds and that may also help to achieve our 20 percent return for the second consecutive year. This is a theme that is being suggested by Jonathan Wilmot Credit Suisse’s Head of Global Strategy out of London. Q: Where do you see the whole China-India interplay? Flows into emerging markets, even in Asia in 2012 were hardly uniform. Some markets pulled in a lot of the money, other markets were completely ignored. In a relative sense, do you think China could do better in terms of sucking inflows in 2013 or do you see India continue to be a preferred bet? A: India continues to be popular. Judging by just yesterday’s flows, it was quite big USD 300 million into India out of USD 800 million into the region, so India continues to be popular. We are in a rather unique position where we are overweight both China and India, which I guess is rather unusual and our theme for 2013 is could equities catch up with earnings. When we look at market indices versus earnings, the biggest gap is in MSCI China but the second biggest gap is in India. As I said we are in a rather unique position, where we are overweight both of the markets and we are suggesting an underweighting in some of the smaller Association of Southeast Asian Nations (ASEAN) markets and Taiwan, as a way of funding the overweight in both India and China. _PAGEBREAK_ Q: There has been a lot of talk about how people should be underweight on consumer names in India for 2013. Some money has started shifting out of Hindustan Unilever (HUL), ITC and those kinds of names. Could you tell us why HUL is in your most preferred list for 2013? A: For the last six months, since August I have been writing a series of notes called, ‘Is Mumbai the home of expensive defensives?”. So, personally on the regional strategy side, we actually continue to suggest a shift out of expensive defensives, not HUL but stocks like ITC, Tata Consultancy Services (TCS), Lupin, Sun Pharma and HDFC Bank. Our call has actually been to shift out of some of these expensive defensives. Given the valuations, the price-to-book gap between expensive defensives and cheap cyclicals is actually even bigger than 2008. So we feel that valuations are still very much in favour of the cheap cyclicals. A couple of times on this show I have pushed Tata Motors and despite last year's good run, on our valuation models it still comes out as the most undervalued stock at least using our valuation models. Q: Staying with that theme of preference for cyclicals you still do not like names like Tata Steel, Larsen and Toubro (L&T), Bharat Heavy Electricals Limited (BHEL) that is some of the large caps which typically people would want to take on if they want more risk in the portfolio going into the year. Why is that? A: Basically, my preference is for Tata Motors and that has been our top pick. We also like Reliance Industries where it is kind of starting to perform but the price-to-book is still below 2008-09 lows. Sometimes there is a difference of view between the regional strategists and the country strategists. So some of the picks like being negative on Tata Steel and being positive on Hindustan Unilever that is actually coming more from Neelkanth, our India Strategist. However from the regional strategy point of view, since early August, we have been pushing quite strongly a push out of expensive defensives like I mentioned ITC, Sun Pharma, some of those names into cheap cyclicals but particularly as I said Tata Motors and Reliance Industries. Q: Where do you stand on Bajaj Auto that also is one of Credit Suisse’s picks for 2013? Are you bullish on the two wheeler space? A: I am bullish on the two wheeler space. My only concern on Bajaj Auto, at least on our valuation models that I run on the regional strategy side, it does not come out looking as cheap on valuations as Tata Motors does. I am also nervous about Tata Motors given it has done so well. But we have done the valuation once again this morning and it still comes out as the cheapest on price-to-book adjusted by Return on Equity (RoE). I am not suggesting that valuations are everything but I certainly tend to use it as a starting point. We added Tata Motors to the portfolio on the 3rd of January a year ago and based on valuations, it was the cheapest then. Surprisingly despite its run, it continues to rank as the cheapest even today among the top 50 Indian stocks by market capitalization. Q: If you are playing for 20 percent upside this year, can you break it up in terms of timing on whether you think that much of those gains will be front-loaded will come in the next two-three months or do you think gains will probably accelerate in the second half of the year? A: I am actually looking for a strong first quarter and a little bit nervous about the second quarter. The reason I am confident about the first quarter is, if I looked at the breadth of numbers coming out of the US in terms of recovery; you are now seeing not just housing but you are seeing bank lending recover, seeing job numbers pick up, consumption pick up, so certainly for me when I look at the US numbers, I feel the breadth of the recovery is certainly the best that I have seen since about 2007. It is really going back quite a long time. The US has already done, this is the sixth year of the deleveraging process and in most cycles the deleveraging process takes about five to six years. So for that reason I am quite bullish about the first quarter. The reason I said I am nervous about second quarter is because for the last three years without fail, something has happened in Europe and we have always had a pullback or a correction of some sort around April. So whether or not that seasonal pattern repeats, people say sell in May but if you look at the last three years, the correction has started kind of late March early April. I am little bit nervous whether that seasonal pattern kind of repeats. So I am confident about the first quarter and then maybe a bit of a pullback in the second quarter, which we would again use as a buying opportunity. If you are worried about chasing markets, India is already up 25 percent in US dollars last year. Wait for the pullback, there are always pullbacks and certainly if you believe in the seasonal patterns that tends to occur around April.