'Macro cues starting to stabilise; move out of defensives'

With macro economic data from around the globe starting to improve, Sakthi Siva of Credit Suisse Asia Pacific believes it is time investors move out of defensives and start betting on cyclical stocks.

“Our main global backdrop is that the macro momentum is starting to stabilize. Over the last one month, whether it is indicators such as the US ISM, US jobs, US retail sales or industrial production, we are now starting to see some signs of stabilization,” she said in an interview to CNBC-TV18.

Due to this stabilization, Siva says investors should now look at moving into quality, but cheap, cyclicals.

From an Indian market perspective, Siva says that stocks like Sun Pharma, Lupin, TCS and ITC are expensive. Her top bets currently are Reliance, Tata Motors and Tata Steel.

Below is an edited transcript of her interview with Udayan Mukherjee.

Q: What is the overall global backdrop that you are working with right now? Do you expect liquidity to remain benign as it has been globally for the last few weeks?

A: Our main global backdrop is that the macro momentum is starting to stabilize. In February and March we saw a peak in a lot of the global macro indicators, and we saw quite a sharp slowing from March through to July-August. But over the last one month, whether it is indicators such as the US ISM, US jobs, US retail sales or industrial production, we are now starting to see some signs of stabilization.

Because of this more positive, or atleast this less negative macro environment, we are making a call to switch out of expensive defensives into both quality as well as cheap cyclicals.

Q: What do you hear when you talk to your clients right now? Are they adding a little bit more risk to their portfolio or are they characterizing this as just another risk-on rally which might fade if the global macro data worsens again?

A: There is still quite a lot of skepticism, mainly because of Europe. Our clients are still worried about Europe and there are also the concerns about China. The one good thing though is that at least some of our clients have listened to us and started adding a little bit of risk. We have seen about USD 8 billion of net foreign buying so far this month, and about USD 4 billion alone has gone into Korea, which in our view is probably the market that benefits the most if global macro momentum does stabilize.

Supportive of this view that macro momentum is stabilizing is also the fact that you have seen US bond yields rise from 1.4 to 1.8%. So there seems to be some asset allocation shift at the margin out of bonds into equities. But in an Asian context, the market that has received the most inflows over the last one month has been Korea.

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Q: Do you sense a discernible change in perception about India or are we just benefiting from the kind of money Asia has got over the last couple of months?

A: I think there is certainly more interest in India as well. India has gotten about USD 1 billion of the flows over the last one month. From my personal perspective, I guess the big change has been the moderation on the inflation front. If you look three or four months ago, in emerging markets and in Asia inflation was already decelerating whereas in some senses India was the odd man out with still very high inflation. But with the last month’s inflation data, it looks like it has started to moderate even in India.

But in India our call is again more specific. As I said, we are suggesting a switch out of some of the more expensive defensive stocks. Remember this is a valuation argument, so we do find stocks like Sun Pharma, Lupin, TCS, HDFC Bank and ITC rather expensive, and we are suggesting a switch into what we call cheap cyclicals. Reliance Industries, where the price-to-book is below 2008-1009 lows, and also Tata Motors which certainly on our price-to-book adjusted by ROE model comes out as one of the cheapest stocks.

We believe that the stabilization in global macro momentum, the recent rise in US bond yields and also the fact that some defensives are missing on earnings may act as the catalyst for this switch, even within India as well from expensive defensives to cheaper cyclicals.

Q: You also have Tata Steel on your list, and that stock has not done very well after a disappointing set of earnings. Is that a pure valuation call as well?

A: Yes, it is a pure valuation call. We published something called the Reporting Season Scorecard, and Tata Steel certainly did see a pretty big earnings downgrade post the results. So our cheap cyclicals basket is Tata Motors, Reliance and Tata Steel.

Our expensive defensive basket includes Sun Pharma and TCS. Some of these stocks post results have actually seen earnings upgrades, certainly Tata Consultancy Services. But on the other hand, you have stocks like Lupin which are starting to see small earnings downgrades.

So for us, the way we look at it is if you are cheap, the risk-reward hopefully is still quite attractive, even if you do miss on earnings. But on the other side, if you are expensive, particularly among the expensive defensives, and if you start to see earnings downgrades like in a stock like Lupin, then again the risk-reward is rather unattractive.

Q: What are you telling your clients to do on some of the other bigger consumer names like Lever, ITC or even something like a Titan?

A: Credit Suisse does not cover Hindustan Lever and ITC, but we did include ITC as one of the stocks also to switch out of. So if you look at the expensive defensives basket, we have included ITC in that list. So there is ITC, TCS, HDFC Bank, Sun Pharma and Lupin.

I guess we started this call about a few weeks back, both in the region as well as in India, and so far the expensive defensives are up 1% whereas the cheap cyclicals are up about 6% or 7%. This is including Tata Steel, which has been obviously a poor performer, but Reliance and Tata Motors have obviously done a bit better.

So as I mentioned it is very strongly a valuation call. We do have outperform ratings from some of our analysts on some of these stocks, but in Asia the cyclical defensive valuation gap is about 80% of what we saw in ‘08-‘09, whereas in India the cyclical defensive valuation gap is even bigger than what we saw in ‘08. Just to try to convince you things are not as bad as 2008, remember US GDP fell by 7-8% during that time. Now we are talking about US GDP growing by around 1.5-2%. So we feel a lot of this call is actually driven by valuations.