BSE Sensex mantra! Top factors which are pulling Indian markets higher: Adrian Mowat

Indian market rose to fresh record highs on both Sensex and Nifty50 for the second consecutive day in a row on Tuesday led by a gush of liquidity, largely led by short covering for foreign institutional investors after SEBI restricted the use of P-notes to hedging.

In the case where the underlying derivatives position are not for purpose of hedging the equity shares, the issuing FPI has to liquidate such ODIs latest by the date of maturity or by December 31, 2020, whichever is earlier.

Well, the large part of the rally seen in Indian market could be driven by covering of positions by foreign investors but there are other positive factors as well, says Adrian Mowat, MD & Chief EM Strategist, JP Morgan in an interview with CNBC-TV18.

According to Mowat, there are other positives which are going for Indian markets –

a) India was an underperformer in the second quarter compared to other emerging markets so there is some catch-up going on with its neighboring markets.

b) GST implementation appears to be going ahead as per expectations

c) There is some bit of optimism on rural demand largely on expectations of better than expected monsoon and loan waivers which could also aid in fuelling demand

d) The outlook for first quarter earnings of the FY2018 are little bit more optimistic compared to delivery of earnings we have experienced before

e) Lastly, there is a technical factor, forced short coverings.

The valuation of the Indian market is at the top band as there is a lot of optimism which is priced in the Indian market. If you get some negative shocks there is no valuation cushion, highlights Mowat. But, there are other positives.

The rally will continue supported by two key factors – the domestic savings flows into Indian equity market continues and the recent inflation print suggest that fixed deposits are not going to be a big competitor of equities.

“The other thing that we have highlighted before that international flows into emerging markets in our opinion is in a pretty early stage. We expect inflows i.e. $30 bn YTD to continue to build which goes into passive products and India gets a fair share of that,” said Mowat.

The technical situation is still attractive for emerging markets and India is a beneficiary, he said.

Below is the verbatim transcript of the interview:

Latha: Would you dismiss this rally entirely as short covering because of Sebi's move or are there other positives to this rally?

A: I think there are a few other positives. First of all remember that India was quite an underperformer in the second quarter versus other emerging markets. So there is a degree of a catch-up with its neighbouring markets. The goods and services tax (GST) implementation appears to be going ahead, better than expected. I think there is a bit more optimism on rural demand with the monsoon plus these loan waivers which people can treat as a positive or negative. I think people's outlook for the first quarter earnings of the current fiscal year are little bit more optimistic than perhaps the delivery of earnings that we have experienced so far this year. So I think these factors are at work and plus as you highlight there is a technical factor here with some forced short covering.

Anuj: Indian market was already outperforming this year but critics would say that this forced short covering removes a bit of a cushion for the market if there is any negative news flow over next two-three months and could make market inherently weak. Would that be right?

A: I think this is a very important point. If you look at the valuation of the Indian market, it is right at the top end of its recent band, one standard deviation - expensive versus its 10-year forward PE.

There is a lot of optimism priced into the Indian market. If you get some negative shocks, clearly there is no valuation cushion. I think the problem that investors are struggling with is that the comment could have been made for a period of time and the market failed to have any significant pullbacks. It does seem to be quite well supported by, I suppose, two key factors here. One is the domestic savings continues to move towards equities and the recent inflation print; the outlook for interest rates certainly suggests fix deposit are not a big competitor for equities. The other thing we would highlight is that international flows into emerging markets in our opinion are at a pretty early stage, we expect the inflow that is over 30 billion year-to-date to continue to build, quite a lot of that goes into passive products and India gets its fair share of that. So the technical situation is still attractive for emerging markets and India is a beneficiary.

Reema: You started off by saying that the catch-up vis-à-vis the rest of the emerging markets on account of the underperformance seen last year towards the end of the year on account of demonetisation. Hasn't that catch-up already taken place or do you still see the Indian market trailing the emerging markets in terms of returns and what would your view on India versus emerging markets (Ems) from here be.

A: My comment was about its second quarter performance; it underperformed in the second quarter, big underperformer in the fourth quarter of last year, demonetisation recovery in first quarter and then underperformance again in second quarter. I think from the perspective of India versus other EMs, we have got a much better earnings revision trend in the balance of EM than we are seeing in India and we also have a better valuation argument. So I am more bullish on places like China and Korea than I am on India.

Latha: We have sectors where there is growth like fast moving consumer goods (FMCG) and consumer goods but their valuations are at 40 times on an average for several of the FMCG goods, somebody was pointing out that they are factoring in some 20 percent growth for the next 20 years - that's the kind of valuations and there is valuation comfort in other areas like public sector banks but there is hardly any earnings visibility. So where do you put incremental money?

A: My advice is to be underweight consumer staples globally including in India because the probability of making decent return over the next couple of years is going to be low at the type of valuations you are buying into. So it is not a criticism of the companies. It is merely too much of a stretch to make decent returns from these high valuations. I can make the same statement about consumer staples in Mexico, Brazil and in Korea. I think in the Indian market, it is a real challenge finding quality and value at this point in time and so what we will need to see for the Indian market to start to make reasonable progress is that being cyclical data in India begins to build some pace as we move into the fourth quarter of the calendar year but we need to see the economic momentum being meaningful move into calendar year 2018.

Anuj: On finding stocks with valuation and growth, we have valuation comfort in pharmaceutical for sure now; do you see growth as well because that is where we have started to see some sort of buying over the last one week or last two weeks?

A: I was looking through the sector performance and pharma is not standing out as an outperformer over one month or three months or even month-to-date, we are barely into the month of July. So I would suggest that it's moving with the market.

We are very pessimistic on pricing of generics particularly in the United States. So India's pharma companies having to deal with the firm rupee and a tough competitive landscape in the major market, so I continue to recommend being underweight healthcare. We are also underweight IT. IT is the other big dollar earner in the Indian market.

Latha: There has been a rush of risk on in all global markets. We are seeing almost goldilocks scenario even in markets like the US where there is growth and central banks cannot be very aggressive in their rate hikes because inflation is so low. Do you think we are going to see higher highs for equities across the band - domestic markets (DM) and emerging markets?

A: I think there is a good chance of that, so what has changed in the last month or so from the perspective of the US equity market has been financials beginning to perform once more. They sold off from early March with the US bond yield and with interest rate expectations. With the recovery in US bond yields, financials have been doing better. It has also been helped by some capital post the most recent stress test. So there is a broadening of market which is healthy. So it is likely that equities do make new highs both developed and emerging.