Eyes on RBI guv, rupee; not so much on poll rhetoric: PIMCO

Foreign investors are going slow on their emerging markets investments not because of stretched valuations but on the back of lacklustre earnings growth. That’s the word coming in from emerging markets specialist Maria (Masha) Gordon of Pimco.

She says the profit growth in EMs compared to their developed counterparts over the past three years has been “anemic”. However, the past quarter or so has seen some sort of a stabilisation on earnings front.  "Investors took that as an encouragement to step back and to take advantage of cheaper valuations. However, to take the markets higher, we need to see a stronger growth stimulus in EMs and that is probably unlikely to happen in coming years," she told CNBC-TV18 in an interview. For India specifically, Gordon says, the street is looking at a 15 percent earnings growth. She says right now there is an overwhelming desire to believe in a political change in the country. There is some positioning happening ahead of elections.  But she is more interested in whether the RBI governor will be successful in his effort to contain inflation and whether rupee is trading in the range where it was expected to be. "These are the foundation for macro stability. There we have seen some hopeful developments on the side of the credibility built up of the RBI governor and clearly this is, for us, a more important variable than speculating on the election outcome," she told the channel. Also Read: 2014 not a runaway election for us, says Salman Khurshid Below is the edited transcript of Masha Gordon’s interview with CNBC-TV18 Q: Emerging markets (EMs) have seen a decent amount of flows from early September up until mid-November, now the flows have kind of become a trickle at least in India. Is there a sense that probably now foreign investors are not finding valuations compelling? A: I wouldn’t say that valuations are looking stretched. There are greater reasons as to why EMs have underperformed dramatically this year. It is clearly a very anemic profit growth in EMs over the past three years relative to developed markets (DMs). It is the lack of momentum behind EM earnings. We have seen a far stronger relative growth picture in DMs. We have seen signs of stabilisation on earnings front in the EMs. Investors took that as an encouragement to step back and to take advantage of cheaper valuations. However, to take the markets higher, we need to see a stronger growth stimulus in EMs and that is probably unlikely to happen in coming years. Q: When do you see Fed starting to taper now? A: We think there is a greater likelihood for some tapering to start take an effect in March or perhaps in the May. We believe that this will be a fairly extended period but given the extent of distortion that the Fed intervention has created in market, we may see some volatility arising in the spring time as investors start anticipating the action. Q: What about in India specifically, what kind of earnings growth do you expect in FY14 and in FY15 because this September quarter surprised us on the upside? A: The numbers depend very much on the key variables which is gross domestic production (GDP) growth and that has been a consistent disappointment over the past few quarters. I think that it is anyone’s guess if you look at the street's prediction; people are looking at 15 percent growth. If you go and dig deeper in sub sectors, who would have thought that the commercial vehicles (CV) would be down depending on the segment anywhere between 20-30 percent right in India that is bound to grow and that has internal demand, that is what it seemed. Q: Which are the sectors or stocks that you find attractive at current prices? A: We continue looking for stories that have exogenous driver. So, we are still very much interested in holding Tata Motors. The management has executed in its Jaguar-LandRover (JLR) franchise and that is obviously not a story of India Inc. When recovery in the commercial vehicles segment happens, that could potentially be another driver. What is interesting is that the recent announcement also of the cost cutting exercise in that part of the business and this is what we would like to see in more of the Indian businesses. In the environment where the political outcome is uncertain, one should be looking at a solvent corporates that are potentially going to be beneficiaries of the asset sales when and if they come. That is what my team is working on very carefully. _PAGEBREAK_ Q: The market itself has been finding it difficult to cross that 2008 and then the 2010 highs of around 6,350, what kind of gains do you see from the markets in the next six-twelve months? A: I have attended an investor conference last week and what was interesting is that overwhelming desire to believe in a political change. I think that people are hoping that there will be change, they are very much hoping that a certain candidate comes to power, what they may underestimate is their own ability to calculate election results. We know that in a democratic country, as compared to India, this is notoriously difficult. So, there is some positioning happening ahead of elections. Clearly, I am watching much more of the fundamental developments and that is what is the currency doing, is the Central Bank governor successful in his effort to contain inflation, is rupee trading in the range where it was expected to be because these are the foundation for macro stability. There we have seen some hopeful developments on the side of the credibility built up of the RBI governor and clearly this is for us a more important variable than speculating on the election outcome. Q: If inflation is that important in what you are watching, in the December 18 credit policy, you will not be surprised if there is a rate hike? A: This is correct. Again we would welcome that given that again mid-term objective is the establishment of the proper inflation based policy. Q: State owned banks are at attractive valuations in India, will you buy them? A: Our firm preference remains with the private sector banks. We actually don’t know what's in the portfolio of the state owned banks. They have provision in the policy which may or may not be adequate. What we know is the economy is extremely weak in certain segments and that the infrastructure loans may not have been provisioned the way they ought to given the underlined profitability of the projects. Now that depends clearly on potentially corrective steps that may be taken on power projects, on the coal supply projects etc. Our firm preference is for private sector banks, but we would admit that the sector is likely to be challenged near to mid-term because of partly the drive of the governor to establish the appropriate savings rate; the banks are still relying on wholesale funding and continued credit quality issues. Q: Many of the private sector banks have also been ranked outperformers, do you like them? A: We have position in Axis Bank where we see a story of credit quality working out in the medium-term. Q: The other stocks that have been doing very well lately have been the capital goods makers, Larsen and Toubro (L&T) always was, Bharat Heavy Electricals Ltd (BHEL) now, you like any of these stocks, BHEL in particular? A: We need to be very careful when we think about the outlook because for every sub-sector there is story of new capacity coming in, there is story of competition. I would be careful making blanket statement because ultimately any of this depends on supply and demand. On demand, you can say things may get better and on the supply side you have to be pretty specific when you look at the new capacities coming through.