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Last Updated : Jul 16, 2016 12:16 PM IST | Source: CNBC-TV18

Focus on domestic businesses than IT firms in India: JP Morgan

JP Morgan has an overweight stance on India with expectations of double digit returns as the index moves towards 9,000 level. Strong earnings are expected in 2017, Adrian Mowat of JP Morgan says.

The volatility in global markets is making investors cautious on developed market equities. More tilt is now towards emerging markets, says Adrian Mowat of JP Morgan.

However, recovery in commodity prices and stable dollar in the US is taking away an important drag, he says.

India, among EMs, is now coming out of weak loan and capex cycle, he says adding that most of this is aided by policies and reforms undertaken by the government.

JP Morgan has an overweight stance on India with expectations of double digit returns as the index moves towards 9,000 level. Strong earnings are expected in 2017, he says.

"I would rather own domestically focused business than owing software services company," Mowat says adding that IT firms will get move affected by global events like Brexit.

He is bullish on financials and building companies, but advises lower exposure to staples and IT.

On the Goods and Services Tax (GST), expected to see light in upcoming Monsoon session, Mowat says that expectations are already low. If the GST doesn’t go through, negative impact will be low.

Below is the verbatim transcript of Adrian Mowat's interview to Latha Venkatesh and Sonia Shenoy on CNBC-TV18.

Sonia: Things are looking exceptionally good across the global screen, how have you read into this momentum and do you think it could continue?

A: I would clarify a few things -- the European equities and particularly Japanese equities are certainly not at highs. Japanese equities had quite a tough year. So if you take a story of the S&P making highs and then when you look at the style of stocks doing well, its low volatility, relatively high yield and very low yield, that will be outperforming. If you look at the financials, a quite a lot of those are still down meaningfully and you are tending to find that midcaps are doing poorer, if you look at the key market where the Footsie is doing well, 70 percent of Footsie earnings come from outside the UK. So the weak sterling is helping them. When you start to look at the midcaps in the UK, many of those are down, some of those that seemed to be more impacted by Brexit are down more than 70 percent. So there is a degree of shine from the largecap indices that perhaps takes a little bit more pain out there.

Latha: What is your sense about even US equities? It is the mother market and there is generous gush of liquidity from other Central Bankers as well, do you think US equities and global equities are good to go for more?

A: Global teen is relatively cautious on developed market equities. They are very constructive on emerging market equities. Our US strategist is forecasting some downside from the US equity market primarily based upon the earnings outlook. Now some of the drags on the earnings outlook have definitely improved the recovery that we have seen in the oil and other commodity prices from their lows. The fact that the dollar is no longer rallying like it was up until March 2015 takes away an important drag but for earnings, there are concerns about the impacts of Brexit.

Sonia: Since we are going to talk a lot about the IT stocks, I wanted to get a view from you on whether you looked at the TCS numbers and what your expectation is from Infosys as well because as you mentioned, the Brexit fear is something that could keep a lid on the earnings of some of these heavyweights?

A: Today is a day of China GDP numbers and there are other things going on. My view as the EM strategist is I would rather own domestically focused businesses where I think there is going to be more positive delta than owning the soft services companies, which typically are very well run, good ROEs, very strong balance sheets hence the margin when looking at India, these are the exporters, these are the earners of revenue from abroad, which could be more adversely affected by events such as Brexit.

There is another thing also -- remember that there is this very unpleasant trend going on globally that seems to be anti-immigration and anything that is tightening up these requirements etc is generally a top thing for the IT services companies.

Latha: For the moment, which areas of India, therefore, do you like? We are just at the start of the earnings season. So, what would you go long on ahead of this?

A: If we think about what is going on at a macro level in India, for the first two years of the Modi administration, there is a couple of very important policy objectives, particularly around bringing down inflation, so India has had very high real interest rates. Particularly if you use wholesale price index (WPI) as your deflator, if we look at manufacturing real interest rates, they were double digit last year. The results have been very weak corporate capital expenditure (capex), weak loans to the private sector in India. We think we are coming out of that. I also think there is an affect where there has been a serious attention given to PSU non-performing loans (NPL), which has added to a sense of weakness in the first half of this year.

As we go into 2017, you going to get a little of that. You will have declining real rates, and so you will be looking to have more cyclical exposure in place. Now, some of the cyclical exposure is already doing incredibly well, if you look at how building materials, cement stocks are performing. We have had a very good auto numbers. I cannot mention specific stocks, but some of the domestic numbers have been much better. We think that is a leading indicator in terms of truck sales although they are still not on their peak. So, we like the cyclical exposure.

If you are looking at engineering and construction companies, typically these stocks rise on order inflows. So, we have got a cyclical bias, we have got a near cyclical bias which is still into financials and on the other side of that, we would be funding that by having a lower exposure to IT services as well as a lower exposure to staples.

Anuj: But what about valuations? Do you get a sense that this liquidity could drive asset markets into a bit of a -- bubble would be a strong word -- exuberance territory? Indian market is already trading above the median valuations.

A: It makes sense that it is above the median valuation, because we are expecting a much stronger earnings story in 2017 and so the market is moving ahead to discount that which is quite rational. Remember that we have had miserable experience when it comes to emerging market earnings on aggregate. They peaked back in 2011 and have been falling every year since. We have been in a five year tightening cycle in emerging markets. We think we are coming out of that and the risk here is the valuations are much lower on a cyclically adjusted basis.

Latha: At what level would you get uncomfortable? We are already well above 8,500. Would you be okay with a Nifty level of 8,800 or would you start worrying at even earlier levels or are you comfortable all the way to 9,000?

A: That would be consistent with our view on India. We have India as we do with the other Brazil, Russia, India, China and South Africa (BRICS) as an overweight. So, our expectation is double digit returns, which would be consistent with the index moving towards the 9,000 level. I am sympathetic with some of the comments that are being made just before I came on air which markets just do not go up in a straight line. If we had a little bit of a pull back, I would view that as a buying opportunity.

Sonia: Next big trigger at least for us is the monsoon session of parliament that kick starts on Monday and there are expectations that the goods and services tax (GST) could perhaps go through in this session. But do you think that the Indian market momentum is strong enough for the markets to oversee any kind of disappointment from GST even if it comes through?

A: I think that is a very interesting question because if we brought this up a couple of weeks ago, expectations on GST were quite low. So, if GST did not go through, it would be a minor negative. But let us not forget that expectations on GST about a month ago were, it was not expected to be happening. And one thing we have been reminding clients is there has been a fair amount of legislation passed by this administration -- the bankruptcy code, these are all bits of legislation where the market is probably underestimating their beneficial impact.

GST clearly is important in business efficiency, making India a common market, a great irony in the world of Brexit, but India is going in the right direction. So, let us hope it goes through, but I would accept that the market might pullback if it does not.

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First Published on Jul 15, 2016 08:31 am
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