India on high-conviction list; buy midcap cyclicals: Walker

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Below is the interview of Jim Walker, MD, Asianomics with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.

Sonia: How are you positioned on the Indian markets now? We are in a crucial phase just ahead of the general elections and things have been slightly sticky since the start of the year.

A: I believe our position on India is that we have elevated at a high conviction global call and we are long India on a global basis, not just on a regional relative basis and the reason for that is that we see Indian companies doing what they need to do after a slowdown in the economy, that is to cut capital expenditure and repair balance sheets which we think will enable the economy to flatten out probably in the next couple of quarters and then take off again. So very long India.

Latha: What about global fund flows? India was very lucky last year, USD 20 billion or thereabouts, but overall it was the developed markets which were the favoured lot. Would US continue to be preferred after that 30 percent jump last year? Which will be the preferred markets for global fund flows?

A: This is one of the reasons that we have elevated India into that global high conviction call as to replace the US. Our view is that with the beginning of the Fed moving towards tapering, moving towards buying less in the way of assets every month from the treasury and from the mortgage market, we are going to see a correction in US equities more than the developed countries. It is purely because that is where it was most effective when they were buying assets over the course of the last year in the first place. So what we are looking at now is the slowdown in asset purchasing having an undue effect on the US and people beginning to focus again on some of the fundamentals elsewhere in the world which means emerging markets are looking better again.

Sonia: You said that you have elevated India to a high conviction list. What is your stance on how to approach the election trigger? Do you feel that irrespective of whichever government comes to power it is going to solve some of the macro ills that India is facing?

A: We think that the macro position is now pretty well understood in India and regardless of which government comes in, there is going to have to be some changes in the way the government runs itself especially with regards to spending on infrastructure and also in terms of tax reform and fiscal position. New governor ahead of the RBI seems to be making the right noises even if some of the policies are not ones I would particularly favour, but the markets will like them. So I think the policy position in India is actually settling down ahead of the election. So our call is not based on politics whatsoever. It is based on the economics. It is based on what companies are doing and it is based on what we believe the government and the central bank is going to be forced into in the course of next few years. That is just much more sound policymaking.

Latha: You are a long fan of Reserve Bank of India (RBI). What about the new governor you find slightly difficult to accept?

A: I am not a fan of inflation targeting which has just been announced as the new policy mechanism for the RBI. That fad of central banking worldwide will eventually pass. I think it has been a tremendous failure across the globe for the last 10 years. It amazes me that people are adopting inflation targeting when inflation targeting was all the rage during the mid-2000s which then led the US into the complacency that (in turn) led to the global financial crisis. I would much rather want central banks for targeting trade and money supply growth which are of course precursors to inflation and deflation anyway.

Latha: Within India itself, what do you think will do well? Would it be the western oriented sectors - IT, pharma with a little bit help from the dollar or would it be cyclicals because you are betting that perhaps the economy gets better from here?

A: I think the export exposed companies have done pretty well already given we are starting with the rupee which we still actually believe to be somewhat oversold although I do not suspect there is much upside now. But yes, I would actually be going long cyclicals in India, especially midcap and small cap cyclicals which have been crushed during the course of the last two years. So to my mind this is a time to be accumulating. Accumulate slowly, there's no need to rush in. This is a start of a five-year cycle for India again, so there is no need for a heavy hand in this year to push prices up. But it is cyclicals that I would be accumulating.

Sonia: Within cyclicals itself do you think the worst of the capital goods sector is now behind us or is it just a hope rally that will play out?

A: I think there is probably still some weakness, in real economic terms, for the capital goods sector for the next couple of quarters. What happens with companies when they are faced with a slowdown and when they know they have probably taken down a bit too much debt and they got capacity is that they begin to cut their capital expenditure. They begin to induce more free cash flow, improve their operating cash flow and that repairs their balance sheets and that is when markets actually start moving. So although there is some bad news on the economy for next couple of quarters, my expectation is that the companies who have been taking the right measures to improve their financial position are actually going to start moving quite quickly. So anywhere that you see companies that have realised that capital expenditure is not that necessary just at the moment, who will start building up their capex again in 2015-16 by operating at higher-efficiency levels, those are the ones which will do particularly well.