"FIIs continue to believe that this is the place that they want to be invested. Most investors have reiterated that they are overweight India and they do not intend to trim that. and I think that is also what I am learning from my clients."
The U-turn in late morning trade that took Nifty below 7690 does not signal any fundamental weakness, according to Ridham Desai, Head of India Equity Research & India Equity Strategist at Morgan Stanley who also refuted that panicking FIIs are in a hurry to exit India. Instead, he said most FIIs are still overweight India. "I hesitate to think that this is the beginning of a bear market and would call it a bull market correction."
He also added that this is not the time to turn bearish since India has more or less rebalanced its economy. This time India's problems are not its own but emerging market specific which in turn is dealing with China issues. That's what differentiate this correction from the previous ones, Desai stressed.
In this scenario, he finds banks have turned very attractive. He also believes industrials, technology and consumption plays will reward investors in the coming months.
Below is the transcript of Ridham Desai's interview with Latha Venkatesh, Reema Tendulkar and Anuj Singhal on CNBC-TV18.
Anuj: What do you make of the kind of market mayhem that we have seen over the last couple of days and do you think we have seen the worst of it or some more pain is left in the system?
A: Firstly we need to distinguish this from previous market panics that we have seen over the last six-seven years. So, if you circle back to say July or August of 2013, there was a India specific problem that India was dealing with. Our current account deficit was wide, fiscal deficit was high, real rates were negative, inflation was high and we needed to respond to a global problem. This time around we are actually sitting on pretty good macro fundamentals. We have brought down our inflation and it is sustainably falling, real rates are positive thanks to a lot of good work done by the RBI. Thanks to a lot of the good work done by the government the fiscal deficit is under control, if anything it is actually surprising us on the downside and as a consequence, the current account deficit is in balance or slightly negative. Domestic saving is back in financial assets, so India has more or less rebalanced its economy.
The rest of the emerging world and this is primarily an emerging market (EM) problem that we are dealing with, not a developed market (DM) as much is actually facing a lot of problems. It is broken in terms of growth, it has got macro issues on the external side, some of them have internal problems, so what has happened is if you look at India since say May and probably a lot of people have not taken note of this but up to yesterday’s close, India had delivered and I am including yesterday’s price fall, had delivered a 20 percent outperformance in a matter of just three months, so it is like the last man standing. Markets elsewhere broke down and then you come and sell the biggest outperformer as you can see inside Indian markets as well.
Anuj: The follow up to that is that in that case would we see more capitulation in India itself? We have started to see for example in India stocks like IT and pharmaceutical sell-off, that normally is when people tend to just preserve their profit as well even in cases where they have made profit. So, do you think this kind of trend is going to continue and are we at the last stage of panic in the emerging markets (EM) and including markets like India?
A: I don’t know about the EM problem because EM has got a fundamental issue. So, it is not just a technical issue. I don’t think India has a fundamental problem and the way the market is behaving say late last afternoon and today, it would seem like we are now capitulating and therefore approaching the end. Those things are always difficult to tell and it is hard to tell exactly where it bottoms out but as the volatility subsides over the next few days, we would probably look back and say yes that was the bottom of the market.
So, I feel that we have given a reasonable correction. We have given up not a lot of the outperformance, a little bit of the outperformance. Our relative valuations have come down slightly, not a lot but our fundamentals are intact. So, India is oaky and at some point in time investors need to re-engage. Timing the bottom is always going to be difficult for anybody.
Latha: Your point is taken that India is the good boy in an otherwise troublesome classroom. But, what is the sense you have made of the global markets itself? How much more will they discount a Chinese slowdown? It appears yes, that they overestimated the emerging market (EM) growth story and particularly the Chinese growth story. But has that not been discounted enough now, the negativity?
A: Yes, possible actually. I would not say that this is time to turn bearish and sell out of global equities for example, not that I am the expert on it. But that of course also does not mean that markets are about to go up a lot. So, it will be very selective and wherever there is growth and there is stability, those are the markets that will trade up. That is precisely what was happening over the past three months and that was what India was up to. It was the market with stability and growth and it was outperforming.
I think at some point down the line, that trade will come back. It is not going to be uniform up trade for every market and there are certain emerging markets which have a lot of work to do in their backroom to fix themselves before their markets go up. But it certainly looks like that markets are oversold. In fact, my European team actually put out a note yesterday which basically said it is an all-house buy signal in Europe.
So, it may be happening with a lot of other markets which is that you have got some capitulation and therefore some of these fundamentally strong markets will trough out quite quickly which would include India.
Anuj: You handle a lot of foreign institutional investors (FII). Yesterday we saw a really large sell number. Of course, yesterday we saw the kind of panic in equity markets as well. What has been the anecdotal evidence as far as today’s trade is concerned and do you think there are bargain opportunities right now which the FIIs could be looking at or are we looking at two or three more days of ugly sell numbers?
A: I do not track that on an hour-by-hour basis and I am not sure exactly what type of investors sold yesterday. It was a big number, it was the biggest ever in our history on a daily basis and I imagine because our market cap has grown incrementally, we will get such record numbers often. But I do think that FIIs are not panicking. Most investors are staying out. Maybe some of the investors who had a short-term trading call may have liquidated their positions given that some key levels were broken yesterday. But, I do not see any investment panic as such.
So, FIIs continue to believe that this is the place that they want to be invested. I think you have interviewed a lot of investors over the past day and a half and most of them have reiterated that they are overweight India and they do not intend trim that. and I think that is also what I am learning from my clients.
Latha: Expert after expert we saw spoke with, did tell us that India is the darling for growth. We got some very extolling adjectives from most of them but usually don’t markets sell-off till the last bull standing is knocked off?
A: That would apply in the event that fundamentals start breaking down. There is a material difference here. There is reflexivity that we must keep in mind which is that share prices fall then they start hurting fundamentals and I can paint a story of how this can all weave into a bad fundamental story in the next six months and that is your dooms day bear case scenario. I don’t see reason to go down that path because we have got reasonable macro fundamentals.
I think we have a fairly responsible reaction from the government in terms of fiscal policy as well as from the Reserve Bank of India (RBI). So, with policymakers in that type of frame of mind we should be rest assured that India is okay. As this global volatility settles down, India will be back up on its feet.
Latha: I personally don’t need convincing at all about Indian macros. I am quite convinced that the improvement we have seen over the last 24 months is absolutely AAA meriting grade. However are the global fundamentals intact? If globally you think that economic growth is much more broken than markets have so far discounted then we can’t be spared in the tsunami. So what is the sense you are making of global investors view of the global growth story?
A: It is not a global growth story as much as it is probably say China and some parts of emerging world, maybe Brazil or maybe some parts of Central Europe. I don’t think this is as much a developed market (DM) growth problem. DM already had some issues with growth. So, there is no incremental growth issue in say US or in Europe except that maybe the strong dollar as the Fed pointed out was feeding into some negativity into the US.
The dollar remains strong and therefore the Fed has sounded a bit reluctant to raise rates in September which I think became the trigger for the sell-off which is that a lot of people thought that maybe the world is in deeper trouble than we thought. However, I don’t think this is a global thing as much as it is specific to China and a few other emerging markets and more so China. So markets will therefore wait for Chinese reaction. There was widespread expectation of monetary policy action from China which has not yet come through in a big way and at some point in time if the pain intensifies then China will react and that will act as a trigger to stabilise markets globally.
However, in my view, if I were to pin it down to one source of problem, it is largely China. It is not global in that sense but China is a big economy and like we saw in 2008 when the financial sector in the US had a problem and that problem reverberated across the world, so, there is that potential. As I said, if you paint a bear case scenario you can take that and say the whole world will be in trouble but it is too early to make that judgement in my view.
Reema: What about sector specific? We have seen nearly a 10 percent fall in the Indian markets in the last four days, which sector’s stocks started to look attractive where the risk-reward has now turned favourable for India?
A: That is happening in a lot of sectors, I would say the banks have turned a lot more attractive. Some of the private sector banks have gone back to where they were a year ago, so they have given up a whole year’s performance and that is lot of compression in price-to-earnings ratio (PE) ratios because most of them have grown their earnings at high-teen growth rate over the past 12 months. The industrials look attractive; the signals from India are that capex is turning. All the indicators that we see suggests that there should be strong capex in the next 12-18 months and therefore industrials will continue to build their order books, so the industrials look attractive.
I also think technology stock are good to buy at these levels even though there is a grovel growth care as we termed it but I don’t think it is so much a developing market (DM) growth scare and technology companies should be okay and the rupee is slightly weaker on a nominal basis which is always good for tech earnings. So, technology should do well and back home urban consumption, it is clearly healing, we recently published our proprietary alpha-wise research which shows that the urban consumption has been improving over the past six months and that continues to be the case. So, urban consumption should do well and that is where urban consumer companies should also do well. So, these are the three or four places where investors should focus on.
Anuj: Let’s talk about the overall market again, we have now fallen 15 percent from the top. This is the first real correction for our markets in the current bull cycle. The last time we had three or four such big corrections, what is the risk that we could be at the start of a bear market? I know this sounds quite scary right now but given the fact that this has been a different bull market which hasn’t had any correction, what is the chance that the 9100 top stays for quite a long time for our market and what we are in right now could be start of a bit of a bear market?
A: If I knew the answer to that question, then I guess we would not be talking to each other right now. It is difficult to tell, we have to-I can paint scenarios and we can come up with various situations where what we saw in February was top of the market, it seems less likely to me. I would be hesitant to go down that path and I would just think that this is a serious bull market correction which actually started in absolute terms way back in end of February and we had a correction which took us down to 8000 and then a rally back to say 8500 and now we have gone back through below, so we have had a couple of falling tops and falling bottoms, so you could call this as a correction which is now six or seven months old and has produced sizeable price retraction as well.
So, to me it still seems like a bull market correction. It is too early for us to say this is the start of a bear market but hindsight will give us perfect vision. I hesitate to think that because we have done a lot of macro healing. Earnings are improving, in fact on the point on earnings, we just did a bit of analysis for the earnings that ended in June and if you strip out the PSU banks, if you strip out a couple of global companies like say Tata Motors and if you take out the metals and mining stocks, earnings for the rest of the stocks in our coverage universe grew at about 17 percent. It wasn’t such a bad quarter, actually this was the best quarterly earnings that we have seen in six years. So, there was a fair bit of momentum that came quarter-on-quarter (Q-o-Q), the headline number hides it because we have got some really weak spots which are largely global and PSU bank related. So, I can see that the source of weakness is global and you can see that on the screen as well. A lot of companies that have global earnings are very weak right now, their stock prices are weak but going back to your question, I don’t think this seems like the end of the bull market, this looks like a serious bull market correction which will; afford opportunity for investors to buy stocks.
Reema: Let me come back to China. The government and the Peoples’ Bank of China (PBoC) have taken a series of steps which include reserve rate requirement cuts, interest cuts and that has not helped stem the fall in the Chinese equity markets. So, what gives you the confidence that even if we get some policy action from China, it will help in reversing this downward trajectory of the market? Because, it seems to be a crisis of confidence for at least in the Chinese markets. So, how will some policy action from China actually reverse this trend?
A: I do not have that much of confidence because I do not understand the Chinese markets as well. And maybe the action taken this far has not been sufficient. And by the way this is not about Chinese stock markets. This is about the Chinese economy. The Chinese stock market is not such a good barometer of what the Chinese economy is doing. Because, arguably even in the first six months of this year, the Chinese economy was still slowing down, but the stock market seemed to be in a different territory and they were up a lot.
So, there are two separate animals here. I am more focused on what happens to the Chinese economy which is slowing down. I think the headline growth numbers probably do not tell us exactly what is happening in what you would call as the old economy if China which is where all the disinflation pressure is coming to the rest of the world. So, that is where action is required. It is more on the economy rather than the markets.
Latha: What is your guess when the chips are down or when the crisis has blown over rather, do you think that India would get more brownie points for being the good boy, not just a recognition of inherent fundamentals, but probably some money abandoning China?
A: On three counts, India has already been rewarded handsomely. So, firstly is the fact that we are now outperforming emerging markets even if you go back to January, 2008. So, the entire bear-market underperformance has been absorbed in the last few months of outperformance. That is the extent to which we have outperformed.
The second is our relative valuations. Actually it is a little bit worrying because as of yesterday, our relative price-earnings (P/E) ratio was at about a 60 percent premium to emerging markets. And only one occasion in history have we traded at a higher multiple and that was in January 2008. So, we have rewarded with a higher multiple as well.
So, we have been rewarded with strong performance, strong multiple and also strong flows. So, what the FII numbers on an absolute basis hide is the amount of relative outperformance we have registered on flows because emerging market have seen continuous outflows for the last six months whereas India at worst is zero. In fact, India has seen net inflows. So, we have been rewarded in all three counts. And some of that reward is giving up because of the nature of the correction globally, but I think it will come back. So, I would expect India to continue to trade at these premium valuations.
In January, 2008, or in fact even before that, almost 6-8 months before January, 2008, the relative valuations had already started worrying us. We were very bearish in markets and after that I saw the index go up 40 percent because everything got so over-extended everywhere. But, this time I do not feel like the relative valuation is a reason to get worried on India because India does certainly enjoy superior fundamentals. So, I think you are right. That reward will come back to us after this correction.The Great Diwali Discount!
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First Published on Aug 25, 2015 12:25 pm