Indian equities at risk from global market connect: Jefferies

The biggest risk for Indian equities is its high correlation with global markets and Nilesh Jasani Head of Research (Asia Pacific) at Jefferies feels in case of a global risk-off situation likely due to events following Brexit, India could be under pressure.

In an interview to CNBC-TV18, Jasani says, it is unclear how post-Brexit economic and financial markets dominos will fall globally, but market risks have certainly climbed.  “Valuations in India are a concern,” he says.  

However, he also believes India's economic connect with global economies in 2016 is materially different from 2008 and this time there is a higher chance of India being insulated.  Below is the verbatim transcript of Nilesh Jasani's interview with Reema Tendulkar, Sonia Shenoy & Mangalam Maloo on CNBC-TV18.Mangalam: What have you made of the Brexit so far and what are the kinds of implications it can have in the markets across the world and at the same time when can we expect the implications to come by. Is it going to be something like Lehman or is it going to take longer period of time?A: The way I see Brexit is that it opens up a completely new event frontier. In my experience over the last 20-25 years there are very few time when you go through a sudden new event, a bit like Thai baht collapse of July 1997, UK\\'s Exchange Rate Mechanism (ERM) collapse and there are two or three other events that you can talk about who start their own chain of events.The reality is that as of now one can only hypothesize and talk about whether this may happen or that may happen. The only guarantee out here is that it is unlikely to not result in almost anything. There are a lot of people out there and there is a tendency that most of us have that somehow this won\\'t matter, somehow it won\\'t result in much, and somehow everyone is overreacting, while that is true of most of the things that we react to. I do not think that is true about Brexit; whether it leads to some sort of event in UK, more referendums, more votes, whether it leads to intense negotiations between UK and Europe, whether it leads to pressure on yen crossing 100 and policy reaction of various kinds in Japan or something in China. There are so many different scenarios one can paint and nobody is going to get them right. As I said the only thing guaranteed out here is that lot many more events are going to happen because of that vote.Sonia: What is the mood like amongst the investor community in Singapore currently? Do they believe that a large part of the Brexit correction has already happened on Friday or is it very naive to believe that it has been largely discounted?A: It roughly depends on the people you talk to. There are investors at various local markets whether they look at only Indian market or a handful of Asian markets. In our part of the world there are definitely large numbers of people who feel that maybe the biggest Brexit shock is over in financial market and the rest is going to b simple from here on while if you give a call to someone in Europe today, you will get a totally different impression. However, you get very different kind of reactions in the entire range.Sonia: What is your view? Is there s a chance of India or the Indian market decoupling from global markets over the next 6-12 months because of domestic issues improving whether it is monsoons or whether it is the earnings pick up?A: It is market versus the economy. I think decoupling is a word which I mocked at back in 2008 when I talked about how our economy was also massively linked to global economy rather than not just our market. I think this time around our economy has higher chance of being insulated. One of the things that I have looked at is capital flows as a percentage of gross domestic product (GDP) which was extremely high in 2006-2007, just as we were entering in 2008, one of the things the market hadn\\'t recognised back then was how much dependent our economy was on capital flows. However, that is definitely not the case now and that is a great positive that the economy is far more independent compared to where it was in 2012 or in 2008 - that was positive. I won\\'t say the same thing about the market. I think our market is extremely correlated with the world markets at least for a while in 2014-2015 when we had the wave on the back of the election, Dr. Rajan\\'s early years, that was the time when India was charting its own different path but if you look at the correlation over the last one year with global markets, Morgan Stanley Capital International (MSCI) world, MSCI emerging market indices, they are back to the very high levels that we witnessed some of the times in the last 15 years. So we are much correlated, we are in over weighted market, we are in over owned market, our valuations are a bit of a concern. If there is a global risk off and people have to sell because of redemption pressure. I think we will come under pressure. Reema: Do you see a global risk off which could result in the Indian markets under pressure because we are in unchartered territory and let me follow that by asking you, do you see the upside cap for the Indian market on account of global uncertainty and your take on the outflows or inflows from the investors?A: Let me try and answer these questions fairly quickly. On first question, whether we see the risk off or not. It\\'s anybody\\'s guess. As I said it totally depends on how events unfold. The chances of an event are high. I think in the nearest term our biggest risk is going to be the market itself. We had such a huge volatility on Friday. There are a lot of people who have come out and talked about their gains. And that always happens that those who make money are the first ones to come out and advertise their victories but logically there should be people who possibly have lost huge amount of money on Friday. Hopefully none of them in the kind of way that cost a major hedge fund burst at various time till last 15 years, but that is one near term risk. If we go pass that then I think volatility will depend on various developments in UK and Europe.In terms of my expectations on India, what I have been saying and that is a long topic, so possibly not for today, that India over the last two years, it was India\\'s tremendous top down, which was helping the market while a pretty weak bottom up was depressing the market and that is the reason why we have been in this narrow Nifty channel for about 18 months. We had last year, for example, one of the best interest rate cut cycle that we had seen in years. We had fall in inflation, fall in current account, fall in fiscal deficit, good GDP growth. It was the kind of top down combination, which according to my charts, we had never seen before in India. On top of that we had a government that everyone liked in the investment community and we had a central bank on which everyone had faith in the investment community. Our bottom up is the fact that we do not have any earnings growths for three years; three years earnings growth is zero, five years earnings growth is 2-2.5 percent. So we have publicly listed companies which are competing with agriculture in terms of the growth they are providing for five years now, not one or two but five years and those are the kind of divergent forces we are dealing with and with Brexit and with global environment, I do not think that it is much that changes on bottom up that our bottom up remains a bit of a negative factor on the market. So overall my view is that we remain in this channel and valuations will remain a concern at some time but equally if the market falls then people will like the way the economy is behaving, the economic resiliency as well as the governance will remain in the channel.Sonia: How high is the possibility of the market perhaps resuming its uptrend with some amount of ferocity? Only because liquidity could perhaps be in abundance now because there are some talks that the Fed rate hike could be postponed from September to December purely because of global volatility and now since Governor Rajan will not be extending his second term, there is a possibility of an easier monetary policy stance by the new Governor who comes through. Of course this is all in the realm of speculation but in your assessment how high is the possibility of the market hitting a new high sometime this year?A: I would say pretty low. One of the biggest themes that I am running with for quite a while was the risk of Dr. Rajan not continuing and one of the things that I have written since Dr. Rajan\\'s decision as not to go for the second terms, is that perversely the chances of any new Governor coming in and raising interest rates and not cutting, have gone up little bit compared to Dr. Rajan doing the same. I think what people often forget in trying to ascribe blames on the government on Dr. Rajan\\'s entire episode is that Dr. Rajan and Mr. Modi\\'s administration were roughly on the same page when it came to inflation. Yes, there was a minor disagreement on the pace of the cut but both the parties were roughly on the same page when it came to inflation even when it came to non-performing loans (NPLs). Their biggest difference was on fiscal policy. And that is where Delhi had a lot of issues with the Reserve Bank of India (RBI) having its own say on where the fiscal had to a headed and there are lot of angle over there including Fiscal Responsibility and Budget Management Act (FRBM), including what kind of things could happen but with inflation on the rise, with consumer price index (CPI) at 12 or 15 or 18 month highest level, with Uttar Pradesh (UP) election in May, with the base effect completely turning against the CPI from October-November onwards until March next year - my own calculation suggests that CPI could even cross 6.5 percent between December this year and March next year. In that kind of an environment, chances of interest rate cuts near zero.Sonia: In this kind of an environment since you are saying that there is a low possibility of the market hitting a new high. As an investor who has perhaps more than a year's time horizon, how do you approach the Indian markets now?A: It is roughly the return of what we had over the last 12 months which is - play the channel. There are times when the market gets very depressed, a bit like January and there are times when we are ignoring lot of risks like the time now when there are revisionist views on a lot of things including liquidity, including monetary policy and monsoon. If you play in this wide channel with some fundamental investments, there are great midcap stories out there, there are great secular stories out there, there is a lot in the market but expecting the market to go up is possibly a bit too much to ask.