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Last Updated : Dec 30, 2015 07:53 AM IST | Source: CNBC-TV18

Indian mkt has lost its beta; it is worrying: Ridham Desai

Even as foreign institutional investors (FIIs) continue to remain positive on Indian equities, with most being overweight, there is one aspect that worries Ridham Desai, Managing Director and Head - India Equity Research, Morgan Stanley.


Even as foreign institutional investors (FIIs) continue to remain positive on Indian equities, with most being overweight, there is one aspect that worries Ridham Desai, Managing Director and Head - India Equity Research, Morgan Stanley.

"India has lost its beta with respect to emerging markets," he told CNBC-TV18's Udayan Mukherjee in an interview, referring to the measure of volatility of a portfolio when compared to a different index or market.

"In some sense, it is not considered as an EM. The risk with that is: if EMs rally [going into 2016], India may lag peers," he said. 

Morgan Stanley has a Sensex target of 30,200 for 2016, Desai said, adding that he was bullish on rural consumption as a theme for next year, even as he believed wider private capital expansion would continue to remain sluggish.

Below is the transcript of Ridham Desai’s interview with CNBC-TV18's Udayan Mukherjee.

Q: Do you think 2016 is the bounce back year after what has been a disappointing 2015 or are there too many ifs and buts clouding the picture?

A: If I just reflect on say, 2015 the number of ifs and buts seemed a lot lesser than they are at the end of 2015. So, intuitively that would seem to be in favour of the market which is that a lot of people are far more skeptical about 2016 than they were of 2015 and usually that is a good starting point. It would tend to suggest that expectations are lot lower. So, that is definitely a positive at the beginning of 2016.

Certainly, there are issues to worry about as they should be and the issues should be a lot more than they were at the start of 2015. For example, who actually imagined that we would get such a fall in commodity prices like we got in 2015. So, that resets the base for 2016 and therefore it makes it less likely that commodity prices fall much more from here but we never know because China is still a source of worry for the rest of the world.

My own view is that we have a better starting point for 2016 than we had for 2015. So, while I have to admit I was optimistic at the start of 2015 and it did not turn out that way I am retaining my optimism for 2016.

Q: Just on that point that the starting point is better because there is more cynicism right now than it was in 2015, from a positioning point of view how would you say that has played out because while the cynicism has played out from an Foreign Institutional Investors (FII) perspective they have continued to be sellers in the second half. From a domestic perspective which has been the bigger liquidity story of 2015 they seem to have still kept the faith. In that they have not reduced their portfolio holdings or withdrawn money from the market because of the seeming scepticism which has crept in?

A: Actually that is a very interesting debate because I would actually argue that even FIIs have not given up their positioning because what you see in terms of FII outflows is actually a fraction of what emerging markets (EM) have witnessed. Let us not forget India operates in the context of the EM world.

The EM world has seen over USD 50 billion of outflows in 2015. India has actually seen net inflows, albeit outflows in the second half but on the aggregate for the whole year it has been net inflows. So, India has actually, I don’t think even seen that type of capitulation from FIIs.

In fact, the data that we track tends to suggests that if anything FIIs are still overweight India. Anecdotally, when I ask fund managers they tell me that India is amongst their favourite market if not their favourite market. So, I would actually argue that even FIIs have not really changed their positioning a lot. Yes it has come off a tad from the highs that we have seen in the start.

Q: Is that a good thing or bad thing in your eyes?

A: That is actually, the challenge for the Indian markets and I was actually going to step in to that point which is that India has lost its beta relative to emerging markets over the past few years. That beta has been steadily declining since 2008 and India is getting isolated in the EM world.

Which is people are looking at India as a different market which is it is not in the EM basket and to that extent that is always a danger because it means that if there is a 2008 style fall in markets around the world then India will obviously hurt a lot more because it of its rich positioning.

It will also hurt India if emerging markets rally, not our base case scenario because we think that fundamentally the EM basket is a lot more challenged then the developed market (DM) basket. However, if the EM basket would rally for some reason India will underperform.

Now for the investor sitting here inside India that may not be a matter of concern because actually what he will see is the Nifty and the Sensex rise in absolute terms while India underperforms and it will be a better situation then say the second half of 2015 where India actually delivered stellar outperformance but fell in absolute terms.

So, India’s low beta characteristic works well if returns in the world are modest as we are expecting right now. However, if the returns turn more bullish then India will underperform.

Now the second part of your question with regards to domestic liquidity that is one of the things that we got accurately than other things that we forecasted about the market in 2015 which is that we believe that we are at the throes of a structural shift in household savings into equity and that is happening because of several reasons.

I won't delve into those reasons here because that will consume a lot of time, but the bottom-line is we think that these allocations that are happening to the equities have a more sustainable nature to it. They are coming through systematic investment planning (SIP). We have seen a six fold rise in SIPs over the last three years and we think that will continue.

So, there is a shift. It is like the 401k type of shift that the US experienced in the 80s and the domestic investing into equities actually sustained for almost 30 years in America. So, I reckon that we are at the beginning of such a shift in India as well. We have seen a few tests. We saw a big fall in the market in September. We saw a lot of question markets in November-December but domestic investors have held their position which essentially points to this underlying structural trend.

So, 2016 domestic investors probably continue to buy equities, foreign investors will depend on what happens to EM flows and if the EM flows turn around dramatically then you should be prepared for underperformance from India though on an absolute basis obviously the market will do a whole lot better than 2015.

Q: Last week I read two articles, two pieces, one from current colleague though in a different arm of Morgan Stanley Ruchir Sharma and the other one was Russell Napier. Russell Napier spoke eloquently about how we should expect liquidity in emerging markets to go down and Ruchir Sharma stopped one step short of saying we could be headed for a global recession in 2016. I am sure you have read both those pieces. Does that worry you that these could be possibilities?

A: Yes, of course these are possibilities and they are part of the bear cases we outline for the market. The learning out of the last decade has been that point forecast has little meaning in what tends to be a very complicated global market place and we have to iron out the ranges for market which is various scenarios that may play out. If I look back on 2015 the index is ending close to our bear case for 2015. So, it was inside the range that we forecast for the index but the bear case scenario.

Now, why can't that happen again in 2016, of course it can and very clearly the risk is that China actually goes down a leg, triggers what you would call as global recession. The EM asset class seems very broken and there is no reason right now to believe that that is turning around and therefore EM could continue to lose money and these are possible scenarios. Mind you, if you these scenarios play out India on a relative basis actually will continue to do okay though the index on a headline basis will struggle to deliver absolute returns.

In fact if I look back at 2015 and it is a point I was making to a fund manager a while back is that actually there was hardly any place in the world where you could make money. Bonds actually delivered negative returns, equities struggled to deliver, gold delivered negative returns, commodities delivered negative returns.

So, it was a very bad place to hold anything other than cash. And if you recall at the beginning of 2015 the consensus view was cash is the worst thing to have and actually at the end of 2015 most people would have been better on to hold on to their cash.

In the context of what was otherwise a very poor market environment India did okay. India has come about pretty unscathed. So, if such a thing continues in 2016 then India probably will again look as I have cited before the good boy in the bad neighbourhood and that situation may not change but these are scenarios and that could take us to the bear case again in 2016.

Q: What are the Sensex levels or nifty levels for your bear and bull case scenario for 2016?

A: Our base case is about 28,000. The bull case is around 34,000, the bear case is around 22,000. If I weigh these by probabilities that we anticipate for each of these scenarios we get a yearend target of 30,200. So, that is the Sensex levels that we are looking at for 2016.

So, we are looking probably at 10 percent or downside from here if things turn really bad. And of course, conversely we are looking at a substantial upside if things turn around better. Overall the absolute return may not seem very attractive but the context here is that we are expecting mostly single digit returns for equity markets around the world.

Q: What about banking? I was going through your focus portfolio and you have a couple of high quality names there like HDFC Bank and IndusInd Bank. But even there you seem to be saying through your portfolio at least that stick to quality out here because it could still be a hairy year for financials?

A: First of all the whole market has actually seen a bit of shift. In fact it may not have escaped your attention and a lot of other people's attention that quality persistently lost performance in the second half and defensive sectors also lost performance. So, even though the market was down about eight or nine percent in the second half it came at the expense of quality and defensives.

Cyclicals and so called high beta stocks did measurably better. So, in a way it was a very odd market because if the market is falling you would not expect that to happen. This is happening because a lot of quality stocks are very richly valued and therefore you have to be careful about buying too much of quality in your portfolio. I would be a little bit more cyclical and a bit more attentive to the starting point of valuations that you pay up to buy a business.

That said the banking sector we continue to remain cautious on state-owned enterprise (SOE) banks and therefore we have to veer towards private sector banks. I would argue that private sector banks are not that richly valued and therefore they do not fit the conventional quality theme which has been persistent in the market in the last four or five years which is buy expensive quality names and you are okay.

So, a lot of private banks actually are trading at reasonable valuations but as I said you have to be careful about stuffing portfolios with too much of quality which has been the anchoring of the market for the past four or five years.

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Q: The other segment of the market which people look at closely these days given the fall in crude has been the oil sensitives whether it is the aviation or oil marketing companies (OMC) I don't see too many of that in your focus list. Any reason?

A: That is also to do with the coverage that we may have as a firm. So, my focus list only consists of companies that we cover rather than a broader universe of companies but I would also argue that the best of the oil sensitives is behind us.

The trade is - I wouldn't use the worst phrase, done and dusted, but a large part of it is done in 2015 and even if oil were to fall from here there is not that much gain that the oil sensitives will make.

So, what I would like to see is buy companies who have used this fall in commodity prices generally speaking, not just oil because it is not only oil that fell in 2015 and invest it in their business for growth rather than report better margins in the next few quarters and show high profits because we don't know how sustainable this is and therefore companies that tend to take this gain and invest it will be rewarded by the markets and that is the way I will pursue the oil sensitives. But as I said a lot of the upside is already baked in the cake.

Q: If you had to bet on either consumption or capital expenditure (capex) as a theme for 2016, what would you lean towards in India?

A: The two things that dragged the economy down in 2015 were rural consumption and private capex. Arguably government capex has done quite okay and urban consumption has shown measurable signs of recovery specially in second half.

So, the question if I were to further narrow it down would be whether I would bet on rural consumption versus private capex and I would go for the former. Rural consumption in my view is bottoming out albeit keep in mind that we should not get another bad monsoon.

The early weather forecast from sources outside India suggests that we may be entering into a La Niña after one of the most - or I should say - the most severe El Nino that the world has witnessed since the 70s and if it is a La Niña it means India will get bountiful rainfall and that will actually help but even without that assuming that we get a modest monsoon rural consumption may have seen its worst.

Rural consumption took a lot of hits in 2014 and 2015. To start with the compression in wage growth that happened which caused real wage growth in rural India to actually turn negative. Then it was followed by the fall in food price inflation and a bad monsoon. So, a lot of those hits are in the bag. So, I would bet on rural consumption.

We in fact just finished a proprietary survey of India's top 200 companies and it doesn't look like private capex is about to start. In fact most companies are saying that for the next one or two years they don't intend to actually start new projects. It doesn't surprise me because there is still a fair bit of excess capacity in the system, especially in the commodity sector.

If you go back to the capex cycle of 2003 to 2008 50 percent of private corporate capex happened in two sectors; downstream energy and steel. I don\\'t think anybody wants to set up new refining capacity and new steel capacity in a world where there is so much of excess capacity in both those sectors. So, other sectors need to find their footing and grab the pie and that may take time.

Outside the internet economy I don't see that much investment happening in the private sector. So, it looks like the private capex will continue to perform in a sluggish fashion whereas rural consumption could turn. Urban consumption is probably going to look stronger. Therefore, overall consumption will outperform capex. I am still bullish on government capex. What they have done in 2015 looks encouraging and that should continue in 2016.

Q: What is the best way to play this rural consumption revival? Do you stick to the tried and tested M&M, two wheelers kind of theme or do you look at areas like agri related companies or even consumer durables? What in your way is the best way to climb that tree?

A: In fact all of them are actually embedded in our focus list. So, quite a few of them should do quite well. Whether it is in the auto space, whether it is durables, I would say even retail because some of them goes into semi-urban and rural India and even the agri place. So, all of them have scope for improved performance in 2016.

Q: What is your most contrarian call for 2016 in terms of a portfolio preference, something which the street does not like but you happen to?

A: Rural consumption because today the consensus is that rural consumption is not going to recover in a hurry and probably that is the theme that stands out versus the consensus. The other place where we have been out of consensus is in our bullishness on technology and I was just looking at the data yesterday.

Technology is going to end this year as the best performing sector in the second half of 2016. It has actually even surprised me that it has done that well because I did not actually think that technology is doing that well but that may sustain because of the calls we have globally is that the bull run in the dollar is not yet over and when I am choosing a dollar oriented sector to me technology looks a lot better than say, pharmaceuticals where the valuation headwind is still strong. It is coming off but it is still strong.

Therefore, technology could also be one of those out of consensus calls that we have.

Q: How do you see deflationary trends, deflation as a threat locally and globally for 2016 because it is something which the world is struggling with. Even in India there seems to be some sense of deflationary winds blowing which is preventing a lot of companies from coming out and saying that I don't have the confidence yet to go out and invest in a big way. Do you see that becoming a bigger problem?

A: Absolutely, in fact that is one of the key risk factors we highlight for 2016 which is that deflationary trends persist and certainly that wont auger well for earnings because if I look back on 2015 we were far more optimistic on earnings than what we actually got and when I analysed why that happened one of the key bottom up constituents of that earnings forecast going wrong was the fact that we got more severe deflation than we anticipated.

On a top down basis it happened because the government's fiscal deficit actually came lower than our forecast and global trade collapsed in a manner in which we were not forecasting. So, these were the three things that fed into earnings.

Deflation was part of the story and that continues to be the case and it is certainly a headwind for earnings. We have had negative revenue growth as a consequence of that. And if the wholesale price index (WPI) stays in the minus four or minus three percent range it is difficult for revenue growth to recover and if revenue growth does not recover it is difficult for profits to recover. So, even though margins are expanding profits are not. So, I would definitely make that one of my key risk factors for 2016.

Bottom line is that India needs a bit of stability in the commodity price situation. Albeit it has benefitted us a lot in terms of improving our terms of trade which looked the best they have been in several years it has helped us rebalance our savings, it has helped us in stemming inflation but now we want commodity prices to stabilise. That will be symptomatic of more stable global growth environment. It is essential for absolute earnings in India to recover.

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First Published on Dec 29, 2015 03:54 pm
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