Indian mkt to move higher along with emerging markets: Adrian Mowat

Indian market will move higher along with other emerging markets as flows into emerging economies could stay positive for the next two years, says Adrian Mowat of JP Morgan.

Indian equity indices were in a state of euphoria today after BJP won 4 out 5 state elections. Nifty crossed the 9000 mark and was also momentarily able to touch a new all-time high.

Speaking to CNBC-TV18, Mowat said that the last two quarters were tough for India due to demonetisation and the US election outcome but a pro-business and pro-reform government will keep confidence high in market.

In preparation of the goods and services tax (GST) it is unclear how the first 2 quarters of FY18 will fare, he said.

There might be some de-stocking as GST gets implemented, he added.

Below is the transcript of Adrian Mowat's interview to Latha Venkatesh and Anuj Singhal on CNBC-TV18.

Latha: We had to disturb you this early because Indian markets at fresh all-time highs. They just about touched and then we have seen some profit taking. What is your sense? Are we going to sustain a higher bracket for the Nifty now that there is a clean sweep for Mr Modi in another big state?

A: Yes, I think you will. We are very positive on emerging markets which obviously includes India. We think we are at a very early stage of a recovery in the relative performance of emerging markets (EM) versus developed markets (DM). Our global strategist has just moved overweight. If you think about the context of a five-year relative bear market in EM versus DM, positioning is still very bearish in emerging markets.

So we expect flows which have been outflows if you look at open ended funds in 2013, 2014, 2015 and only basically neutral in 2016, we think flows could be very positive this year, next couple of years and as people return to EM because it is offering premium growth and India will get a share of that story. So, I do expect India to move higher with emerging markets.

Anuj: You spoke about emerging markets correcting the underperformance versus developed markets. Within that, this year we have seen India in particular stand out. This year, MSCI India is up 13.5 percent while the MSCI Emerging Market is up 9.5 percent. Do you think some more outperformance would be there for Indian market especially considering we underperformed a lot last year in the last quarter?

A: You make a very important point there. Remember, we had the demonetisation story which was hand-in-hand with the US election surprise results, so India had a very tough final two quarters in 2016. So, you have got to be a little bit careful if comparing the performance from January 1 to date. It is probably fairer to look at how India has performed relative to EM since the beginning of the fourth quarter of last year. It is really performing more in line as opposed to outperforming when you take away the demonetisation correction.

Latha: To come back to the big political change that we have seen, strengthening of Mr Modi\'s power, as well as probably a greater certainty of him coming back in 2019, what should this mean to the markets? Any increase in earnings immediately, any increase in multiples?

A: Two years is a long time in politics, so I would not read too much in the 2019 election outcome based upon very impressive results in Uttar Pradesh. But for now, it is helpful for market sentiment around the political environment and on reform, but we have already had a lot of very good news on reform and so, much of that, I would argue is probably priced into markets.

The real test for this year is going to be the macroeconomic data particularly, do we see a pickup in business investment or will business investment be a little bit distorted by demonetisation and then by preparation for goods and service tax (GST). So, now it is about looking at the economic data as a opposed to politics and reform agenda where there is a lot of good news already priced into the market.

Anuj: We had a bit of a counter view this morning from Jefferies and their thought process is that a stronger Modi may not necessarily mean the reforms that market likes. It could be people-friendly, but may not necessarily be market-friendly. Could that be a bit of a risk?

A: Possibly, but the fact that we have a pro-business, pro-reform government that has been demonstrating that through actions, through legislations will keep the market reasonably confident and if, as we move closer to the general election which again is still a while away in terms of 2019, one would expect measures which are more electorate friendly rather than business friendly to occur. That tends to be what happens in democracies within that point of the elections cycle.

Latha: What is your view on economic growth and earnings now? Because of this stability and because of probably stronger state level governments, are you changing your gross domestic product growth forecast as well as your earnings growth forecast for FY18?

A: We have not changed those as of now but if we discuss earnings specifically, remember the composition of the Indian market. So you have got healthcare and IT where there are challenges to earnings particularly, because of some of the US administration\'s policies with regards to trade and outsourcing as well as their attack on the price of pharmaceutical products in the United States. The consumer staples space will have its normal steady growth and probably will not see positive revisions. We have had some stock specific issues in consumer discretionary and it is still unclear how the first and second quarter pan out in India with the preparation for GST.

So, there is a chance that you might get some destocking in the second quarter ahead of GST if that is deemed to be the right thing to minimise the tax implications. So, I do not see a strong reason at the moment to upgrade the gross domestic product (GDP) numbers and the earnings numbers for the market broadly.

Anuj: In that case, is there a risk because some of these are large sectors. Is there a risk of Indian market entering a bit of a bubble territory at least optically over the next six month period?

A: In discussing India with clients, there is some concern that the cyclical sectors that they want to get into are relatively high valuation versus their history and also versus the valuations available in other emerging markets. It is very important to understand here that the broader EM index is forecast to deliver around 16 percent earnings per share (EPS) growth this year.

So, there is no longer the shortage of earnings growth which there had been from 2011 to 2015 period. During that period of time, India did outperform as it was a significantly better macroeconomic story. Now, it looks as if it is on par with the other big EMs and the fact that valuations are higher may hold back the flow of funds into India relative to other emerging markets as the global allocator finds that it is easier to find value in growth elsewhere.

Latha: Do I understand you right? Generally, you are not a buyer at current Nifty levels overall. If you are, what pockets at all would you be buying and in fact, what would you be selling?

A: If you look at our asset allocation which has been sitting quite consistently at a sector level, we are underweight Indian IT, healthcare and consumer staples. So, I talked about the trade risk with IT and healthcare. Consumer staples sits in the camp of an expensive defensive. We are currently neutral in financials and in consumer discretionary. This is within our global emerging market portfolio and then we are overweight building materials, we are overweight at selected petrochemical plays, we have overweight in property and in some of the contractors.

But these cyclicals plays that we like, we like at a macro level, but then when we look at the stock valuations, we have some discomfort that they are quite high valuations for cyclical sectors particularly when elsewhere in EM I can often find cyclical sectors that are trading at material discount to their historic price-to-book.

Anuj: In a couple of days' time, we will be talking about the Fed decision. Do you think that has the potential to derail this rally or do you think emerging markets will move on regardless of what the Fed does?

A: I just remind people in 2004, the Fed had rates of 1 percent. By the time you got to 2006, they were at 5.25 percent. Emerging markets did extremely well during that period of time. If the Fed is raising rates because the US economy is strong then that is a very bullish signal for growth assets such as emerging market equities and that is now the way that equity markets are trading.

The market would be disappointed if the Fed did not raise rates because that might be signalling that they were less confident about the economic growth. So, it is great that we have broken through this psychology around higher rates being bad. They were never bad, they were a very good sign that the Fed felt confident that they could start to normalise rates.