Adrian Mowat OF JP Morgan said that China, which has been a laggard, is beginning to outperform. He believes that there will be inflows into emerging markets in general.
Adrian Mowat OF JP Morgan said that China, which has been a laggard, is beginning to outperform. He believes that there will be inflows into emerging markets in general.
His Nifty target stands at 10,000 by 2016-end.
Among sectors he is underweight on, he includes IT and healthcare. The Indian IT is an investment capex play on the corporate sector, he said.
Even if the US Fed hikes rates, it won’t be bad news, he says, adding that Fed will be raising rates from low levels to normal levels. “That is a positive sign.”
He is looking forward to a 25 basis point cut in repo rate in the final quarter (Oct-Dec) of the year. "We expect the RBI to be data dependent," he said.
Monsoon trending lower than expectations is a negative, he said, adding that it is important that the rural sector enjoys the benefits of a good cloudburst.
In the financial space, he thinks the housing finance story is working well. “The underlying dynamic is a large delivery of units is coming through. If you look at household debt to GDP, it is very low.” He also flagged some questions that remain about credit quality.
Below is the verbatim transcript of Adrian Mowat's interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.
Latha: The volatility that Anuj was just speaking about -- we are confused as viewers and you will be better placed to explain this to us, on the one hand, several big economies are going through negative interest rates and on the other equity valuations more than India and in the US are near all time highs. Which is correct? Is it that the economy is doing well or is it that the economy is doing poorly? So should we expect that there is going to be a big meltdown?
A: I think there is a link here because you have got risk-free rates at record low levels, which will have an influence on other assets, which are priced at relative levels. So this is why valuations in US and in India are at high levels. Now India has another advantage, which is high growth rates. I think we also are too negative on the US economy. We had some very strong household income numbers at the US, employment growth is healthy, credit growth is healthy and so the fact that the Fed is debating, moving interest rates to a more reasonable level is a very positive message.
Latha: We have got about just two or three days of foreign investor outflows. It is about all of Rs 1,400 crore; it is not a great deal in terms of -- maybe USD 500 million or not even that much, probably USD 200 million. Should we worry that there can be a net outflow. It is three continuous days so Indian markets start palpitating?
A: I don’t think you should worry about that. If we look at the context of this flow into emerging markets, if we did the three years to the tapering scare which was back in May 2013, the open ended funds got something like USD 340 billion. In the last three years, we have had USD 85 billion of outflows. So, positioning in emerging markets is very underweight by global clients.
Now, I would say that within specialist emerging market funds, India remains a popular overweight.
Latha: If you are not worried about the outflow itself, within emerging markets would you say there could be a major churn? We know that you have moved from overweight to neutral on India, do you think that we are going to expect outflows, maybe not too much of inflows into India, would that be a legitimate worry?
A: I think the dynamics of this is we are still forecasting very high return out of emerging markets. So, another 15 percent and India being a neutral is really implying that the Nifty goes to 10,000. So, that is a very decent return. However, we think a market like China which is being the year-to-date (YTD) laggard, is now beginning to outperform.
This market is undervalued, it has got a very nice cyclical lift coming through in the economy, the earnings numbers are coming through very strong for the cyclical stocks. So, definitely we think there will be a rotation by the specialist emerging market fund into places like China and India as an overweight will see some of the bad side of that rotation. However, let us also imagine we will have a situation where there is inflows into emerging markets in general.
Latha: You said 10,000 on India, that sounds very positive, what may be the sectors or stocks that will take us to 10,000 and is that a one year outlook or beyond that?
A: This is our year-end target, so, just to show how optimistic we are on emerging market as Nasdaq falls. The drivers are not going to be the drivers that worked for the last five years. So, you want to be very underweight, things like healthcare, IT, defensive names like staples and you are going to be overweight your consumer discretionary, your near cyclicals like financials, building materials, engineering companies that should be starting to see order inflows.
So, we also think the way you structure Indian portfolio is changing very dramatically. What we are finding is that because being defensive for the last five years has been the right strategy, there is a natural reluctance from the active managers to do this.
Latha: In the 2003 to 2008 period when the Fed kept raising rates, we saw emerging markets do exceptionally well. So should we assume that even if the Fed were to start hiking rates, it would not be negative for countries like India?
A: It is absolutely not negative. The Fed raising rates from ridiculously low levels, this is emergency interest rate levels to more normal levels is a very positive sign. It is a confident sign, it means risk-on and the problem we have had is we were zero interest rates for so long, the people have come out with all these different financial theories, they used this word, liquidity constantly without even defining what it means. It is a negative sign when the Fed doesn’t raise rates from these low levels.
As they have raised rates -- it would be great if they raise rate in September and December. Our core call is they raise rates in December. Remember when they did Fed lift-off December last year, we did see very steady emerging market (EM) currencies, there wasn’t a capital outflow the people feared. The other thing to bear in mind at the moment is there is distortion because of changes in money market regulations. So, if you look at the interbank market in the United States, it is already pricing about 45 basis points (bps) of Fed moves. So the currency market is already reflecting this.
So I would like the Fed to move more and that is very good for risk assets.
Latha: If you have looked at the performance of India, the sectors that you are underweight on, for instance IT -- yesterday Apple had its best day so to speak, would you move out of IT or is it that you are not just incrementally adding to IT and healthcare as you said?
A: Apple is a very specific hardware story to do the iPhone7 and also Samsung has problems with its key flagship product at the moment.
Indian IT is more of an investment capex play on the corporate sector, which has some influence maybe with the uncertainty that is going on in Europe, it is not just the United States' play.
Latha: So, are you saying that you expect Indian IT to be sold off further or do you think scaling down their growth rates from 15 to 20 percent to probably at the most, high single digits or maybe 10 percent is adequately factored in in the price.
A: What I am saying is that we are going to make more money out of cyclical sectors, which are domestic cyclical sectors. So, you have got this strange effect here where the real gross domestic product (GDP) number's forecast come down a little bit but, what is going to happen is the nominal GDP number is accelerating. So, if you speak to companies that are in domestic cyclicals, they felt that 2015 was a pretty tough year, you had wholesale price index (WPI) deflation. As we look at 2016, generally the message coming out of these companies is much more upbeat. We have had quite a lot of earnings beats, earnings upgrades in the more cyclical sectors.
Latha: Generally what was your view of the earnings season itself? I think we had three years of practically flat may be 0-3 percent earnings growth. This Q1 numbers did they impress you more in India?
A: They were definitely better particularly if you are looking at the more cyclical sectors. When you looked at the financials, obviously, they were at the tail end of the provisioning cycle and so those would have an influence.
The other thing is you get big sectors such as energy having a drag on the overall earnings growth numbers. As we look to the cyclical, we are expecting to see the surprise. There is evidence of that coming through but the real momentum is going to be in 2017 as real interest rates in India fall that will support particularly corporate capex going into 2017.
Latha: Real interest rates, what are you factoring in by way of interest rate moves? We have had a fairly decent inflation number, dipping all the way from 6 percent to 5 percent. So, what are you factoring?
A: We are looking for a 25 basis point cut in the repo-rates in the final quarter of the year and moving down to 6.25 and we expect the Reserve Bank of India (RBI) to be very data dependent. They have a specific target on inflation and depending on how the data moves, we will see maybe further cuts.
We are very much focused on the data. If the data allows them to have further cuts, then those come through. But at the same time, what you are seeing is a normalisation in WPI which is deflation into a more normal level so the real cost of capital is falling.
We have also had an opening up of the bond market here, the corporate bond market. So if you look at the yield curve, it is moving down by about 100 basis points across the curve. So, the actual cost of money, maybe relative to the reference rate is getting cheaper as well.
Latha: How do you react to this news that we are just getting? It probably could change that the monsoon is afterall not going to be as good as it was earlier predicted to be, that it would probably be about 3-4 percentage points below the long-term average. Would that change the kind of stocks you are looking at in the consumer space?
A: One thing I have been always been very impressed that people try and predict the monsoon. I am not entirely sure what the weather is going to be like tomorrow. So, it certainly looks like that September data -- we have got 14 days or so of September -- there is a deficit building and I think they are talking about a 5-6 percent for the overall monsoon, but possibly September down 15 percent. At the margin, that is negative and maybe would result in a little bit less flexibility for central bank as poor monsoon is going to be negative for inflation.
The other thing that we need to think about as capital market investors, if we are thinking about the continuity of the government, it is very important that the rural sector enjoys the economic benefits.
So, having a good monsoon is clearly good for rural incomes. We need to be sensitive to this. We live in a world where there is a protest vote in the form of Trump, Brexit and often as capital market investors, we do not have a lot of empathy to what the voters are feeling and what is the median income of these types. So, there is some nervousness around the monsoon.
Latha: Let me come to your specific sector preferences. You have a neutral on stocks like ICICI Bank and State Bank of India (SBI) and an overweight on HDFC Bank. Now, I know you will not talk specific stocks, but if you are betting that the economy is turning, what is the reason for keeping away from corporate banks like ICICI and SBI? Is it only a matter of time or is it a valuation problem?
A: First of all, I am an equity strategist, so I do not cover these stocks. As the equity strategist, I am overweight Indian financials in a global emerging market portfolio. That includes corporate banks. So, as a strategist, I have a different perspective than the analyst and the analyst is making recommendations within their universe of stocks that they cover.
Latha: In that case, in the financial space, would you go across? Lately, we have seen a lot of non-bank finance companies also doing well. So, would all that be positive for JP Morgan?
A: The housing finance story is one that has been working extremely well. The underlying dynamics of it is there is a large delivery of new units coming through which may be negative for property prices. But it does mean that there is this demand for mortgage financing. And if you look at household debt to GDP here, it is around 10 percent to GDP so it is very low. So, as a structural story, housing financing looks interesting.
There is some nervousness. When you grow credit at such a large rate, there are some questions about credit quality, but typically, loan to value ratio is relatively modest here and the medium-term risk, that is quite low.
This is more a story of as we enter an environment of falling real rates and acceleration in nominal growth, then the concerns, which at the beginning of the year which were all about a provisioning cycle, those move into the past and you will tend to move down the quality curve a bit as that happens. And so it has backed this whole cyclical argument.
Anuj: I wanted understand, this 10,000 target that you have is for 2016 end? Are you calling for a big rally in the last two months once this Fed uncertainty is out of the way?
A: Absolutely. We are expecting EMs to perform very well in the final quarter. I do not think you will get the uncertainty of the Fed out of the way. Our core view is that the Fed will lift in December. I just think people are going to get a little bit more considered in this paranoia about the Fed moving rates by 25 basis points, particularly, if they cared to look at the inter-bank market which is already more than discounting this.
Sonia: I heard you mention the sectors that you will stay away from like IT because of the problems that they face, but over the next 6-12 months, what are the sectors that you see more value in because, pieces like consumption have done exceptionally well up until now, but here on, where do you see value?
A: The strategy view is you want to be in domestic cyclicals. So, we are not necessarily saying something negative about the defensive sectors, in that there is a negative delta in their fundamentals. These have been the places that investors have hidden for the last five years. We think they underperform as you move into more cyclical sectors, which will have the positive earnings revisions. The dynamics of constructing our views in India, but in other emerging markets -- it is six months into the rally -- is very much driven by positive earnings revisions.
Anuj: In terms of positive earnings revisions, could we be at an inflection point of earnings in corporate India and in that sense, maybe we are being a bit myopic looking at the above median valuations? Hindsight of course, will be 20/20, but 2-3 years down the line, could we look at these numbers and say that the market was trading quite cheap and not above median valuations? Could we be at that inflection point?
A: There are a number of factors that are influencing valuations so, globally we have got very low risk free rates. So, if you look at the US equity markets, it is expensive both on price to book and price to earnings versus its 10-year history, but it looks very cheap versus bond yields. Now, the US valuations are having an influence on global equity valuations and remember with the US and with developed market equities this year, there is zero earnings growth whereas in emerging markets, at the moment, the number is about 7 percent earnings growth and many companies in India delivering higher earnings growth than that. So, the valuations on a relative case do look attractive. When we are looking at valuations in India, we are probably looking a little bit more price to book at the moment than price-earnings ratio (P/E) in the sectors where earnings are depressed.
Sonia: Just a larger question with regards to the emerging market flows. Post the Brexit, the Chinese stocks have been the biggest winners of the EM flows, so we have seen a lot of passive flows move into the Chinese market. In this India versus China debate, where do you see the higher amount of fund flow coming over the next six months?
A: Definitely in favour of China, people have been comfortable with the fundamentals in India is definitely getting a cylical lift but positioning in India has been more favourable than it has been in China. So the wall of worry is much greater in China and gradually investors are being forced to put more capital to work in an underweight market which is China.
Latha: It is interesting that you say China because earlier this year recently as in January, there was this big fear of a potential Chinese devaluation, where would you see the red flags? Of course earnings growth has picked up in India, Q1 indicates that but nevertheless, if we have to look at red flags, could it be yet another Chinese issue, what in the global scenario makes you nervous?
A: I think near-term, it is much more likely that the risk premium around China continues to decline. There is a growing realisation that the People's Bank of China (PBOC) is maybe being the most fortunate Central Bank. In that they have very steady foreign exchange reserves and a modest appreciation of the renminbi, which is very good for their cyclical sectors. The Bank of Japan would love that, they have experienced 20 percent appreciation in the yen.
So I think the area where investors are most nervous is this whole debate around the review of qualitative easing (QE) by the Bank of Japan and the European Central Bank (ECB), although in our interpretation, investors are missing what the Central Banks are going to do here. It is quite possible that the ECB will expand its QE programme in terms of eligible assets and I don’t think there is any indication from governor that the Bank of Japan is going to moderate their programme. So, we should not compare this to the 22nd of May of 2013 where we read about tapering, which was the Central Bank in US ending QE.
So this is tiny amount of volatility, we are worrying about market moving 2 percent and then the following day was at 1 percent and the next day was down about 1 percent which is basically flat. I think a little bit more volatility is just normality, we shouldn’t be so anxious about this and I think the EM equities are trading well, EM currencies continue to trade well, even with this extra element of volatility.