Overweight FIIs the biggest risk to Indian markets: HSBC

Sonia: The International Monetary fund (IMF) has downgraded global growth and has also said that the China situation is worse than what they had expected, how much incremental bad news would you expect from China and how much of that do you think is already in the price?

A: In a sense you answered the question already --would it be in the price.

So we know that growth is quite weak and we have seen that the IMF has downgraded some of their estimates and they are looking for at 6.8 percent this year and China 6.3 percent for next year. That is alright but the valuations have come down for the Chinese markets as well.

The way I look at the Chinese market is basically it is a trading market. I think share value is somewhere around 11 times earnings, if it trades at a significant discount to that, it is a good idea to be overweight on China and that is where we are at the moment.

Sonia: Given the growth problems that we have beset with for the larger part of this year, would you write off equities as an asset class for the rest of the year?

A: Equities as an asset class, I would not write it off as for the rest of the year. I do think what we might see is a bit of a bounce in the markets. If you look at various indicators; you look at valuations, you could look at retail surveys, it does appear that some of the sentiment indicators are a little bit in the oversold territory. So you might get a bounce back.Currencies have moved a lot, price to earnings (P/Es) are lower, earnings estimates have come down but a bounce is only what it is, a temporary recovery in the markets.

For anything more sustainable to take place, we will need to see China to turnaround or at least to stabilise. Today we have a better grip on the numbers there and that I suspect will take a bit of time to materialize.

Latha: If you can elaborate a little more on China, we spoke earlier today to a Chinese expert who thinks, like the IMF that 6.8 percent growth is well within the grasp of that economy, is your sense that all the bad news is known about China and that markets have adjusted to that 6.8 percent or do you think that there is going to be further bad news?  A: No, I see that the markets are adjusting to levels even below that at the moment. So if you look at bottom up indicators across China, it would appear that things are not as bad as at least some people in the media are suggesting. I will give you one example, UnionPay has come out and said that spending in luxury hotels in China in August is as high as it has ever been. So clearly there seems to be things going on.

My Chinese strategist in Hong Kong, showed me a chart of the amount of cargo around China, I believe was down 5 percent year-on-year (Y-o-Y). But the amount of passengers is up 20 percent Y-o-Y. So we see shift taken place in that economy away from investment to consumption, away from manufacturing into services. In fact the picture that comes is with the lower growth profile but also sometimes the things which we were used to look at to understand what was going on in China, need to change as well. That uncertainty is a little bit added to that picture.

However, if I look from the bottom up perspective, I do not think that economy is collapsing as much as it is and gross domestic product (GDP) growth between say 6.5 percent and 7 percent seems to be quite achievable. We are actually looking for 7.1 percent for this year.

Latha: Indian growth has been lowered both by the Reserve Bank of India (RBI) and by IMF 24 hours ago, by about 20 basis points, 7.3 or thereabouts. What is your take on Indian equities?

A: Interest rates have come down this year, earnings growth is better than elsewhere across the region, at the beginning of the year, the consensus was looking for about 18-19 percent earnings growth, now it is about 11 percent, might come down a little bit further.

So, there is decent growth and it is relatively well exposed to lower commodity prices and less exposed to the downturn in China, so that is all positive right. But on the flip side because the earnings have come down, more than the markets come down, price earnings ratios have gone up in India this year, which is against all the other markets so it has become even more expensive.

This is my biggest worry, everybody is hiding in India. Global fund managers are overweight India, emerging markets fund managers are overweight India, Asian fund managers are overweight India. It is difficult to find someone who is not overweight India. So, this is my worry. If we do see a recovery in some of the other markets -- you can only sell what you own. It is very much a consensus trade and you have to be careful with consensus trade. So that is why we are cautious on India.

Sonia: What is the biggest risk for India now?

A: I think the biggest risk is not necessarily reform of momentum, I do not think it is earnings either, I think it is that holdings that is the consensual overweight that everybody is hiding there and in that sense the biggest risk is, for example, we do see stabilisation in China coming through, the Chinese markets suddenly look attractive, people want to switch in that market. I think China starts looking a little bit more even defensive and looks a little bit more attractive than India at the moment.

Latha: Where are you weighted on India? Even when something is screamed out, what will be the relative outperforming sectors here?

A: There are a couple of sectors which we look at. We know that US consumption is doing relatively okay. So some of your companies are exposed to that -- some of the selective IT names here, and of course you got lower interest rates coming through, which is good for some cyclical sectors, selective auto stocks would look good there as well. Even if there was more going on in terms of infrastructure, that is the place to look as well, although the evaluations of some of the key stocks are a little bit too high for myself but cyclical in that sense I would prefer.

Sonia: You were saying that the biggest risk for India now is the fact that everyone is overweight in India, but in your interaction with long only funds or with foreign investors, are you getting a sense that waned or are foreign investors still looking at increasing their allocations to India?

A: I would say if that enthusiasm could have been described as being euphoric about 12 months ago, with people dancing on the table -- at the moment we are off the tables -- but it still feels like reasonably good. I must say that in my conversations with regional US and European based funds some of that mood seems to be changing and as I said, I think that it is driven by China to certain extent. Some of the other markets are started to look a little bit more interesting. So I do not think people are lining up to sell and leave that market whatsoever but on the margin I think you might see a bit of rotation taking place. However, in general I would say the feeling is still the people like structurally India because there is a bit better growth and there is a bit of reform taking place. Interest rates can come down, the mood is changing away from euphoric to more normalised levels of optimism.

Latha: Let me come to crude. Lately, over the last 48-72 hours or maybe a week, we are seeing a floor being put to crude prices, noises about Russia negotiating with The Organization of the Petroleum Exporting Countries (OPEC) may have added to it, but there was one forecast actually calling for a turning point in crude. Do you see some fairly longish bit of upward correction in crude prices?

A: In the longer-term yes, we do believe that it is the case. Fundamentally, it is the market that remains oversupplied but if we work through that we see oil prices going to USD 60-70-80 per barrel in 2015-2016 and 2017. So we see a gradual recovery, that gives a weak demand environment. it is interesting to know that the oil prices given what is going on in the Middle East have not spiked which it normally does, if there is so much unrest in the Middle East, so clearly demand is a worry.