2013 outlook: JPMorgan AMC cautiously optimistic on India

JPMorgan has been a big foreign institutional investor (FII) into the Indian market over the last many decades. Edward Pulling, managing director and chief information officer, Asia Pacific Equities at JP Morgan AMC runs or oversees about USD 3 billion of FII money into the Indian market. He is an old India hand and a veteran.

In an interview to CNBC-TV18’s Udayan Mukherjee, Pulling says, he is pretty constructive on Asian markets for 2013. "There is more upside for valuations in Asia, assuming earnings can deliver," he adds. Talking specifically about India, he says, he has been astounded and depressed by the level of deceleration in investment in this country. "I did not predict this evaporation investment in India. A revival in investment is necessary," he asserts. He remains cautiously optimistic on India. "We need to see concrete action by the Indian government," he adds. According to him, foreigners are in stock picking mode. "India has always been a rich market for stock picking. If you look at the companies in India, if you look at share prices, there are a lot of stocks trading at all time highs despite where the market is. So, global capital will search out the best companies and will invest in it and will push those companies up to relatively high valuations," he elaborates. The biggest risk, he says, is the fiscal cliff. "It is going to dominate the airwaves atleast for another six weeks," he adds. Also read: Nifty to touch 6000 on reform; market may be volatile, says UR Bhat Below is the edited transcript of his interview with CNBC-TV18. Q: How are you feeling about 2013? Year 2012 has turned out to be a pretty good year for equities, contrary to what people thought at the start of the year. How do you see the next year in terms of Asian equities in general or emerging markets and India in particular? A: Let’s start with Asian markets. We are pretty constructive looking into 2013 for a couple of reasons. First and foremost, valuations are conducive. There is more upside for valuations in Asia, assuming earnings can deliver. In terms of earnings, we have been suffering from consistent downgrade to earnings forecast in about the past 18 months. There is a belief that, after this most recent quarter results, earnings forecasts have stabilised or be at lower levels, but they have stabilised. Equally, there are some bright spots in the global economy, which could lead to improvement in earnings acceleration. So, we are pretty constructive on Asia looking into 2013. Q: Would you say that it is too early to say that it is a start of a multi-year trend or a bull market or do you think what has started with more than 25 percent gain in 2012 could be the early start or the early signs of a bigger trending bull market? A: There are reasons to be more optimistic looking into next year. I would say that the strength of the US economy is more compelling and in particular the housing market looks much better now than it has in the past. Certainly, in China, the economic data, from the past couple of months, is much better than it has been in the previous three-four quarters. In Europe, we are not sceptical, but we are still cautious. We would say there is significantly diminished tail risk, but we have very low expectations for the European economy. It is too early to predict a linear bull market. But valuations are still conducive. There are reasons to believe earnings forecast have stabilised. When you are in the fund management business, its earnings and valuations more than anything else it matter. _PAGEBREAK_ Q: At the fulcrum of it, there has been those huge flows, we have got more than USD 20 billion this year, do you see that construct being in place for 2013 where we continue to benefit from some serious global portfolio flows into Asia and disproportionately large in India? A: Let us talk about India. It looks like this year is going to close with about USD 20 billion of FII investment. When you scrub the data, there are few anomalies in there, but still it is pretty good year for investment. I think that foreigners are very much in stock picking mode. India has always been a rich market for stock picking. If you look at the companies in India, if you look at share prices, there are a lot of stocks trading at all time highs despite where the market is. So, global capital will search out the best companies and will invest in it and will push those companies up to relatively high valuations. That you have seen in the Indian stock market this year. The best companies have been rewarded. Q: What in your eyes is the biggest risk right now between Europe and the fiscal cliff? What would you say is the biggest risk to your hypothesis that 2013 might be good? A: The biggest risk, right now, is the fiscal cliff. This is going to dominate the airwaves atleast for another six weeks. I say this with a lot of caution, but in all likelihood, Congress will arrive at a band-aid solution in the near-term. They will punt in the medium-term. This subject will continue throughout atleast the first half of next year. There is a positive risk to the fiscal cliff, we are surprised by Congress and all of a sudden a grand bargain is struck. That should release a significant amount of corporate money into investment. That will be fantastic. So, fiscal cliff is a number one risk, right now, in terms of global risk. There is an opportunity there also. Coming back to India and around the subject of investment, I have been astounded and depressed by the level of deceleration in investment in this country. I did not predict this evaporation investment in India. A revival in investment is necessary. Q: It seemed even gloomier before September. Have you got more optimistic after the moves that the government took in September? Are you seeing India in a better light today? A: We are cautiously optimistic. Our old friend Chidambaram has returned to the finance ministry and he has articulated a lot of good ideas or ideas that were articulated earlier and he is just reviving them. You can talk, but now we need to see action. We need to see concrete action out of this government and we need to see that fast. Otherwise, the market ups 25 percent and we are floating on hot air. Q: What have you been doing since the month of September? Have you been buying stocks in India? Have you upped your weightage in certain sectors or have valuations run up too much for your comfort? A: We are very much aware of valuation. So, at certain points during this year, when the market was trading at below 14 times forward earnings, we compelled ourselves to become more active. In general that has worked well for us. Equally, we have always had high quality buyers when investing in India and our investments in certain stocks and sectors that have quality buyers have worked out very well. We have been happy to invest more money in those companies. We have been a net buyer. We have been very selective, we feel that valuations here are opportune. So yes, we have been pretty active. However, we are going to need to see more concrete action in the investment area from the government before we can commit more sums of money to this market. We cannot continue to invest in India simply because the consumption argument is strong and at a certain point, even our favourite and largest investments have a valuation ceiling. Q: Quality has paid off in 2012 and you stuck to quality, but now are you tempted to move down the quality ladder into areas which are a little less expensive or demanding in terms of valuations? A: That is what we get paid to do sometimes, but as I said, we are going to need to see some concrete action. I would not say we have gone down the quality turf because we have made some new investments and I do not consider them to be poor quality. I consider them to be good quality companies with great management that are operating in tough sectors. We have looked at those sectors and obviously here I am referring to the infrastructure sector. We believe things can get better. So, we are going to broaden our investment horizon, maybe pick up a few more names but we always do this with management where we have a great degree of trust. Q: Where do you stand on politics in India? That’s is the big risk which a lot of people are talking about for next year as we get closer to the general election. Does that bother you? A: It is not a key risk for India. There is skepticism about politics all over the planet. So in that respect, India is not alone. I am not too hung up on the election. I understand why people look at the election as a variable in the medium-term horizon, but what needs to be done is near-term immediate concrete action. Investors do not need brilliant solutions to all the problems but what Government of India (GoI) needs to do, is to deliver certain solutions to certain problems and show progress. _PAGEBREAK_ Q: Do you get that feeling that both GDP growth and earnings growth are in the process of troughing out and come 2013 we might get more evidence that things are on the mend? A: First of all, I am not convinced of any real linkage between earnings growth and gross domestic product (GDP). Certainly when I look at our largest holdings, our most active positions, they have delivered on the earnings front regardless of government policies and regardless of GDP growth. So there is no direct linkage there. In terms of where we are on earnings, there is reason to believe right now, that earnings forecast may have stabilised. Mind you, they have stabilised at lower levels. We are talking about single digit EPS growth in India for fiscal ’12-13 and fiscal ’14 numbers coming in at around 13-15 percent. This is relatively pedestrian by Indian standards but maybe it is not pedestrian, maybe it’s realistic. When you decompose the earnings forecast for fiscal ’14, it is hard to get confidence, but have confidence in that 14 percent number. It can break single digit or it can break north of 20 percent. Time will tell. Q: What do you see when you look even further than FY14? Is it difficult to extrapolate that what is 10 percent earnings growth this year gets to 14 percent next year and maybe even gets better in FY15? Or are there too many ifs and buts involved and it is difficult to make that extrapolation? A: It’s the latter, its too many ifs and buts. I have, in the past made some assumptions about future earnings that did not pan out. So once bitten, twice shy! There is a degree of indebtedness within certain promoter groups in India. At the same time, there are other promoter groups that are in quite a strong balance sheet position, who would be very keen to invest if they thought the policy roadmap were clear enough to justify deploying a couple of billion US dollars. However, we are not there yet. Q: What about the Indian currency?  Does the rupee worry you because that has not done as nearly as well as equities would suggest and has actually taken away a bit from your gains this year? A: The currency is down about three to four percent this year but that is one a point to point. We all know that the currencies are very weak end of its long-term range. This is a tough question to answer but India is conspicuous in an Asian context. In that it runs a very high fiscal deficit. It has a high current account deficit. There is no reason to assume that the Indian rupee will strengthen unless you really believe that the price of oil is going to decline. So yes, the Indian rupee is a great concern. I talked to a lot of international investors and some of them look at me and say we think, ‘Now it’s a great time to enter the Indian stock market because rupee is so weak, that is, we have missed the currency weakness. I do agree that its true, but I cannot guarantee you that it is not going to go to 57/USD. Flows this year have been strong and the rupee has been weak. There’s been USD 20 billion of FII, USD 15 billion of FDI, very strong NRI remittances and still the currency is very weak. India is conspicuous. It runs a very large fiscal deficit and a large current account deficit in a part of the world where that’s not the case.

Q: In 2012 fund managers like you have done quite well by sticking to very high quality. Do you think in 2013 you will be able to generate alpha in a similar way by picking the right stocks? Or do you think the market is showing signs of becoming a bigger top down macro call in 2013? A: Looking across the Asian landscape, we are seeing the markets are less macro, correlations are breaking down. Atleast in the past three-six months, the winners in Asia have been the best stock pickers. So, I am happy to say that atleast recently, macro has been less of a factor and I hope that remains the case because for most of us we would prefer fund management Asia to be about picking the right stocks. Now the main question is how to generate alpha in calendar ’13. Generally speaking, in Indian context it comes down to six decisions; being overweight three good stocks and being underweight three bad stocks and the rest of the portfolio will take care of itself. We have done that in 2012, but we need to repeat that in 2013. The best quality or the highest quality stocks in India, many of them are trading on very punchy multiples. So, I think the key to next year is going to be to pick three stocks that are operating in tough neighbourhood, but have great management and the management figures out a way to navigate the shows of policy in this country and take advantage of a couple of opportunities which hopefully will present themselves.

_PAGEBREAK_ Q: Do you mean in 2013 you will come out of the shelter of the HDFC Bank, ITC, HDFCs and will probably have to bark down other trees to generate that alpha in 2013? A: Yes. It is. Q: That is a short answer. A: I just went from one word to three words. I am not going to tell you stocks that I am looking at next year and will not talk about stocks that worked for us this year and everyone knows which stocks have worked for us this year. Q: Will you be looking at areas like infrastructure, real estate which have underperformed so far in a relative sense? Could that be the hunting ground for generating serious outperformance this year? A: The biggest opportunity in 2013 will probably be the infrastructure sector and infrastructure is a very big bucket. If you look at the degree to which investment in India has cratered in the past two year infrastructure/investment is where potentially the biggest opportunities are in 2013. Q: What are your big bets for 2013 in terms of country preferences given that countries like Philippines, Indonesia, Thailand have done so well this year? A: Yes, Association of Southeast Asian Nations (ASEAN) has delivered the goods for more than two years, now. The result being that it has obviously outperformed significantly, but more importantly it has rerated to India or to Greater China and certainly relative to North Asia. If you start your search with valuations, you are going to be led inexorably to China where the market has derated significantly over the past three years. Earlier where recent economic data has improved and earnings expectations are very low and there is a belief that earnings have stabilized. So you start your search pretty much in China. Then equally you need to be searching in India, because relative to its own historic valuation range and Indian valuations relative to other parts of Asia are also attractive. So India and China are a pretty good place to start your stock picking search. Q: Indian investors have been very shy of equities. They have chosen fixed income and gold over the last four-five years. Given relative performance, can you build a strong case for equities to outperform gold and fixed income this year in 2013? A: Equities already outperformed those two asset classes in 2012. You would have made 9 or 10 percent on a fixed deposit in January of this year if you held it for a year. You have made 25 percent in equities so equities have already outperformed fixed income this year. Considering on a two year basis, one of my esteemed colleagues told me that her equity portfolio has now caught up with her fixed income portfolio on a two to three year basis. So, I am pretty constructive on equities. Gold is a huge opportunity. This country is sitting on over a trillion US dollars of gold assets. A lot of that speaks to domestic expectations about inflation. If inflation is going to be bottled in this country, a lot of money from fixed income and from gold would migrate into equities.