 "FOMC's policy approach has little significance for Indian markets: Gautam Chhaochharia")
With the US Federal Reserve unveiling the road map for tapering its bond buying programme, Gautam Chhaochharia, head of India research, UBS Securities India, tells Puneet Wadhwa the implications for India will be limited. Our high potential on growth and for an improvement in the economic outlook, and the high quality of Indian companies, makes Indian equity markets attractive in an emerging markets context, he says. Edited excerpts:
Now that we know the road ahead that the Indian and US central banks are likely to adopt, what is your interpretation from their statements? And, how are you extrapolating these to the trajectory for the markets over the next six to 12 months?
Our US economics team continues to expect that the tapering of the (Fed’s) quantitative easing (QE) will continue over time. We believe the implications of tapering for India will be limited. In the face of a stronger dollar globally and the structural CAD (current account deficit), we expect the rupee to depreciate versus the dollar but a repeat of the sharp move akin to July–September is unlikely.
Do you believe the case for buying into emerging markets’ (EMs’) equities, especially India, is getting weaker by the day? Do any other EMs look attractive now?
Our global EM strategists expect equities to outperform fixed income in these next year, albeit within the context of weak returns in EMs overall (across assets). In equities, we like Korea over Thailand and Mexico over South Africa. Our Asia strategists prefer Japan (currency, margin improvement, earnings momentum), Korea (playing the export cycle) and China (reform-driven re-rating).
India’s high growth potential, the potential for an improvement in the economic outlook (post elections) and the high quality of Indian companies make India’s equity markets attractive in an EM context.
On a Narendra Modi-led victory for the BJP/NDA, do you think the markets are running a bit ahead of what the actual poll outcome could be? Have they factored in a fractured mandate or can one expect a major correction, closer to the event?
There is a lot of speculation as to which party/alliance will win the national elections. Based on our discussions with investors, the markets are positively inclined towards a Modi–led Bharatiya Janata Party and less so towards the Congress, notwithstanding recent policy course corrections. The markets are also worried about a potential Third Front government, given an increasingly fragmented polity. However, history suggests such a dispensation can also deliver on policymaking. A surprise election result is always a key risk and the markets might react violently to a fractured mandate.
How much of an additional fiscal burden have the markets factored in, given that we are headed into an election year and the government could announce sops to garner vote share?
The government’s red line on the fiscal deficit, at 4.8 per cent of GDP (gross domestic product), implies spending cuts ahead, despite impending elections. This is quite likely in the light of fiscal trends so far this year and the likelihood that the revenue target will not be met, given the weak economy.
Given the vicious cycle between slowing growth and fiscal consolidation, further slippage in the fiscal deficit will be inflationary and negative for markets. We do not expect the deficit target to be breached. However, from the sequencing point of view, the fiscal drag on growth does imply things might get worse before getting better.
We expect a deficit of $55 billion or three per cent of GDP in FY14. Our scenario analysis suggests a positive surprise remains a possibility. Longer term, a revival of the investment cycle and, thus, a sustainable economic recovery remains key to ensuring the twin deficits remain under control
Do you expect more pressure on Asian currencies over the next few months? What levels can one expect on the rupee in the near to medium term?
We expect 2014 overall will be another year of general US dollar strength, driven by the Fed being the first major central bank to shift policy to less easing and, eventually, potential tightening. Asia’s reluctance to raise real interest rates once Fed policy reverses course is a recipe for weaker nominal exchange rates, in general, for the region.
We expect the rupee depreciation to be the trend in the face of a stronger dollar and a convalescing domestic economy. We project the rupee at 63 and 65 (to a dollar) by the end of calendar year 2013 and CY14. There remains a possibility of interim appreciation if the CAD surprises positively and capital flows remain benign.
You have a target of 6,900 on the Nifty. Where is the enthusiasm or euphoria coming from and what is likely to drive the next leg of the up-move?
Based on a one-year forward PE (price to earnings multiple) range of between 12.5 and 15x, and our top-down FY15 earnings growth forecast for the Nifty of between 10 per cent and 15 per cent, we expect the Nifty to trade between 5,500 and 6,900 in 2014.
Given our base case of market direction being positive for 2014, we have a target of 6,900 for 2014. These estimates factor a positive political outcome which aids economic recovery, in which scenario we estimate earnings growth in FY15 could reach 15 per cent, with markets potentially re-rating to 15x forward PE.
We are overweight on information technology (IT), telecom companies, media, oil & gas, private banks and power; underweight on automobiles (two-wheelers), consumer discretionary, infrastructure & capital goods and public sector banks; neutral on automobiles (four-wheelers), rural-focused consumer staples, metals & mining, and pharmaceuticals.
What are your earnings forecasts for India Inc over the next few quarters and where is there scope for an upward and downward revision?
From a top-down strategy perspective, we expect FY14 earnings growth to be likely in high single digits. FY15 earnings growth will likely be between 10 and 15 per cent, depending on how the local economic cycle takes shape and the rupee behaves.
Earnings momentum has recently turned positive and this reversal appears to be building in positive environment for defensives, cyclicals and rupee depreciation beneficiaries – appears unlikely, logically, in terms of earnings estimates momentum.
If we end up getting a strong recovery in 2014, that could entail cuts in rupee depreciation beneficiaries’ (IT, pharma and metals) earnings. Our view of potential growth dampening ahead from fiscal drag also implies that FY14 earnings estimates for cyclicals might be at risk.
What about portfolio – how would you position it from cyclicals versus defensives?
This year, defensives outperformed cyclicals, with recent reversals, with hopes building around a favourable political outcome and some respite in macro data. We believe 2014 is also likely to see early-stage reversal in the trends of performance of cyclicals versus defensives, albeit selectively, and more in the second half. It still is early days to rely on cyclicals on any such recovery, in our view.
We would recommend investors to be overweight on private sector banks, selectively, to position for this at this stage of the cycle. Investors might also position in defensive power sector stocks, as recovery in this sector remains critical for the economy and is likely to attract continued government focus.
At a later stage, during recovery of the investment cycle, infrastructure and cap goods companies will benefit. In mid-caps, we would also recommend investors to selectively look at industrials with strong balance sheets and attractive valuations.
Now that we know the road ahead that the Indian and US central banks are likely to adopt, what is your interpretation from their statements? And, how are you extrapolating these to the trajectory for the markets over the next six to 12 months?
Our US economics team continues to expect that the tapering of the (Fed’s) quantitative easing (QE) will continue over time. We believe the implications of tapering for India will be limited. In the face of a stronger dollar globally and the structural CAD (current account deficit), we expect the rupee to depreciate versus the dollar but a repeat of the sharp move akin to July–September is unlikely.
More From This Section
The Reserve Bank’s (RBI’s) policy appears to be of balancing growth and inflation but the central bank is more concerned about inflation than it has been historically — rightly so, in our view. A monetary easing cycle is not yet visible for 2014, unless there is a sharp moderation in inflation. In our view, the policy approach of both central banks has little significance for Indian equity markets in 2014.
Do you believe the case for buying into emerging markets’ (EMs’) equities, especially India, is getting weaker by the day? Do any other EMs look attractive now?
Our global EM strategists expect equities to outperform fixed income in these next year, albeit within the context of weak returns in EMs overall (across assets). In equities, we like Korea over Thailand and Mexico over South Africa. Our Asia strategists prefer Japan (currency, margin improvement, earnings momentum), Korea (playing the export cycle) and China (reform-driven re-rating).
India’s high growth potential, the potential for an improvement in the economic outlook (post elections) and the high quality of Indian companies make India’s equity markets attractive in an EM context.
On a Narendra Modi-led victory for the BJP/NDA, do you think the markets are running a bit ahead of what the actual poll outcome could be? Have they factored in a fractured mandate or can one expect a major correction, closer to the event?
There is a lot of speculation as to which party/alliance will win the national elections. Based on our discussions with investors, the markets are positively inclined towards a Modi–led Bharatiya Janata Party and less so towards the Congress, notwithstanding recent policy course corrections. The markets are also worried about a potential Third Front government, given an increasingly fragmented polity. However, history suggests such a dispensation can also deliver on policymaking. A surprise election result is always a key risk and the markets might react violently to a fractured mandate.
How much of an additional fiscal burden have the markets factored in, given that we are headed into an election year and the government could announce sops to garner vote share?
The government’s red line on the fiscal deficit, at 4.8 per cent of GDP (gross domestic product), implies spending cuts ahead, despite impending elections. This is quite likely in the light of fiscal trends so far this year and the likelihood that the revenue target will not be met, given the weak economy.
Given the vicious cycle between slowing growth and fiscal consolidation, further slippage in the fiscal deficit will be inflationary and negative for markets. We do not expect the deficit target to be breached. However, from the sequencing point of view, the fiscal drag on growth does imply things might get worse before getting better.
We expect a deficit of $55 billion or three per cent of GDP in FY14. Our scenario analysis suggests a positive surprise remains a possibility. Longer term, a revival of the investment cycle and, thus, a sustainable economic recovery remains key to ensuring the twin deficits remain under control
Do you expect more pressure on Asian currencies over the next few months? What levels can one expect on the rupee in the near to medium term?
We expect 2014 overall will be another year of general US dollar strength, driven by the Fed being the first major central bank to shift policy to less easing and, eventually, potential tightening. Asia’s reluctance to raise real interest rates once Fed policy reverses course is a recipe for weaker nominal exchange rates, in general, for the region.
We expect the rupee depreciation to be the trend in the face of a stronger dollar and a convalescing domestic economy. We project the rupee at 63 and 65 (to a dollar) by the end of calendar year 2013 and CY14. There remains a possibility of interim appreciation if the CAD surprises positively and capital flows remain benign.
You have a target of 6,900 on the Nifty. Where is the enthusiasm or euphoria coming from and what is likely to drive the next leg of the up-move?
Based on a one-year forward PE (price to earnings multiple) range of between 12.5 and 15x, and our top-down FY15 earnings growth forecast for the Nifty of between 10 per cent and 15 per cent, we expect the Nifty to trade between 5,500 and 6,900 in 2014.
Given our base case of market direction being positive for 2014, we have a target of 6,900 for 2014. These estimates factor a positive political outcome which aids economic recovery, in which scenario we estimate earnings growth in FY15 could reach 15 per cent, with markets potentially re-rating to 15x forward PE.
We are overweight on information technology (IT), telecom companies, media, oil & gas, private banks and power; underweight on automobiles (two-wheelers), consumer discretionary, infrastructure & capital goods and public sector banks; neutral on automobiles (four-wheelers), rural-focused consumer staples, metals & mining, and pharmaceuticals.
What are your earnings forecasts for India Inc over the next few quarters and where is there scope for an upward and downward revision?
From a top-down strategy perspective, we expect FY14 earnings growth to be likely in high single digits. FY15 earnings growth will likely be between 10 and 15 per cent, depending on how the local economic cycle takes shape and the rupee behaves.
Earnings momentum has recently turned positive and this reversal appears to be building in positive environment for defensives, cyclicals and rupee depreciation beneficiaries – appears unlikely, logically, in terms of earnings estimates momentum.
If we end up getting a strong recovery in 2014, that could entail cuts in rupee depreciation beneficiaries’ (IT, pharma and metals) earnings. Our view of potential growth dampening ahead from fiscal drag also implies that FY14 earnings estimates for cyclicals might be at risk.
What about portfolio – how would you position it from cyclicals versus defensives?
This year, defensives outperformed cyclicals, with recent reversals, with hopes building around a favourable political outcome and some respite in macro data. We believe 2014 is also likely to see early-stage reversal in the trends of performance of cyclicals versus defensives, albeit selectively, and more in the second half. It still is early days to rely on cyclicals on any such recovery, in our view.
We would recommend investors to be overweight on private sector banks, selectively, to position for this at this stage of the cycle. Investors might also position in defensive power sector stocks, as recovery in this sector remains critical for the economy and is likely to attract continued government focus.
At a later stage, during recovery of the investment cycle, infrastructure and cap goods companies will benefit. In mid-caps, we would also recommend investors to selectively look at industrials with strong balance sheets and attractive valuations.