 "Impact of demonetisation largely priced in: Ridham Desai")
Ridham Desai, Head of India Research at multinational financial powerhouse Morgan Stanley, and its India Equity Strategist, met some journalists for a discussion on the Indian market next year. He expects a U-shaped recovery in growth once the impact of demonetisation is absorbed. Hamsini Karthik compiled this discussion:
Impact of demonetisation on the market:
The impact is almost priced in and I don't expect a V-shaped recovery to happen. While stocks are forward-looking animals, with this particular event, we are still grappling with the extent of impact. I think the market has overestimated the impact and, therefore, the worst might be done. But, if you are looking at it tactically, you might want to see the fine print. It's a question of time-frame. For people with a three to five year frame, they are at a fairly comfortable pricing.
Whether demonetisation will have the desired result:
There have been a series of moves by the government to arrest the creation of black money. They have renegotiated tax treaties, tightened tax laws and linked the PAN card to transactions and the (coming) goods and services tax (GST). So, when you see the sequential steps, demonetisation becomes an addition, which has got great messaging. But, it's not as potent as GST to curb black money. GST would have greater implications on unaccounted money.
On market valuations:
Equity valuations are looking good against bonds now, the best since 2013. They also look attractive against emerging markets (EMs). India had become very expensive compared to EMs at the middle of last year -- that's starting to change. The dispersion of valuation (difference between the most expensive and cheapest stock) had risen to a very high level during the tech bubble of 1999. Most recently in September, we saw a post-tech bubble high. That's starting to correct and I am expecting this to correct further. I don't think demonetisation destroys India's growth story; it defers it by a bit.
On earnings growth:
We've had a couple of good quarters but, unfortunately, earnings growth could be disrupted with demonetisation. So, there could be some delay in the recovery but an earnings recovery is happening. This is in contrast with what happened in the 2004-08 cycle when global growth was five per cent; today, it is sub-three per cent. Between 40 and 50 per cent of index (Nifty) earnings growth comes from outside India. The earnings revision index, which is the upgrades minus downgrades, would have turned positive if it were not for the fact that demonetisation would hold analysts back. It has been negative since 2011. It would have been a big thing if it turned positive but now gets deferred by a few months.
On interest rate cuts:
There would be room for India's central bank to cut rates, as inflation is easing. The next rate cut, which we think would happen in December, is now mostly baked in the price.
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On sector preferences:
Financials, information technology (IT), consumer discretionary and, to some extent, industrials look attractive. I would still avoid defensives like consumer staples and health care. I find private banks and some select NBFCs (non-bank financial companies) lot more attractive in the financials space. For financials, I would encourage you to look beyond two months, as they are sitting on a pretty good story.
IT is a pure-valuation play. These stocks correlate very positively to US bond yield, which reflects underlying growth in the US. If yields are rising, growth in the US is improving and that means US companies will start investing, and they will give more contracts to Indian companies. There's a three-months lag for this.
On key risks to the market:
First, the rupee looks overvalued. While this is a reflection of the confidence that investors have in India, it's always a bit of a problem. A trigger can cause it to correct, like what happened to mid-cap stocks in November. Commodity prices have started increasing and that doesn't mean well for India.
Next, our return correlation has risen to a post-Modi high. It had significantly dropped after Narendra Modi became prime minister and was at 10-year lows; it has come back. So, we are more dependent on global events. There's also some more room for mid-cap valuations to correct.
Finally, we have to be prepared for bond market volatility, as the gap between Indian long-bond yield and US bond yield has collapsed. Equities have already done their bit in terms of volatility and bonds will follow. This will make the case for equities versus bonds.