 "India will race ahead of emerging markets this year: Jonathan Garner")
Improvement in India’s macro fundamentals and early signs of economic and earnings recovery is helping markets here to do better than elsewhere, says Jonathan Garner, chief Asia & emerging markets equity strategist at Morgan Stanley, the multinational financial services entity. Speaking to Samie Modak on the sidelines of the 18th Morgan Stanley India Annual Summit, he says EMs might give negative returns this year but India will outperform. Edited excerpts:
This month has been weak for emerging markets (EMs) and their currencies. What are the key reasons?
EMs were strong between mid-January and mid-April. They have started to sell-off again as concerns over the US Federal Reserve’s interest rate policy have resurfaced. The dollar has again started to strengthen. Commodity prices have also started to roll over, with the exception of oil. We have seen weakness in iron ore and steel. We think China’s growth is starting to slow down again. We had a mini-cycle recovery in China but that is now coming to an end. We put out a number of notes in April saying ‘sell the rally’.
We upgraded India about a week earlier. A key reason is the Indian market has become low-beta compared to the other EMs. It used to have a beta of about one and it's now down to below 0.8.
India is not particularly exposed to weak global trade. It doesn’t sell much to China or compete much with China. That means when China slows, there is no negative impact on India. Crucially, in relation to the US Fed and interest rates, since the summer of 2013, India has lost a lot of vulnerability on the rupee side or monetary policy sensitivity to US rates, as its current account deficit has narrowed dramatically. The fiscal deficit has narrowed. India’s macro balance is now much better than it was. It has been able to withstand the force of a strong dollar. Put that together with the fact that corporate earnings have started to pick up, whereas elsewhere in the EMs, they are still very weak. In the recent week, it has started to outperform EMs, which is exciting.
Will India be immune to a US rate hike?
I think so this time. We at Morgan Stanley don’t expect the US Fed to raise interest rates in June-July but in December. But, we do except the dollar to be strong globally. We expect China’s growth to get slower and commodity prices to weaken. In that world, given the domestic things here in India, we are very happy to recommending being overweight on India. We are underweight markets like Australia or South Africa and some others in the Asean bloc.
Is India your most preferred bet in the EMs?
It is one of our biggest overweights. India ranks three out of 27 other countries that we cover. There are a couple of other smaller markets we like; the other big one we have emphasised is Taiwan but that’s a different story, more around a high dividend yield or secular themes in technology. But, India is definitely one of our top picks.
How has your India stance changed?
We have been overweight other times in the past two years. Most recently, we were equal-weight going into this year. We downgraded it compared to other countries like Brazil and Russia, which had become extremely oversold. There has been some selling in India. So, in terms of the positioning, fund managers were extremely overweight India about a year ago. Now, they are down to a much more normal position. They are overweight but in line with a five-year average position.
India’s valuations are still at a premium to other markets. Is that a concern?
India is at a 40 per cent forward P/E (price to earnings multiple) premium on earnings number. At the peak, it was 70 per cent. That has come down considerably. On the basis of return on equity, this is a fair valuation premium.
What are the key risks to the Indian markets?
If oil prices continue to go higher, that is always a negative for India. We think oil will start to reverse and go lower by the end of the year. If it goes higher, that’s a headwind. We are also looking at the GST (national goods and services tax) Bill. We are assuming it can be passed, which would be very exciting.
We also continue to look for delivery in the government’s agenda in maintaining a reasonably tight fiscal stance. We are also expecting 50 basis points of interest rate cuts from the Reserve Bank in the next 12 months. Probably more important is that corporate earnings have to pick up. We have seen early signs of that. If you look at the most recent quarter, Indian companies beat the consensus after earlier missing it. Only a few EMs are now managing to beat the consensus.
Is the earnings improvement for good?
We are projecting that Gross Domestic Product growth will accelerate to 7.5 per cent this year and 7.7 per cent next year. A lot of micro data points like motorcycle sales and job creation suggest growth is picking up. Rural India seems to be able to spend a bit more. We are hopeful again for the monsoon season. There was a relatively tight monetary and fiscal stance early on. Now that macro stability is more assured, the authorities can ease the stance somewhat. All this adds up to cyclical pick-up, which we think is going to happen.
What are the EM return expectations this year?
In absolute terms, we expect EMs to fall through the end of the year. But, we expect India, on a relative basis, to outperform. That has already started. Unlike India, were we expect earnings for Sensex companies to grow nine per cent this year and 17 per cent next year, we actually expect EM earnings to decline.
What’s the outlook on foreign flows?
Foreign fund managers have moved to a lower overweight on India. At this conference, we are getting global investors who have limited exposure to India and want to buy into the growth recovery. So, there will be lot of fresh interest in India, which is going to be the fastest growth economy in the world in three years running. That’s something.
Which are your most preferred sectors in India?
We like sectors like consumer (goods), automobiles, industrials and private sector banks. We are underweight (on) telecom and utilities. We are slightly underweight (on) pharma and software, which are export-oriented. For us, it is about domestic growth.
This month has been weak for emerging markets (EMs) and their currencies. What are the key reasons?
EMs were strong between mid-January and mid-April. They have started to sell-off again as concerns over the US Federal Reserve’s interest rate policy have resurfaced. The dollar has again started to strengthen. Commodity prices have also started to roll over, with the exception of oil. We have seen weakness in iron ore and steel. We think China’s growth is starting to slow down again. We had a mini-cycle recovery in China but that is now coming to an end. We put out a number of notes in April saying ‘sell the rally’.
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Has the past week's rally in the Indian market come as a surprise?
We upgraded India about a week earlier. A key reason is the Indian market has become low-beta compared to the other EMs. It used to have a beta of about one and it's now down to below 0.8.
India is not particularly exposed to weak global trade. It doesn’t sell much to China or compete much with China. That means when China slows, there is no negative impact on India. Crucially, in relation to the US Fed and interest rates, since the summer of 2013, India has lost a lot of vulnerability on the rupee side or monetary policy sensitivity to US rates, as its current account deficit has narrowed dramatically. The fiscal deficit has narrowed. India’s macro balance is now much better than it was. It has been able to withstand the force of a strong dollar. Put that together with the fact that corporate earnings have started to pick up, whereas elsewhere in the EMs, they are still very weak. In the recent week, it has started to outperform EMs, which is exciting.
Will India be immune to a US rate hike?
I think so this time. We at Morgan Stanley don’t expect the US Fed to raise interest rates in June-July but in December. But, we do except the dollar to be strong globally. We expect China’s growth to get slower and commodity prices to weaken. In that world, given the domestic things here in India, we are very happy to recommending being overweight on India. We are underweight markets like Australia or South Africa and some others in the Asean bloc.
Is India your most preferred bet in the EMs?
It is one of our biggest overweights. India ranks three out of 27 other countries that we cover. There are a couple of other smaller markets we like; the other big one we have emphasised is Taiwan but that’s a different story, more around a high dividend yield or secular themes in technology. But, India is definitely one of our top picks.
How has your India stance changed?
We have been overweight other times in the past two years. Most recently, we were equal-weight going into this year. We downgraded it compared to other countries like Brazil and Russia, which had become extremely oversold. There has been some selling in India. So, in terms of the positioning, fund managers were extremely overweight India about a year ago. Now, they are down to a much more normal position. They are overweight but in line with a five-year average position.
India’s valuations are still at a premium to other markets. Is that a concern?
India is at a 40 per cent forward P/E (price to earnings multiple) premium on earnings number. At the peak, it was 70 per cent. That has come down considerably. On the basis of return on equity, this is a fair valuation premium.
What are the key risks to the Indian markets?
If oil prices continue to go higher, that is always a negative for India. We think oil will start to reverse and go lower by the end of the year. If it goes higher, that’s a headwind. We are also looking at the GST (national goods and services tax) Bill. We are assuming it can be passed, which would be very exciting.
We also continue to look for delivery in the government’s agenda in maintaining a reasonably tight fiscal stance. We are also expecting 50 basis points of interest rate cuts from the Reserve Bank in the next 12 months. Probably more important is that corporate earnings have to pick up. We have seen early signs of that. If you look at the most recent quarter, Indian companies beat the consensus after earlier missing it. Only a few EMs are now managing to beat the consensus.
Is the earnings improvement for good?
We are projecting that Gross Domestic Product growth will accelerate to 7.5 per cent this year and 7.7 per cent next year. A lot of micro data points like motorcycle sales and job creation suggest growth is picking up. Rural India seems to be able to spend a bit more. We are hopeful again for the monsoon season. There was a relatively tight monetary and fiscal stance early on. Now that macro stability is more assured, the authorities can ease the stance somewhat. All this adds up to cyclical pick-up, which we think is going to happen.
What are the EM return expectations this year?
In absolute terms, we expect EMs to fall through the end of the year. But, we expect India, on a relative basis, to outperform. That has already started. Unlike India, were we expect earnings for Sensex companies to grow nine per cent this year and 17 per cent next year, we actually expect EM earnings to decline.
What’s the outlook on foreign flows?
Foreign fund managers have moved to a lower overweight on India. At this conference, we are getting global investors who have limited exposure to India and want to buy into the growth recovery. So, there will be lot of fresh interest in India, which is going to be the fastest growth economy in the world in three years running. That’s something.
Which are your most preferred sectors in India?
We like sectors like consumer (goods), automobiles, industrials and private sector banks. We are underweight (on) telecom and utilities. We are slightly underweight (on) pharma and software, which are export-oriented. For us, it is about domestic growth.