 "There is a lot of value in emerging markets: Jan Dehn")
How do you think the rest of 2016 will pan out for global financial markets?
This is the first year since 2011 when emerging market (EM) countries will re-accelerate away from developed economies. Developed economies have benefited tremendously from QE (quantitative easing) programmes that have sucked global liquidity into their markets, but they have failed to use these tailwinds to reform and deleverage and now the outlook is bleaker. The US is a clear example.
EM countries have been forced to adjust their economies and now look more competitive than in many years. This combination of slower developed market growth and better EM prospects is probably going to support fixed income markets more than equity markets in 2016. The possible exception is EM equities, which are now cheap, especially in the energy importing countries.
China’s measures to stem the market fall have proved futile. Even the yuan's devaluation hasn’t helped much. What are your thoughts?
I think PBOC (People’s Bank of China) will maintain their course. They will provide liquidity when it is needed. They will only cut rates if the economic conditions warrant. They are right that China does not need a devaluation, so they will intervene if the markets get too wrong.
A lot of investors are now underweight on emerging markets, including India. What is your positioning now and has this changed over the past few months?
We have expanded exposure compared to this time last year. There are five important reasons: First, there is a lot of value in EM after years of sell-offs. Secondly, many EM countries, including India, have seen much better fundamentals in recent years. Many EM countries have strongly improved their external balances. Thirdly, the QE markets (Europe, Japan and the US) offer poor investment returns. US stocks were negative in 2015 and this has continued this year. Some 40 per cent of European government bonds already trade with negative yields. And, Japan looks hell-bent on weakening its currency. Fourth, the US may be flirting with recession now. Finally, the dollar rally looks like it may peter out this year versus EM currencies. If the dollar stabilises, then interest in EM local markets, including equities, will blossom.
In the Indian context, do you think the fall could get aggravated as we head deeper into 2016 owing to domestic factors such as policy logjam, weak corporate earnings, higher inflation, etc?
No, I think Indian markets have been weakened by global factors. The Indian economy is resilient and the prospects for reforms such as GST (goods and services tax) look decent. I think the Indian markets will rebound strongly this year from the weak start, because it is not caused by India-specific problems.
Do you think the Reserve Bank of India will cut rates aggressively in 2016?
We think there is little room for rates to be cut from here, because food inflation is looking less benign going ahead, though energy and other material prices should remain soft. India is a large net importer of energy. Weak crude oil outlook significantly helps India’s current account deficit, reserves position, currency outlook and has an ameliorating effect on inflation.
The banking sector has been at the epicentre of the recent market sell-off. Do you see better days ahead?
Outlook for the financial sector should improve. A majority of government-owned banks and some large private ones like ICICI Bank and Axis Bank continue to trade at a big discount to long-term average valuation multiples because of stressed assets in the system.
Our sense is that the banking stocks have not provided for bad loans. But, good loans are not slipping into bad loans. Hence, given time, the bad loans can be provided for. In any case, some lenders like ICICI Bank, Axis Bank and State Bank of India (SBI) are probably much ahead on the road to recovery, which is not priced in today.
What is the outlook for corporate earnings and your sector preferences in this backdrop?
We should see very strong earnings growth in smaller companies where our thesis of improving margins and better cash flows has played out over the past year or so. We expect much better top-line growth going ahead. Midcaps trade at a premium to larger stocks, which is a source of concern, but stronger earnings may continue to support these valuations.
We do not like base materials, telecom, staples or healthcare – the latter two being expensive. In the smaller cap universe, our approach is far more bottom-up stock-specific, where we are looking for stocks which are not very expensive and offer an exciting growth outlook backed by a decent balance sheet.