'UBS underweight in Indian equities vs other EMs': Sunil Tirumalai

Within EMs, UBS prefers markets that have attractive fundamentals and valuations, says Sunil

The recent stimulus from China has made global investors sit up and take notice of the developments. SUNIL TIRUMALAI, head of emerging market (EM) and Asia equity strategy at UBS Securities, tells Puneet Wadhwa in an email interview that despite the recent rally, China is trading at a 40 per cent discount to EMs, compared to a 10-year average of a 20 per cent premium. Within EMs, UBS prefers markets that have attractive fundamentals and valuations. Edited excerpts:

What is UBS’ stance on Indian equities for Samvat 2081?

UBS is underweight on Indian equities relative to other EMs. MSCI India’s earnings growth outlook for the next two years is at its lowest compared to EMs. However, India is trading at an 80 per cent premium to EMs, compared to a 10-year average of 42 per cent. This divergence between the fundamental growth outlook and valuations drives our underweight stance on India.

Is there a complete disconnect between the state of India’s economy and its stock market? If yes, how do you think this anomaly will be corrected?

We acknowledge that India is going through one of its slowest nominal gross domestic product growth periods in history. Somewhat related (but not exactly the same), the stocks in the larger indices are also experiencing very slow earnings growth expectations. So, the optimism in the markets is primarily based on valuations and real rates rather than fundamentals.

It is also worth noting that the primary support for the markets has been domestic household money — whether directly into stocks or through intermediaries like mutual funds. Households in India perceive real rates to be too low, which explains their behaviour of low savings, high borrowings (sometimes flowing into consumption), and a low affinity for saving in bank deposits while flocking to the markets for higher returns.

This could change if the perceived real rates increase — either with bank rates rising (which has been happening for a while now) or inflation expectations coming down (or both). In this context, monitoring the actions of banks regarding their deposit rates would be crucial.

What are the key themes that UBS thinks could drive EM returns in the next year?

Within EMs, our preference is for markets with attractive fundamentals and valuations that are also favourably exposed to these themes: 1) domestic economic resilience that matters to markets; 2) higher-for-longer oil prices; 3) favourable exposure to the tech/artificial intelligence cycle; and 4) lower policy/political uncertainty.

Among major economies, we are overweight on China and South Africa, neutral on South Korea, Taiwan, and Brazil, and underweight on India.

Is China the best equity market to invest in within the Asian region from a year’s perspective?

China, over the past couple of weeks, has seen a flurry of stimulus news, with coordinated efforts from the central bank and market regulators. Importantly, the much-awaited fiscal expansion is also likely on its way.

China remains an overweight market for us, with key arguments still intact: the fundamentals of companies haven’t deteriorated, earnings expectations have held up, and clear signs of geopolitics and domestic real rates are causing the market weakness rather than direct macro/property impact. There is also very high dividend/buyback support. Despite the recent rally, we find China trading at a 40 per cent discount to EMs, compared to a 10-year average of a 20 per cent premium.

What are your sector preferences in the current environment?

We are coming out of a situation where household behaviour (low savings and high borrowings fuelling consumption) has been supporting business-to-consumer sectors (including discretionary, staples, banking, etc.). Some of this could reverse.

On the other hand, political stability could imply that demand visibility for business-to-government sectors (industrials exposed to government capital expenditure and utilities) remains strong. We are overweight on infrastructure/industrials, utilities, and cement, while underweight on automotive and consumer discretionary within India.

What’s your view on small and midcaps (SMIDs)?

SMID valuations have run up relative to largecaps over the past couple of years, and there are some signs of overheating. However, they have also been able to reduce their leverage faster and close the gap in return on equity/return on invested capital relative to large caps. So, there are definitely selective opportunities — UBS analysts favour stocks in chemicals, forging, hospitality, etc.

What’s your interpretation of how the July-September quarter results season has played out thus far?

Heading into the earnings season, we are seeing positives in jewellery (beneficiary of tax cuts), cable and wiring, hospitality, hospitals, and information technology (particularly in North American banking, financial services, and insurance recovery), while witnessing weaknesses in chemicals, life insurance (value of new business contraction), non-life insurance (slower premium growth), and mixed results in automotive.

The credit cycle is moderating, with some signs of asset quality stress in lenders (for example, microfinance institutions) exposed to unsecured lending.

Overall, we see downside risks to the consensus 18 per cent earnings growth expectations for 2024-25 and 2025-26.