 "Manishi Raychaudhuri")
Heightened geopolitical tensions between India and Pakistan evoked a knee-jerk reaction from the markets last week. Hong Kong-based Manishi Raychaudhuri, Asian equity strategist at BNP Paribas, tells Puneet Wadhwa that any correction in Indian equities is an opportunity for investors to put in money for the long term. Edited excerpts:
What are the implications for the markets and fund flows into India, given the recent surgical strikes?
Beyond a possible short-term dip, we don’t expect significant negative impact on flows into Indian equities.
How do you see the markets playing out over the next three-six months, given global developments?
We think the emerging markets (EMs) and Asia, in the medium term, will possibly do better than the developed markets (DMs). There are a couple of reasons behind this. First, the DMs are far more expensive right now compared to the EMs. This is partly due to the sharp rally in the DMs since the past few years. Second, we are also seeing earnings recovery in EMs, including Asia.
However, in the near term, equity markets – both DMs and EMs – could see some correction after the recent sharp rally. There can be some geopolitical risks that are getting concentrated over the fourth quarter, which may have a bearing on the sentiment.
What are your December-end targets for the Sensex and the Nifty?
For the Sensex, we have a target of 29,000 points. This implies that Indian markets could either correct from present levels, or remain around the current levels for some time. The latter scenario is that of a time correction, which the Indian markets are already going through, compared to other Asian markets.
Having said that, the risks investors face are not India-specific but are outside Indian shores. The most recent geopolitical tension has added to that. Potential slowdown in the European Union or the political change of guard in the US and its implications on the economic policies are questions investors increasingly ask now.
Is life tough for fund managers who are looking for a good bargain, given the rich valuations and the 2016 rally?
In the near term, say about one quarter, they might have to tighten their belt and brace for a correction. However, over the medium-to-long term, we don’t really see much risk in the EM universe. EMs are likely to outperform, and India continues to be a bright spot.
Which regions in Asia are you overweight on?
We are overweight China, India, South Korea and Thailand.
Can you elaborate on your India-related stance?
Fundamentally, India appears relatively a lot better than many other EMs. In India, we are seeing a gradual recovery in growth. At the same time, interest rates have been declining. We anticipate a steep decline in inflation in the near term, which leaves room for the Reserve Bank of India (RBI) to cut rates – if not this year, definitely in early next year. So a combination of increasing growth and declining rates is a rare combination in EMs. Economists refer to this as the ‘Goldilocks scenario’.
That apart, we think earnings estimates in India, as in the rest of Asia, are beginning to revive. This economic and earnings recovery will be aided by a revival in the monsoon and the Seventh Pay Commission payout, which should support consumption in the semi-urban, tier-I and tier-II cities. Even the political and legislative decision-making situation has improved remarkably.
What about valuations?
India trades at a premium to its EM peers. But, this premium has declined. India’s valuation premium peaked around March–April last year, when it was nearly two standard deviations above the long-term average. It is now between half and one standard deviation. In relation to Asia (ex-Japan), India does appear expensive but not in relation to its own history. Any correction in Indian equities is an opportunity for investors to put in money for the long term.
Which sectors do you still find value in the Indian context?
There are four silos that we are concentrating on. First is consumption. This implies both consumer discretionary and consumer staples but with a slightly higher tilt towards semi-urban consumption. Second, we also think at some stage, industrial recovery will lead to alpha generation. So, industrial companies, particularly those with low leverage, are the ones to focus on. We also like cement. The third is private sector banks, especially those with a retail focus. The fourth is the information technology services space. As a consequence of the valuation correction, one can selectively pick stocks that will be significant alpha generators in the medium term.
What are your earnings forecasts for FY17 and FY18?
For FY17, for the S&P BSE Sensex or the MSCI India, we think the earnings growth will be around 10 – 11%. However, the consensus estimates at around 15 – 16% are more bullish than this. But I think those are slightly overstated. Over the next couple of quarters, we will likely see those expectations coming down. For FY18, the earnings growth should be around 14 – 15%, driven by the sectors mentioned above.
Consumption related stocks have performed well over the past few months. Is there more headroom in these stocks, especially autos, FMCG and telecom?
We are not very bullish on the telecom sector. We think that the extent of competition that has picked up in this business segment could keep margins depressed for quite some time. Investors need to see how things play out before getting enthused about this sector. But the others – consumer discretionary plays like autos and the consumer staples (FMCG), there are stocks where investors can find value.
Talking about disruptors, Reliance Jio has been to telecom sector as Patanjali was to the consumer staples / FMCG segment. How do you view this?
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In any sector, when we see incumbents generating return on equity (RoE) in triple digits, which is way higher than the cost of equity, the sector obviously becomes attractive for new investment. Given this, entrepreneurs are bound to invest in a sector that is generating super-normal return. I think returns in the telecom sector, to some extent, may be under a question mark because of the high cost of spectrum and constant change in regulations. But consumer staples and discretionary sectors in India have always benefitted from high RoE and therefore, seen the entry of new players. As regards FMCG, we are not surprised that new players have attacked the traditional bastions that the multi-national companies (MNCs) and the Indian companies enjoy. Having said this, we think for some of the incumbents the distribution reach is so wide and the product range is so vast, it will be difficult to make a serious dent in the RoE, at least in the near-to-medium term. The sector is so large that there is always place for a new player.
What are the key concerns of investors as regards India now? What more are they expecting from the government in terms of policies in its remaining tenure?
If you look at policy action, the big frontline reforms one can think of are labour law reforms and making the FDI in retail a little more investor friendly. We think that the government is likely to take a gradual and calibrated approach towards these two initiatives.
Do you think that the global markets are overdoing the fears of a rate hike by the US Federal Reserve (US Fed)?
As of now, we haven’t seen much fear given how equity and bond markets have behaved. Both these market segments seem unperturbed by the possibility of a rate hike. In fact, the US Fed has been sending verbal signals about a rate hike for quite some time now, and I think both these market segments have taken it in their stride. Even if the US Fed does start a rate hike cycle, it is likely to be a very dovish and benign rate hike cycle. It is now clear that the US Fed is trying to guide down the normalized interest rates in the United States (US). While the normalized rate used to be around 3 – 3.5% earlier, it now appears that it will not be more than 2%. So in such a scenario, we are not thinking about a steep rate hike. It will be a very long drawn and calibrated rate hike cycle.
So the flows will continue into EM then?
Given this backdrop, we are not concerned about the flows into EMs suffering very badly. Over the last 46 years, we have seen six US Fed rate hike cycles. Of these, only once did the US dollar (USD) appreciate. We don’t expect the USD to appreciate significantly from here on, and in that context I think the risks to EM flows would be minimal.
