 "John Praveen")
Liquidity conditions will continue to remain benign globally even if the US Federal Reserve raises rates in the near term, says John Praveen, chief investment strategist, Pramerica International Investments. He tells Samie Modak that besides easy liquidity, improved GDP growth and earnings are the key factors supporting the markets. Edited excerpts:
Do you think liquidity conditions will continue to remain benign?
What is important to understand is that the Fed may raise rates in the near term, but it is not the start of a tightening cycle globally. Japan and the European Central Bank (ECB) continue to provide stimulus. The Bank of England has said, if needed, it will cut rates again. So, there is still a lot of support for liquidity support. Also, you might see rate cuts in countries like Brazil, Russia, Taiwan and India.
The markets have done well this year. What has driven this rally?
Liquidity clearly has been the biggest factor in driving the markets higher. BoE cut rates in August and increased quantitative easing (QE). The ECB at its last meeting didn’t raise QE but could provide more stimulus in December. So, there is a lot of stimulus and liquidity, which is driving markets.
In addition to liquidity, the expectation of improvement in global growth and earnings is also a factor. The US economy should see a rebound in the third quarter and growth could be above three per cent. Growth should also improve in Japan, following the big stimulus package. Also, in Europe and the UK there were fears about Brexit’s impact, but it has been modest. Even in emerging markets (EMs) as a whole the growth outlook has improved. China has been stable, India is growing at 7-7.5 per cent and should improve further because of a good monsoon. Also, Russia is coming out of recession, which should add to positive growth.
Another factor is earnings. In the first half of the year, earnings were weak because of the decline in energy and raw materials sector as a result of the fall in oil and commodity prices. We are looking for a pickup.
Has the ongoing rally created bubbles or pockets where valuations have run ahead of fundamentals?
I wouldn’t say bubbles. The way we look at is not just price-to-earnings (P/E) multiples, but we also compare yield on bonds with those on stocks. Bond yields in the US are 1.5-1.7 per cent, stock yields are at 4.8-4.9 per cent. So the gap is quite big. If you look at P/E multiples as a measure, the market is expensive. But, if you compare valuation of stocks to that of bonds, stocks are not expensive.
In the context of the Indian markets, valuations may be slightly stretched, particularly in the mid and small-cap space. But, you have to look at valuations in a dynamic context. If earnings are growing, then maybe valuations will not be that expensive. We have to admit that there are certain segments and stocks where valuations are expensive and you have to be careful. But, markets as a whole are not expensive. There are plenty of pockets of opportunities.
Which are the themes one should play?
A lot of macro-level initiatives are going to benefit certain sectors and stocks. The monsoons have been good, which will be positive for rural income. So, sectors that cater to rural consumption, like staples and two-wheelers will benefit. Also, the Seventh Pay Commission’s award will lead to increase in demand for some white goods. Then, if there is increased infrastructure spending, companies in related sector will benefit.
How does India look on a relative basis?
In our global portfolio, we are overweight EM and within Asia and among EMs we are overweight India, which will probably continue. We think India offers a lot of opportunities. The composition of Indian markets offers a mix of everything, health care, utility, consumer goods & information technology. In comparison, EMs like Russia are dominated by one or two sectors. The sectoral mix of the Indian market is very diverse, such that when you construct a portfolio you become overweight on India.
Which is your biggest overweight in Asia and EM portfolio?
In the Asia portfolio, India is our biggest overweight. But, in the EM portfolio, India used to be our biggest overweight, but it is now Brazil. In early January, we took a call to go from underweight to overweight on Brazil. We have not reduced our overweight on India, but increased it on Brazil.
Do you think liquidity conditions will continue to remain benign?
What is important to understand is that the Fed may raise rates in the near term, but it is not the start of a tightening cycle globally. Japan and the European Central Bank (ECB) continue to provide stimulus. The Bank of England has said, if needed, it will cut rates again. So, there is still a lot of support for liquidity support. Also, you might see rate cuts in countries like Brazil, Russia, Taiwan and India.
The markets have done well this year. What has driven this rally?
Liquidity clearly has been the biggest factor in driving the markets higher. BoE cut rates in August and increased quantitative easing (QE). The ECB at its last meeting didn’t raise QE but could provide more stimulus in December. So, there is a lot of stimulus and liquidity, which is driving markets.
In addition to liquidity, the expectation of improvement in global growth and earnings is also a factor. The US economy should see a rebound in the third quarter and growth could be above three per cent. Growth should also improve in Japan, following the big stimulus package. Also, in Europe and the UK there were fears about Brexit’s impact, but it has been modest. Even in emerging markets (EMs) as a whole the growth outlook has improved. China has been stable, India is growing at 7-7.5 per cent and should improve further because of a good monsoon. Also, Russia is coming out of recession, which should add to positive growth.
Another factor is earnings. In the first half of the year, earnings were weak because of the decline in energy and raw materials sector as a result of the fall in oil and commodity prices. We are looking for a pickup.
Has the ongoing rally created bubbles or pockets where valuations have run ahead of fundamentals?
I wouldn’t say bubbles. The way we look at is not just price-to-earnings (P/E) multiples, but we also compare yield on bonds with those on stocks. Bond yields in the US are 1.5-1.7 per cent, stock yields are at 4.8-4.9 per cent. So the gap is quite big. If you look at P/E multiples as a measure, the market is expensive. But, if you compare valuation of stocks to that of bonds, stocks are not expensive.
In the context of the Indian markets, valuations may be slightly stretched, particularly in the mid and small-cap space. But, you have to look at valuations in a dynamic context. If earnings are growing, then maybe valuations will not be that expensive. We have to admit that there are certain segments and stocks where valuations are expensive and you have to be careful. But, markets as a whole are not expensive. There are plenty of pockets of opportunities.
Which are the themes one should play?
A lot of macro-level initiatives are going to benefit certain sectors and stocks. The monsoons have been good, which will be positive for rural income. So, sectors that cater to rural consumption, like staples and two-wheelers will benefit. Also, the Seventh Pay Commission’s award will lead to increase in demand for some white goods. Then, if there is increased infrastructure spending, companies in related sector will benefit.
How does India look on a relative basis?
In our global portfolio, we are overweight EM and within Asia and among EMs we are overweight India, which will probably continue. We think India offers a lot of opportunities. The composition of Indian markets offers a mix of everything, health care, utility, consumer goods & information technology. In comparison, EMs like Russia are dominated by one or two sectors. The sectoral mix of the Indian market is very diverse, such that when you construct a portfolio you become overweight on India.
Which is your biggest overweight in Asia and EM portfolio?
In the Asia portfolio, India is our biggest overweight. But, in the EM portfolio, India used to be our biggest overweight, but it is now Brazil. In early January, we took a call to go from underweight to overweight on Brazil. We have not reduced our overweight on India, but increased it on Brazil.
