 "Gautam Chhaochharia")
Most Asian markets tumbled in trade on Wednesday on the back of worrisome key economic data from China. For the Indian markets, it was a double whammy as the Rupee went past the 60-mark against the US dollar. Gautam Chhaochharia, head of India research, UBS Securities India tells Puneet Wadhwa in an interview that he remains positive on global equities as an asset class. Rupee depreciation does make the growth recovery tougher for India and will likely require more concerted government response, he says. Excerpts:
Did the recent announcements by the US Federal Reserve and the economic data from China and Japan catch you off guard? Since liquidity has been a major driver for the markets, how do you see foreign institutional investor (FII) flows panning out going ahead?
It is debatable as to whether the US Federal Reserve said anything new. Neither weak China data nor the liquidity crunch was a surprise unlike the market’s reaction to the news, which was. We consider the response as evidence of an uptick in short-term risk-off sentiment rather than the beginning of a crisis in India or anywhere else. Nonetheless, tail risks remain.
Investors in Indian equities look for growth, not yield. History suggests equity outflows from India are rare and happen only when there is global crisis – not the case now. We believe concerns from higher UST yields (carry trade reversal) may be relatively less relevant for Indian equities versus other emerging markets, where growth outlook is less promising at least over the medium-term. In fact, for some countries, we expect Debtopia-driven growth cycle to be peaking.
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Do you think that the recent correction in emerging markets was just the tip of the iceberg and things could get worse from here on? Do you see a reversal in this trend? What about the bond markets?
According to our US credit strategy team, the recent up-move in treasury yields (US and others) on the back of Federal Reserve chairman Ben Bernanke’s remarks on a possible reduction in QE (quantitative easing), seems premature in the absence of consistently better economic data.
Our global equity strategy team believes that from ultra-low levels, rising bond yields actually support higher P/E (price-earnings) multiples. But the move over May was too fast and thus strongly impacted EM FX (forex), debt and equities. Given that the Fed is likely to taper asset purchases only from Q1 next year, as our US economists expect, we think this is likely just a “dry run” of what might occur as we get deeper into the tightening cycle, closer to the actual change in US monetary policy.
UBS remains bullish on global equities and we see the recent pullback as part of the transition from extreme, reflationary monetary policy and crisis management, to a more “normal” world of self-sustaining growth and higher rates. We expect the correction in global markets to be short-lived.
How do you see the liquidity situation panning out in the near-to-medium term? What’s your outlook for the rupee? Is the worst behind us?
We expect a gradual depreciation of Rupee over the medium-term, until CAD (current account deficit) improves structurally. In the near-term, the worst seems behind us. Our forecast for the rupee remains 57 by year-end and 60 by the end of next year. Liquidity remains tight and will likely improve but only marginally, as CAD moderates and inflation comes off.
What makes you positive on the Indian markets since the macros seem to be painting a gloomy picture?
Indian bond yields are falling, not rising, unlike other markets. Though India is vulnerable to a rise in the risk premium globally, India’s cost of capital is arguably moderating due to falling bond yields. This can help support equity market performance, at least relatively.
Our positive stance on Indian equities is premised on a gradual economic recovery, albeit fragile, aided by Government measures to support the recovery. Markets are also now near the low-end of our 5,500-6,400 (Nifty) range for the Nifty in 2013. At this stage, the risk-reward looks attractive, again.
Despite our positive equities stance, we have been recommending INR hedging, but recent worry as well as move appears overdone. We remain cautious but leave it to investors to decide appropriate / comfortable hedging levels. Recent sharp move also reflects dollar strength globally.
So, which sectors/stocks are you bullish on at the current juncture?
We remain overweight on IT Services and recommend this as a way to participate in this INR depreciation theme. We do not recommend the pharmaceutical space due to valuations as well as recent adverse developments in some companies in the sector. Earnings estimates for consumption names clearly do not appear to be building this scenario while valuations are near peak. Reverse is the case for cyclicals like banks and infrastructure/industrials.
What’s your expectation from the upcoming quarterly results of India Inc? Have the markets factored in another few disappointing quarters of earnings growth?
The markets are not expecting a recovery in this quarter. It will be the extent of any decline sequentially over the fourth quarter, and adjusted for seasonality, that will be the key.
The carnage in the mid-cap and the small-cap space has been more severe than the large-cap peers. Are there any sectors or stocks that still hold promise from a medium-term perspective?
India overall still holds promise from a medium-term perspective. Within the small-mid-cap space, there exist a number of companies with great medium-term outlook and supportive valuations.
Banking sector has been in news recently given the new licence application. How are you positioning yourself in the large-and mid-cap stocks from this sector?
We expect the benefits of license to play out only over long-term and there remains a lot of moving parts. As of now, we are not really recommending any of our coverage stocks to investors to buy just based on this theme.
What about the oil & gas space in the light of the recent announcements and the rupee’s slide?
As regards the rupee impact, Cairn, Oil India, ONGC and RIL are positively impacted, while Essar Oil, HPCL and BPCL are negatively impacted. We remain positive on gas price hike beneficiaries.
