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Rising bond yields in the US and the Rs 114-billion fraud unearthed at Punjab National Bank have kept markets choppy over the past few weeks. Hong Kong-based Manishi Raychaudhuri, Asia Pacific Equity Strategist, BNP Paribas, tells Puneet Wadhwa that while the performance of global equity markets will be divergent, emerging markets (EMs) are likely to outperform the developed ones in 2018. Edited excerpts:
How do you see the global equity markets play out over the next 6–12 months?
We believe the performance of global equity markets shall be divergent in 2018. While returns from developed markets (DMs) could be pedestrian, returns from EM equities, particularly Asia, could be significant. Valuations in DMs — particularly in the US — are considerably higher than their long-term average even after the recent correction. Asian valuations are only marginally higher than the long-term average.
What are the key concerns?
Rising bond yields in the US are usually a concern, particularly for flows into EMs, but the present instance of US yield spike has been accompanied, somewhat surprisingly, by a depreciating US dollar (measured by the dollar index — DXY). After the bout of flow withdrawal from EMs in early February, we believe flows should stabilise in the remainder of the first quarter of 2018.
I would also point out that the recent rise in bond yields has been accompanied by fundamental improvement in economic and corporate earnings environment — our real gross domestic product (GDP) growth forecasts for the US and Eurozone had been rising steadily in 2017, and jumped recently by another 30 basis points (bps) and 40 bps, respectively.
What policy action do you expect from the global central banks over the next one year?
We expect four rate hikes of 25 basis points (bps) each by the US Federal Reserve in 2018 and one rate hike in 2019. We believe the European Central Bank shall end its asset purchases in December 2018 after a short tapering and start raising the deposit rate from June 2019. We don’t expect Bank of Japan to raise interest rates till late 2019.
Where does India stand in your preference list?
Currently, the EM equities appear more attractive than the DM (equities). The sharp valuation discount of the EM (equities) relative to the DM equities, in relation to their own histories and forecast earnings growth, is one of the reasons for our preference. We also believe that strong tailwinds for EM equities – particularly Asian equities – are steady improvement in ROEs (return on equities) and consistent upward revision of earnings estimates. These tailwinds are likely to sustain over the medium term. Within Asia, India is one of the markets we are overweight on. We are also overweight on China, (South) Korea and Indonesia.
What is the road ahead for fund flows?
While the total quantum of flows is difficult to predict, flows into Asia in 2018 should be similar to that of the last year. The picture of domestic flows looks considerably brighter – particularly in India – where returns from alternative asset classes are significantly lower than potential equity returns.
Indian retail investors for decades have under-invested in equities and we’re now seeing a reversal to the trend. In 2017, DIIs (domestic institutional investors) put in $14 billion in Indian equities, and we believe in 2018, despite the disappointment on account of long-term capital gains (LTCG) tax imposition, DII flows could turn out stronger.
Which sectors are you overweight and underweight on?
In India, we are overweight private retail banks, automobiles, select consumer staples – particularly the rural-focused ones, and select industrial companies – especially the ones that are diversified and the ones that focus on growing segments like power transmission and distribution. However, I must point out that in India we focus more on stock selection rather than top down. The Indian stocks in our Asian Model Portfolio are primarily from the large-cap segment. Some mid-caps do look interesting, though after the recent correction – from diverse sectors like industrials, healthcare, energy and financials.
What are your earnings projections for FY19?
For most of the frontline Indian indices, we expect about 5 per cent earnings growth in FY18 and about 17-18 per cent in FY19. Consensus earnings growth expectation in FY19 is even higher than ours. There are signs of earnings growth revival in India – reflected in the October–December quarter results and in the reviving trajectory of index of industrial production (IIP) growth, auto sales, freight volumes and various other on-the-ground indicators. We are currently focused more on the domestic companies.
To what extent are the markets factoring in the possibility of a higher inflation in India and a rate hike by the Reserve Bank of India (RBI)?
Our economics group’s current forecast is that of two rate hikes by the RBI in the second half of 2018. We don’t think this is what the market expects right now. If the rate hikes are accompanied by strong growth revival, the equity market should take such monetary tightening in its stride.