India equities could outperform rest of Asia, says Manishi Raychaudhuri

FY19 earnings growth would possibly settle at 12-14% and that for FY20 could turn out to be 15-16%, says Manishi Raychaudhuri, BNP Paribas' Asian Equity Strategist

The S&P BSE Sensex hit an all-time high last week. MANISHI RAYCHAUDHURI, BNP Paribas’ Asian Equity Strategist, tells Puneet Wadhwa that they have recently downgraded India to ‘Neutral’ rating from ‘Overweight’ in their Asian Model Portfolio, keeping the Sensex target unaltered at 37,500 by end-2018. Edited excerpts:

Do you think the Asian and the emerging market equities could slip into a bear phase over the next few months?

Going by technical definition – a fall of 20 per cent or more from the peak – a few Asian markets could be considered to have entered a bear phase. The onshore China market (Shanghai Composite) is the largest among them. Several risks have converged over past two – three months: USD appreciation, escalation in trade war, slowdown fears in China and a spike in commodity prices are the notable ones. While the near-term volatility might linger around the current levels, with the ongoing trade friction, a prolonged bear phase in Asian equities appears unlikely to us because the key tailwinds viz., sharply recovering return on equity (ROEs) and stable earnings estimates, seem very much alive.

 
Which Asian and emerging markets are still worthy of investment?
 
We are overweight on China and (South) Korea despite the trade friction having raised the risk premium for both markets. We think domestic demand-driven sectors in China remain robust. The Korean tech sector — the largest in the market—is benefitting from technological transformations globally, translating into vigorous demand for memory. Separately, hardening bond yields are supporting margins for financials in “Developed Asia” —Hong Kong, Korea and Singapore. In a similar vein, Indian information technology (IT) is benefitting, partly from the depreciating rupee, though the latter is a headwind for the Indian market as a whole. In a nutshell, while it may be difficult to identify markets that are unequivocally attractive, certain pockets within each market look attractive.

What policy action do you expect from the global central banks over the next one year? Are the global financial markets factoring this in at the current levels?

Our Global Economics Group expects US Federal Reserve (US Fed) to raise rates twice more in 2018, i.e. a total of four times this year. We expect European Central Bank (ECB) to end the quantitative easing (QE) program by 2018-end, with rate hikes commencing in 2019. We don’t expect rate actions by Bank of Japan (BOJ) in the medium-term. We believe our expectations are broadly within the realms of market’s expectations; however, the consensus in the market is possibly a total of three rate hikes by the US Fed in 2018, not four.

 
How does India look as an investment destination? What are the key risks?
 
In the near-term, India could outperform the rest of Asia. India is relatively unaffected by the trade war, and if there’s a moderation in commodity prices, especially crude oil, due to global trade concerns that could act as an additional tailwind for Indian equities. In the medium-term, however, risks to Indian market arises from its disappointing earnings profile, the continuation of a lacklustre private capex cycle and potential political uncertainty surrounding the provincial elections in late 2018.
 
Macroeconomic growth has rebounded from the mid-2017 trough, but we think that’s inadequate to neutralise the earnings-related worries. Even though earnings estimates in North Asia moved up all throughout 2017, and estimates in some Asean pockets have started rising lately, Indian earnings per share (EPS) estimates have been facing a consistent downdraft over the past couple of years.
 
Despite this inferior earnings environment, India is trading at a significant valuation premium to the Asian peers. We very recently downgraded India to ‘Neutral’ from ‘Overweight’ in our Asian Model Portfolio, keeping the S&P BSE Sensex target unaltered at 37,500 by end-2018.
 
What is the road ahead for fund flows?
 
Both emerging market (EM) and Asia ex-Japan funds have reduced the extent of their overweight stance on India, though they still retain small overweight positions. It’s difficult to predict foreign fund flows in the medium term because they’re contingent on how the currency performs.
 
Domestic fund flows, however, have been more than neutralising the foreign institutional investor (FII) outflows and we believe that trend should continue for now. Returns from alternative investment avenues — real estate and gold in particular — are uncertain. Equity investments are also gaining larger retail mindshare with a gradual formalisation of the economy.
 
What is your view on oil and rupee? What are your sector preferences?
 
Our Economics group’s target for the Rupee is 69 to the USD by end-2018 and 70 by mid-2019. In other words, the worst of INR depreciation is possibly behind us. In India, at present, we like autos, premium two-wheelers, IT, select media and consumer staples and select industrials, particularly those with a broad footprint across various segments of capex.
 
You had earlier forecast 17–18 per cent earnings growth in FY19 for India Inc. Is there a reason for lowering this projection?
 
The earlier forecast of 17-18 per cent earnings growth for FY19 has declined — both for us and for consensus. The decline has been driven largely by banks, consumer discretionary and healthcare sectors. Consensus earnings per share (EPS) growth estimates for MSCI India are currently 15 per cent in FY19 and 19 per cent in FY20. We believe FY19 earnings growth would possibly settle at 12-14 per cent and that for FY20 could turn out to be 15-16 per cent. We expect further downgrades to consensus estimates for banks, consumer discretionary and industrials, while IT earnings could be upgraded.