Politics and a setback to reforms are the biggest risk: Gary Dugan

Interview with CIO, Asia & Middle East, RBS Wealth Division

Indian stocks might not repeat their 2012 performance but investors can expect 10-15 per cent returns, driven by economic reforms, says Gary Dugan, chief investment officer, Asia & Middle East, RBS Wealth Division. In an interview with Jitendra Kumar Gupta, he speaks about what to expect from Indian, US and European markets in 2013. Edited excerpts:

What is driving foreign investor inflows?
Two things are pushing the Indian markets. One is continuous policy reforms, which came as a surprise. Second, improving confidence about the global economy that growth is going to be strong and emerging markets and the economies are going to lead the way. The world is still awash with a lot of cash on account of the quantitative easing by global central banks. A lot of investors are shifting or increasing their stake towards risky assets. They are coming out of bonds or safe assets to invest in equities. And, among the equities, the emerging markets; within these, India is one of the preferred ones.

Can Indian stocks repeat the performance of 2012 this year?
This year, the returns are not going to be 25 per cent as in 2012. However, one can expect another 10-15 per cent return from the market, backed by reforms which will lead to further re-rating of Indian equity. Second, although the relative valuations are higher at these levels, India can sustain, given its higher return on equity. The risk is not in the valuations and possibility of foreign outflows. The biggest risk is politics and a setback to reforms. But in general there is scope for further capital flow from the developed markets, as the risk appetite is increasing.

Are expectations of an earnings revival in Indian companies overdone?
We do not need a 30 per cent growth in earnings for a further rise in the markets from the current levels. Even 10-15 per cent growth in earnings is enough and possible with the higher GDP growth. We have already seen some of the key economic numbers signalling a bottom, suggesting scope for improvement in the earnings. Further, a cut in interest rates and lower reserve requirements for banks will help revive earnings. Importantly, this rally is devoid of involvement of domestic investors. I think they will come back and that will reinforce the rally.

So, is the bet on growth or recovery?
I think one should focus on recovery. One should bet on recovery or cyclicals more compared to growth at this point. The Indian economy needs to look different; it needs to invest rather than consuming more. The emphasis of growth will shift more towards investments, which will revive housing, capital goods, the financial sector or, broadly, the capex-led sector. The portfolio should be tilted more towards the cyclical.

Are investors ignoring possible risks to the US and European economies?
There is a risk to recovery in the US but I think this recovery is for real. The risk comes from the fact that a large part of the recovery has come from the housing market. Industrialists’ confidence is better but is still not high. I think the biggest risk this year is the US’ constant battle with the fiscal deficit. US consumers and industrialists are still hesitant to spend money because there are concerns over the uncertainty about the possibility of higher taxes. In Europe as well, the situation is better compared to what it was a year before. I think what international investors have overlooked is the marked improvement in the situation in Spain, Portugal, Italy and, to some extent, in Greece.

Can global equity markets ask another 12 months from these two (US and Europe) regions for stability?
The market is somehow forgiving some of the things that have been talked about. It is not certain whether the US can deliver better growth but we are hopeful that the deficit issues will be resolved. Then, an improvement in the housing market, and the equity market will see a further phase of growth. This should be the case for at least the remaining months of the current year.