Polls, while noisy, can have little relevance: Julius Baer's Mark Matthews

It was an eventful week for the markets as they coped with the sudden resignation of the governor of the Reserve Bank of India (RBI) and the outcome of the Assembly elections in five states. Mark Matthews, managing director, head of research for Asia at Julius Baer, tells Puneet Wadhwa that he remains underweight on India. The key thing to watch now will be the direction of the monetary policy action, he says. Edited excerpts:

How are you viewing the outcome of state polls and the sudden change of guard at the Reserve Bank of India (RBI)? 

The state poll outcome is in line with expectations. The inference is that the Bharatiya Janata Party (BJP) may have to form a coalition at the federal level in 2019. The market could go down because it thinks a coalition would be messy. Or, it could go up because it thinks the BJP could listen more to representatives of the business community. The market seems equally split between these two views; so the elections, while noisy, could have little relevance. Just two years after Raghuram Rajan’s resignation, Urjit Patel’s resignation hints at some structural friction between the central bank and the government.

How are foreign investors viewing these developments?

Neither development is surprising, in the sense that there was talk in October that the RBI governor wanted to resign, and political pundits expected the BJP to lose ground in the state elections. That said, the churn at the top level of the RBI is not positive for the rupee.

India was a 'buy-and-hold' market for you. What's your view now?

We went to neutral in mid-September and underweight in early October. What caused us to change our stance was the rise in oil prices, worse-than-expected earnings, the issues facing non-banking financial companies (NBFCs), and hawkish commentary from the US Federal Reserve (US Fed). Since then, the oil price has come down, there has been some improvement in corporate capex, the NBFC problems seem to be contained, and the US Fed has become less hawkish in its commentary. 

Where does the change of guard at the RBI leave the reform/policy process regarding banks and NBFCs?

The key thing to watch now will be the direction of the monetary policy action. Some of the points of differences between the RBI and the government included prompt and corrective action (PCA) norms for PSU Banks, dividend distribution to the government, and liquidity provisions to support credit growth, SMEs and NBFCs. If the new incumbent's policy orientation is directed toward providing the requisite support for liquidity/growth, it would be beneficial for the financial sector in the medium term. We would like select retail and corporate-oriented banks, which have strong franchises. We also like select NBFCs with strong parentage and niche businesses.

Your expectations for corporate earnings growth?

The consensus is currently expecting earnings growth of around 14 per cent in FY19, a significant cut from the earlier expectations of 22-24 per cent. It still looks for 24 per cent in FY20. We see FY19 at 12 per cent, while FY20 could be 17 per cent, so below expectations still. And, a lot of that earnings growth is contingent on the contribution of the financial sector, which should be treated with some scepticism. Sectors we prefer include good quality financials (especially ones with a strong CASA franchise), autos and cement. We do expect a pick-up in capex and the investment cycle over the next 12-18 months. 

How are you approaching equity as an asset class in 2019?

It is impossible to say with certainty if the market will be up or down next year. Clearly, 2018 was a disappointment, so the mood is sombre. 

But that may not be a bad thing. Earnings growth in the US will be over 20 per cent year-on-year (y-o-y) this year, but the S&P 500 is down over the same period. So it is cheaper than it was then; in fact, this year has seen the third largest decline in the S&P’s valuation since 1990. We do not expect a recession until mid-2020.

Can the developed markets outperform their emerging market peers in 2019?

The worst case is that the United Kingdom (UK) moves to a World Trade Organization (WTO) rules-based relationship with the European Union (EU). It would be painful in the short-term, but the country would survive, perhaps even be revitalised to be on its own again. Brexit could keep the European Central Bank (ECB) from raising interest rates, and therefore, keep the dollar from falling much.

How many hikes do you expect from the US Fed in 2019?

We still expect a strong US economy will warrant three more rate hikes next year. Having been disappointed by the current year’s profit growth, we would like to wait and see what happens next year rather than betting on an improvement now.