Indian markets can withstand a somewhat expensive multiple: Jonathan Garner

For foreign investors, there is a good opportunity to buy Japan, Korea and Taiwan in the Asian region, he said in this exclusive interview on the sidelines of the Morgan Stanley India Investment Forum

Morgan Stanley has not changed its stance on Indian equities in the last few months despite a healthy correction from the peak levels in frontline indices. Puneet Wadhwa caught up with JONATHAN GARNER, Asia Equity Strategist at Morgan Stanley on the sidelines of the Morgan Stanley India Investment Forum in Mumbai, on his interpretation of the global equity landscape, and his views on the Indian markets. Edited excerpts:

Most global frontline benchmarks, be it the NASDAQ, S&P 500, or even the Sensex, have actually gained ground over the past few months with only a handful of stocks participating in the up move seen in the last two-three months. Do you think that the leading indices and the global markets per se are actually treading on thin ice?

I think in Asia and emerging markets, including India, we had some features which are quite different from what's going on in the US and Europe. In Asia, we never really had the inflation breakout that you saw in the US and Europe. And we've had a return to pretty strong gross domestic product (GDP) growth.

In India, the recent quarterly GDP print has surprised – tracking for over 6 per cent. In the US, the tight monetary policy is dealing with the inflation breakout and growth is set to slow sub 1 per cent, which is a much more difficult environment for earnings. So, for much of the emerging markets in Asia, we are actually anticipating decent growth, subdued inflation, pretty good earnings and that speaks to an environment that is quite constructive for stock markets.

You still have not upgraded Indian equities to overweight. Why is that, and by when do you plan to be overweight India?

We had changed our view on the overall situation in Asia in October 2022 and were looking at early cycle cyclicals in markets, like Korea and Taiwan and then China to perform well. China's performance, however, has been somewhat disappointing recently. After an initial recovery and growth, activity has slowed. But Korea and Taiwan have done very well since then. 

In October 2022, we had downgraded India to underweight due to steep valuations. Back then, the Indian markets were at a record valuation premium to Korea, trading about 24-times one-year forward PE on Sensex on our calculations, or more than two-times the multiple of overall emerging markets. By March 2023-end, the Indian market had underperformed and it de-rated in multiple. It's still around one standard deviation expensive to its history versus the EMs. 

The Indian markets can withstand a somewhat expensive multiple given relatively strong GDP growth, subdued inflation and the fact that the RBI can probably move towards cutting interest rates sometime in the next 18 - 24 months.

Which equity markets across the globe is the big money chasing now?

Our top pick market is Japan and we've been constructive on Japanese equities for many years. Leading companies there are generating much higher ROEs than they used to. That's to do with improved capex and operating margins, but also better balance sheet management. And this year in particular, as the US dollar is quite strong and the yen is weak, which is actually helping corporate margins. Within the overall EMs, we like Korea and Taiwan. But India, we think, will perform in line with the overall emerging markets. There can be around 10 per cent upside from here on, which is also our base case.

So what's the base case target for the Sensex and the Nifty? / Can you put a number to this base case?

As per our Indian team, the Sensex target is 68,650.

Why is the mood so lukewarm regarding Indian equities? Are the valuations still not supportive?

For foreign investors, there is a good opportunity to buy Japan, Korea and Taiwan in the Asian region. They're three very large markets. India will get its share of passive flows into the EM tracker funds. However, I don't think there's an exciting opportunity to be a contrarian around the valuation situation in India. The valuations have been very expensive. Many foreign investors understand that there is a strong domestic mutual fund bid here in India from local investors; and that's frustrating for them because it keeps the market relatively expensive.

What are your views on China?

For about two years, we were quite negative on China due to bubble-type valuations. The market was extremely expensive. More policy stimulus is needed to actually help the property sector to recover in China. We've cut our position a bit and retain a small overweight position; but, we do want to see that policy stimulus before we think foreign investors will re-engage with China. Our preferred markets remain Japan, Korea and Taiwan, all of which have near-term catalysts. So, I don't think it's really a sort of switching between India and China story. It's more than people have switched from China actually towards Japan, Korea and Taiwan.

How will you approach the Indian markets from now till May 24, when we have the general election scheduled?

We don't comment on politics per se, but obviously we will be looking at how policies evolve, particularly what happens to monetary policy and real interest rates, which are very important for equity valuations. The economic growth outlook here is pretty favourable. Our India team is emphasising domestic sectors like as financials, consumer discretionary and industrials, and they should do well if our base case of 6 per cent plus GDP growth number holds true for the next couple of years.

What's your view on the MSCI emerging market index? By when can we see actually India's weight go up there? What's your sense?

Well, India's weight has been going up for some time actually, and at one point it was the second largest weight in the index. And we are getting more initial public offers (IPOs) and equity listings, which I think will help that weight gain over time. Maybe seven - eight years ago, India's weighting in the EM index was down to about 6 per cent, which has almost doubled since then. It's consistently around 12% plus now, which means it's one of the top four markets consistently within the emerging markets index already.

What are the key risks that you see for the Indian markets from here on out, over the next six to 18 months?

One traditional risk is the oil price. However, the OPEC+ has cut production because of the weakness of global oil demand. That said, I am concerned about the El Nino that is developing and the fact that that may lead to a continuation of, or worsening of, very hot and dry conditions in India, which in turn could have an effect on the rural sector. So, that's something we'll watch quite closely.

What are the three or five big themes in the Indian equity market landscape that you like at the current levels, or would probably like once the markets were correct to correct a bit more?

It is really about the domestic consumer and to some extent the industrial development story, and maybe the real estate sector over time. One can play the consumer discretionary sector in India in quite a wide range of stocks. We sort of de-emphasize somewhat for the time being the IT services and the pharmaceutical sectors. Most investors are more interested in tapping into this early phase urbanisation and industrialisation story, and that's the right way to play the market.

How do you see fiscal 2023-24 (FY24) earnings layout in the Indian context?

Our India team is above consensus on FY24 earnings, maybe even in the high 20 per cent earnings per share (EPS) growth and that is higher than consensus. Earnings growth for three years — FY23, FY24 and FY25 — can compound at above 20 per cent, which brings down the forward PE multiple maybe down to only a little over 16x in FY25.

Have the financial markets overcome their fear of a global recession? By when will the US Fed and the RBI pause and pivot?

Inflation is coming down in the US, but it is coming down quite slowly. Interest rates are likely to remain over 5 per cent for quite a considerable time, and that is already squeezing the interest rate-sensitive parts of the US market, like housing and commercial real estate. We have had some problems in regional banks in the US, too. That is why we think it is quite a dangerous environment for growth. We have the US equity market as the least preferred of the major regions, with Asia being the most preferred region, and Europe in second position. The underlying inflation and growth picture is very different here in Asia.