The markets have welcomed the recent policy decisions by the Indian government. At the global level, measures by various central banks have boosted sentiment. Richard Gibbs, Global Head of Economics, Macquarie Research tells Puneet Wadhwa in an interview that the foreign institutional investors (FIIs) are positioning to take advantage of the expected rise in equity markets. Agri commodity prices are likely to remain firm, he suggests. Edited excerpts:
Do you think that there is another bubble waiting to burst among risky asset classes, perhaps a couple of years from now?
In all cases the additional stimulus measures recently announced are directed at supporting real economic activity and certainly in the case of the US they are targeted at reducing the unemployment rate. However, to the extent that long-term interest rates are being held down by monetary authorities, there is ultimately the capacity for a bubble in this asset class.
Indeed, should long-term interest rates be held down in a climate of accelerating economic growth, then a mispricing of the inflation risk premium for bonds will occur and this would have the potential to create dislocation in long-term capital markets.
What are the top three negatives you see from such quantitative easing and stimulus measures?
On balance, we can identify three key negative risks associated with quantitative easing measures: (a) Fuelling inflation pressures in asset and general prices in economies and thereby distorting the efficient allocation of capital and the employment of factors of production; (b) Increasing the volatility of global capital flows as liquidity is exported to ‘higher yielding’ economies; and (c) Pressuring ‘trade-exposed’ economies to devalue their exchange rates in order to maintain export competitiveness against further weakening in the US dollar and Euro exchange rates.
How to you interpret the recent move by the Reserve Bank of India (RBI)?
The decision to leave interest rates unchanged and to only cut the Cash Reserve Ratio (CRR) by 25 bps reflects the RBI’s concerns about persistent inflationary pressures even against a background of moderating domestic demand growth.
We continue to believe that the Indian economy faces difficult supply-side conditions, which if persists, will ultimately reduce the potential growth rate for the economy. Needless to say, we continue to anticipate that the Government will pursue further measure in respect to its ‘reform and development’ drive as it comes to recognise that building the economy’s productive capacity is the best form of stimulus that can be delivered.
How are the foreign institutional investors (FIIs) positioning themselves with respect to India now?
In the wake of the recently announced quantitative easing measures by the US Federal Reserve and the European Central Bank (ECB), the FIIs are positioning to take advantage of the expected uplift in equity market performance. Previous instances of global liquidity easing have led the Indian market to an average 8 – 10% rise in a three month period. We would expect this uplift to run further in light of the new global liquidity easing measures.
FIIs are also being kept interested in the Indian markets by the latest moves by the Government on liberalisation of the retail and civil aviation sectors of the economy. Investors will also be watching to see if the Government now maintains its ‘reform and development’ drive ahead of the elections, particularly in respect to SEB loan restructuring, clarity on coal blocks, divestment of PSUs and the fast tracking of big infrastructure projects.
What are your earnings estimates for India Inc for FY13 and FY14? Have the overall estimates and any sectors in particular seen an upward or downward revision? Can you please provide these figures?
We anticipate earnings per share (EPS) growth for the Sensex of 9 – 10% for FY13 and 12 – 13% for FY14. For the MSCI index, we anticipate 11 – 12% for FY13 and 13 – 14% for FY14. Overall, our estimates have been revised down in-line with the downgrades to earnings ratios in the past few months. That said, Indian markets are now showing signs that earnings ratios are bottoming out, with downgrades now running at a snail’s pace. Across the sectors, we have made some downward adjustments to our EPS forecasts in the Materials, Telecom, Utilities and Information Technology sectors.
Defensive bets have done quite well recently. Do you see the momentum continuing? Can you name a few sectors and companies that one can look at from a year’s perspective?
Given the strong performance of the Indian markets following previous global liquidity easing measures, we are now looking towards the higher beta sectors. Fundamentally, the actions of the US Federal Reserve and the ECB have inspired another episode of “risk-on” trades, so we would expect the defensive sectors to occupy a lesser focus on the part of foreign and domestic investors.
We believe that stocks in consumer discretionary, autos, banks and PSUs geared to infrastructure capex spending will be a very rewarding way to play the uplift in Indian markets. We also expect these stocks to be relatively better off during the post-correction period.
In addition, it may be worthwhile screening for cyclical stocks that are trading at cheap valuations both relative to history and the market and may be ripe for picking from a relatively longer-term perspective.
The last time we spoke in April 2012, you were underweight financials and capital goods (CG) sectors. Are the order-book position in CG and the NPA levels of the banks still a cause of concern? Do you see any hope of improvement over the next few quarters?
Being underweight in the financials and capital goods sectors in the first half of the fiscal year did serve us well as we were about to limit our exposure to the sharp earnings downgrades and also the generally ‘risk averse’ global investment climate. That said, we are mindful of the likely over-reaction in the Indian markets to the earnings downgrades and the earlier episodes of ‘risk aversion’.
It is likely that there is now some light at the end of the tunnel, particularly if the Government continues with its ‘reform and development’ agenda and the further global liquidity easing measures encourage greater and more stable risk-taking by institutional investors.
Could you name a few companies within the new allocation that you are now overweight or underweight?
Yes, we have made some changes to our portfolio to reflect our preference for cyclical sectors in the aftermath of the recent global liquidity easing measures. We have now moved to overweight stance in Consumer Discretionary, Healthcare and Industrials sectors, while maintaining underweight stance in Consumer Staples, Energy and Information Technology sectors.
Can you identify the stocks in these sectors?
Mahindra & Mahindra, Maruti Suzuki India, and Tata Motors in the Consumer Discretionary space; Dr Reddy’s Laboratories, Ranbaxy Laboratories, Glenmark Pharma, Wockhardt in the healthcare pack and BHEL, Cummins India and Larson & Toubro in the industrials segment. Sugar, cement and fertiliser stocks all have the potential to provide good contrarian trades in the current global climate.
How do you see the commodity space panning out in the remaining half of the current fiscal year?
We continue to expect that commodity prices will be supported by pro-growth liquidity easing measures (with the exception of bulk commodities – iron ore and thermal coal – as these commodities will continue to be leveraged to expectations about China’s fixed asset construction growth). With respect to agricultural commodities, we expect to continue to see robust prices reflecting crop production issues emanating from the drought in North America.
