Adrian Mowat of JP Morgan believes that India still looks very good but valuations are pretty stretched.
Mowat says that JP Morgan's official forecast is that the Fed will hike rates by another 25 bps on December 12. According to him, it could be as high as 6 per cent in March and that reflects their view on core inflation and it will not be good news for the global equity markets.
Mowat further adds that even if oil prices were to fall, it would have no real impact on the Indian consumer because of the cross subsidisation, which is going on for some of the key products, such as kerosene.
Excerpts from CNBC-TV18's exclusive interview with Adrian Mowat:
How are you feeling about the market after the pullback that we have seen because right now people seem a little undecided again on whether we can take another move up or we need to pause for a bit?
I am still of the view that the fair value for the market for the year end is 11,000. I think any move up from this level, will be reasonably temporary.
Now everyone says that the markets have got a target of 11,000, which must make you very bearish. Actually, I think it is a very bullish target, that has got the market ending the year just under 16 times forward earnings.
If I look at MSCI (Morgan Stanley Capital International), India compares to a long-term average of around 13 times forward earnings. So India still looks very good but valuations are pretty stretched.
What about the flow situation because August has been a better month, more than USD 0.5 billion has come in this month. A little bit of it got stacked into IPOs and bulk deals, block deals but there is an air of expectation that some of that cash, which was lying with emerging market funds is now beginning to get deployed. Do you get a sense that there could be more money coming this way?
I think you are right to say that institutional investors globally do have cash and cash is still flowing in, particularly to emerging market mandates. However investors are still quite cautious, I would probably actually use the word 'nervous', particularly after their experience in May.
I think markets may be getting a little bit complacent on the Fed, the consensus move towards the Fed is now on hold, and some people speculating the Fed will be cutting next year.
Our view on this is the core inflation continues to rise in the United States. We have an inflation number on September 15. I think that there is a risk that this number might disappoint the market. You might see consensus on Fed fund rates moving away rather than being concerned about the next tightening move.
Our official forecast is that the Fed will take up rates by another 25 bps on December 12. We think that it could be as high as 6 per cent in March and that really reflects our view on core inflation and that would not be good news for the global equity markets.
If that is the view, then would you say that the odds of these markets including India dashing to new highs any time in the near future do not look very high to you? There is an air of expectation, which is building up before the next quarterly numbers, that we could actually be trading at almost new highs.
As I said before, I am cautious about this market making a new high because of current valuations. I am also a little bit nervous about markets in September, if we were to get some disappointments on the US inflation numbers.
One also tends to find September as a poor month for markets as we have been through the result season and normally, stocks would react positively to results because we have had some good results out. Then there is a lack of news flow, which may make us more sensitive to some other global factors.
Are you expecting any meaningful pullback in the market in India out here. Do you think that the market might just soften up a little bit and consolidate more than correct?
I would be in the latter camp but I am not very good at calling markets with a short-term perspective. I think it is more constructive to really focus on what could happen in 2007. We need to see relatively robust level of earnings growth in 2007 in order to justify current valuations in the Indian market.
I think there is a danger that the international investor gets less tolerant of the lack of policy action in reforms. I think there is much chatter still about the level of losses that one is seeing in the refining sector at the moment and international investors will like to see that addressed. So we hope that the markets see pricing in strong growth next year. If there is any disappointment in growth expectations, then the market would be vulnerable to that.
Are you seeing any new money being raised for the region? Some global voices say, people believe that emerging markets have a good relief for the next two-three months and then the global concerns will come back maybe early next year. So this is a nice little period to actually get invested and go up on the risk curve once again, do you see any new money coming in then?
I have made comments earlier on it that the institutional investors are still seeing inflows into international equity mandates, including emerging market mandates. But the pace at which those inflows will be invested will be relatively slow as the investors are cautious about some of these global concerns, particularly with regards to the direction of the Fed.
Whether we will see a more meaningful slowdown in the US economy next year, we have got the consensus that believes that the Fed is on hold and that we will have a soft landing, which is quite a favourable outcome.
My advice to investors is to look out for the US core CPI (Consumer Price Index) numbers, which comes out in the middle of the month. Also one should look at initial jobless claims, which will be a good indicator of whether this economy will slow down in a more meaningful way.
What about banks because bond yields have cooled down quite a bit out. There has been renewed surge of interest in bank stocks, what do you think of Indian financials right now?
I think the underlying case for the level of credit growth in India is still supportive although we are probably at the mature end of the credit cycle in India after the passive growth that we have seen. We know that the loan deposit ratio is high and so there are some stresses in terms of banks needing to put up positive rates to encourage capital to come in.
So our advice is to stick with high quality names, one might have to pay up for them but that is the right thing to do at the mature end of the credit cycle. I think the key-differentiating factor for India within emerging markets is that the Indian rupee is likely to be one of the weaker currencies, particularly within the Asia Pacific region.
That makes one lean towards the IT companies as the major exporting sector in India. Clearly, there are risks in doing that as one is exposing himself to the US economy. However, it is the US corporate sector that one is exposing oneself to rather than the US consumer, where the weakness is at the moment. One would have seen that the second quarter results season in the US was very strong, 18 per cent YoY growth, which suggests that there is plenty of cash with corporates to spend on IT.
Where do you stand on the whole crude theory and stocks like HPCL and BPCL, where there has been some interest over the last few weeks?
Hopefully we have all learned some humility about the crude oil market in terms of how difficult it is to forecast. Some are naturally reluctant to make an investment decision based upon an expectation for the oil price.
Even if the oil prices were to fall, it would have no real impact on the Indian consumer in Indian CPI because of this cross subsidisation, which is going on for some of the key products, such as kerosene. I think what investors would like to see in India is that if there was a fall in the crude price, the government will use that as an opportunity to reform the current pricing structure and allow refineries to make a decent margin.
There is clearly a concern that India won't add sufficient refining capacity, it is the same story in China as well, where they are holding down margins and that may ultimately lead to higher gasoline and diesel prices for both the economies at some point over the next couple of years.
What do you do with a stock like Reliance now because it looks like it might have the mantle of leadership and might lead the market up, what kind of appetite do you see for that one now?
If I look at this on a regional perspective, Reliance Industries is quite expensive versus some of the refineries that I can buy in Thailand, Korea. Also the refinery and the petrochemical stocks and energy stocks in China seem to be of better value to me.
We have seen lot of swings in the real estate sector, particularly in big stocks like Mahindra Gesco and Bombay Dyeing. What are your thoughts on Indian real estate and the listed real estate plays now?
I have no interest as an emerging market strategist or as an Asian strategist in the current valuations that you have in India. I can find much better value elsewhere in emerging markets, particularly in China, which has the same level of GDP growth, if not a little bit higher. Probably there is more rapid level of urbanisation and mature property stocks in terms of them being listed for a longer period of time. I would not choose India to buy property stocks at these valuations.
What do you like in India after the pullback to 11,500?
Mowat: I still think that the engineering story remains very good. There is a shortage of heavy engineering capacity globally, despite the fact that these stocks have done very well, I think they are quite unique. As I said, we have got the weakening rupee situation so that should favour the IT sector as well.
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