The strong show by consumer stocks is a reflection of the dynamic of capital markets and not a medium-term investment theme, Adrian Mowat, EM – Equity Strategist, tells ET Now.

Edited excerpts:
These are tough and challenging times for emerging market investors, not only in India but across the board. What is your view?

It is a very tough market. Most of the emerging markets are down. Some are down double digits, particularly places like Brazil, Philippines, Thailand, Indonesia and Turkey. India is sort of middle of the pack. Year to date, a little bit of money has been made in China offshore shares at around 1% return and it has only been markets like Qatar, Columbia and Peru which experienced a clear up-to-date commodity play. It is a tough year to date. It is important when you are talking about the midcap performance. In 2017, we made supernormal returns. To some extent, what we are seeing in markets is a little bit of a give back after a very strong year rather than reflecting the move into a secular bear market.

For the longest time, for Indian markets we have argued that the earnings recovery is round the corner. The grain of the truth is that except for a select few, none of the companies are showing any green shoots. Do you think that those who are betting on very large earnings recovery in FY19 or second half of FY19, will still get it wrong?

It is really difficult to see that the drivers about earnings recovery beyond may be exporters having numbers flatted by a weak Indian rupee. The macro economic data for India is sort of okay but I put it more as steady as you go. There may be a little bit of pressure on the funding side and that is a global phenomenon. As interest rates move higher and currencies get weaker, it will have an impact on people’s ability to raise fund abroad even if the RBI is not necessarily indicating much change in funding rates.

I agree with you that earnings are probably going to disappoint again for the market broadly and perhaps that’s why we are seeing such a polarisation in performance.

I want to talk about this dichotomy — that the midcaps and smallcaps are doing one thing while the largecaps and Indian equities are doing the other. Would you say though that pessimism perhaps is at its peak when it comes to the broader markets? May be now is the time to start deploying cash, start nibbling into those beaten down names from the mid and the small cap universe?

There are some interesting global drivers that might be impacting India. These are not necessarily about India’s fundamentals and we should try and take advantage of that. Globally, we have the Fed raising rates, a relatively strong dollar, a relatively good performance out of the oil prices. More recently, perhaps that has come off a bit but we are also moving into what looks like a very meaningful geopolitical risk for the global economy which is tit for tat trade war.

We have got Trump starting this trade war with both China and the Europeans. And that has the potential to have a meaningful impact on the economy. The dynamic will be bearish here but the global economy is relatively strong going into this, particularly the US. You start to have a trade war which pushes up costs as tariffs rise and then you begin to start to be a bit more worried about inflation and the pace at which central banks move. If that is the outcome, then it is going to be quite tough for global markets.

It may be a story that we will get further weakness through the summer because of the trade conflict and that generates an opportunity to buy some stocks specific examples in India. I would caution people about doing that today in June. The summer months could prove more troubled but that will provide a better buying opportunity and perhaps that is when one should turn a little bit more constructive.

What are you buying now until that peak summer correction kicks in? Is the strength going to remain with traditional defensives? One is seeing some positive news flow coming from the pharma sector. Pharma and IT stocks have been bouncing back. These stocks are sitting at a 52-week high in an otherwise bleak market. What is your view?

I would expect the trend of IT and pharma outperforming to continue. It is the other side of the weakness in the Indian rupee. We got to be a little bit careful with both of these. May be, the FDA news for pharma has been a bit more constructive. But we are entering a trade war and it is possible that the collateral damage to the services names like Indian IT and pharma cannot be overlooked. The pharma names have been dealing with other issues related to FDA compliances etc. and probably moving in the right direction away from those issues.

Let us look at the opportunities in India. You find insurance an interesting space. Why is that?

Adrian Mowat: I absolutely believe in the thematic of a financial penetration expanding in India. A rapidly growing middle class will want to buy financial products such as insurance products. Expect a high growth rate but as the case requires a lot of stuff listed in the Indian markets, prices often reflect those high valuations. Just to be clear here, we will get an opportunity to add risk in India. The underlying fundamentals are relatively solid but for now, India is going to continue to be buffeted by some of the global issues that are hitting emerging markets.

I also think that we could have a domestic issue here which would be the election cycle being accelerated and that could also have an appetite impact on risk appetite in India as well.

Beside insurance, private banks and defensives have outperformed. If that pocket is something that investors are either ways chasing, where can one find value? Or is it going to be more of the same where you keep paying premium for growth because there is certainty there?

You are trying to protect your capital and you have a patient approach and let some of the conflicts around trade wars, what is happening with the oil price, rise in US interest rates generate opportunities for you. But I would not be recommending that people aggressively add risk in India today.

The consumption names in India are not only stretched but are overstretched — both in terms of ownership and valuations, But that is where all the action is. If I look at the stocks which are outperforming or stocks which are sitting at a 52-week highs, they are anchored in and around consumption. You may hate their valuations but for investors, frankly there is no other option. Those who bought HUL or Godrej or some other consumer names in staples and durables, are the ones who are actually making money?

Yes, but it probably reflects more the dynamics of the capital markets and active management. There is concern about the outlook for the Indian economy about earnings. We have a weakening currency and so the margin flow has been out of cyclical names, out of domestic names into consumer staples or consumer defensives.

This is not going into autos, two-wheelers, etc and it has also gone into the export earners such as IT and pharma. I would also that IT and pharma are perhaps moving away from some of the near-term secular concerns because of the underperformance of those sectors, particularly in 2017. So, what we are seeing reflecting here is the dynamic of capital markets as opposed to a medium-term investment theme.

Would you align with the classic themes like consumption, private banks or would you align with cyclicals?

My advice here would be patience but to be open minded about looking at the cyclicals over the summer months. Expect further weakness but use that time to research some of the cyclical names that have been hit. As a medium-term strategy that would probably work better. But again, I want to caution people against aggressively committing capital at this point. The global trade war has started and as of now there is limited evidence that the US is going to lower the tension here and both the European Union and the Chinese are responding in a tit for tat fashion.

That is a material risk for the global economy and until we get some clarity on that it is very difficult to see global capital markets getting stability. Without that stability, you are going to struggle within the emerging markets.

Are you also then sensing the same weakness trickle by for US equities, for instance?

What we expect to see here is that the US equities that are more vulnerable to global trade, will be at risk. To some extent, you are beginning to see that with a narrower market with the FANGs retaking the lead with all-time highs. Facebook, Apple are continuing to do well and Netflix is hitting all-time highs. So, it is a sort of domestic tech doing well and not necessarily getting the same sort of strong performance out of some of the tech hardware names in the Unites States which could be impacted by trade flows.

Major stocks like General Electric have fallen by nearly half over a one-year period. We are seeing damage within the US market related to this but this index statistics gets flattered by a narrow group of stocks which continue to do well.

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