There seems to be a departure from the assumptions of 1st of January that interest rates will remain low, US bond yields will not go close to 1.5% and oil prices will remain under check. We are staring at a completely reverse picture right now.
I would agree. In the near term, it does appear that a bit of inflationary picture is getting painted but let me extend this to the rest of the year. In the developed countries especially, you are going to get a combination of a golden period where growth will do well because vaccinations are pretty rapid and we are expecting a lot of reopening in the developed economies in the second half of this year.
We are also seeing reasonably strong fiscal stimulus, especially in the US, with a $1.7-trillion package that is currently being worked on. The monetary policy remains supportive. Whatever bond yields may be doing at the moment and whatever is its impact on equity markets, the monetary policy remains very favourable to asset prices through this year.
The combination of a very strong fiscal policy, a very strong monetary policy and a growth revival is typically very good for assets. The valuations are very high but that valuations themselves will lead to a significant correction and downward movement in markets, seems to be a little or no probability to me.
I am going to keep the macro aside. 10 out of 10 brokerages are saying that Indian economy is doing well but valuations are strong. What is the right way of looking at valuation because if we are in the beginning of an earnings bull market and not stock price bull market, then valuations will always look strong because the surprise will come on the earnings front and that is where you know normalisation will happen?
Let me change the presumption bit. It is not 10 out of 10. At least we are of the view that the recovery in the Indian economy is still incomplete and what we have seen so far is a rapid recovery to where the country was or activities were prior to Covid. Growth remains a very unanswered question.
The concerns we have in terms assuming that the Indian economy is strong are two-fold: one, consumer confidence is very weak. This is supported by RBI data. We have done our own surveys to corroborate that. Two, any measure of wage growth that you look at in India remains at multi-year lows. Yes there has been some fiscal stimulus in the Budget, yes the RBI has managed to get rates lower and banks are cutting lending rates, but the impact of these tend to show up with a little bit of lag.
Our worries are that in the near term, the Indian economy or the sequential growth in the Indian economy is likely to stagnate a little bit. We are of the opinion that the slowing down of sequential momentum will lead to broader based earnings downgrades for the market. This upgrade cycle that we have seen over the last couple of months is a one-off. It happened because the economy opened faster than we thought, but we are going to go back to a downgrade cycle and this means that you will have this unfortunate combination of very elevated multiples for a large number of companies, with lacklustre earnings for the next few quarters.
What is the best way to participate in this recovery? Stick to traditional sectors or align with the new growth sectors?
This recovery is not linear. Recovery was partly because the base that had gotten eroded during Covid and it is the reopening that has driven this strong growth numbers. A large number of sectors have just gone back to where they used to be pre-Covid in terms of volume numbers.
I do not think that you can extrapolate linearly to say that the pace of opening up our growth is going to continue and the data on many consumer sectors suggest significant deceleration of month-on-month volumes across the board right. There was this dip when the Covid lockdowns happened. We had a big rebound after that and now the economy is settling down into a slightly lower trajectory of growth rate. The whole recovery was a one-off reopening rather than linear projection.
The only reason we are not going out and saying sell equities in India is because of the globally favourable macro and liquidity situation which means that the Indian index can keep getting dry and up as the global tide keeps rising through the year. But in India, the framework has to be to look for stocks that do not disappoint earnings. We have done a lot of quant work on this, some time ago. The correlations of one year stock return is to earnings surprises and not to earnings growth. It does not matter what growth it delivered, a company needs to surprise on earnings for investors to make returns within a one-year period. That is why the weakening of the momentum on the economy is likely to lead to a narrower market to our mind.
T Now: In light of that, do you still see India as a preferred emerging market? Is there a threat of fund flows receding?
Sanjay Mookim: There are two time frames to this answer. If you are a longer-term investor and looking for three-five year investment horizons, India remains a preferred destination because this is one country where steady compounding growth is relatively assured. This is rare within the EM complex. Most EMs tend to be far more cyclical than the Indian economy has been so far. However, in the near term of a few months or quarters, the rising oil prices and rising inflation globally tends to have a negative impact on India’s relative performance.
MSCI India tends to underperform when oil prices are going up. So yes, in the short term, this is relatively negative for Indian equities. India may still go up if global equities are going up but the longer term fund flow into India probably continues on growth expectation over the next decade.
