Back home in India, bulls ran for cover on Dalal Street as the fear factor returned, with major indices tanking 2 percent, the biggest single-day fall in four months.
Nilesh Shah of Kotak AMC says China is one factor that the markets will have to watch out for and unfortunately for India, it is still a part of BRICs and for global Emerging Markets Fund, the topic ends there. He says: “India needs to differentiate itself from China. Also, the market is seeing negative headlines from Russia and Brazil too.”
However, he says this creates an opportunity for India if marketed well. “We need to demonstrate to the world that we have grown companies like Maruti , which have grown beyond its parent here,” he told CNBC-TV18.
Robert Parker of Credit Suisse too feels that the downside risks to India are low and also it will benefit from low commodity prices. However, he cautions that global factors are not positive.
Parker also does not think markets will go into a significant bear market, but sees unimpressive gains this year in equities.
Below is the verbatim transcript of the interview..
Sonia: It was a really disappointing start and it came out of nowhere. Of course these China problems have been talked about for a while but today we saw a damage of more than 500 points in one shot. How do you read into this and would you get spooked now?
Shah: Definitely China is one factor which we have to watch out for and clearly today for the global emerging market fund India is still part of the Brazil, Russia, India, China and South Africa (BRICS) we need to differentiate ourselves vis-à-vis China. The ultimate investor when he is seeing headline that Chinese economy is slowing down or Chinese economy has problems of debt he probably loses confidence across Brazil, Russia, India, China altogether. They are seeing headlines which are not conducive from Brazil as well as Russia as well as China and whatever positive headlines we make probably is not making impact on them and which is why we are seeing selling pressure.
But this selling pressure in turn creates an opportunity if we can market ourselves well. Within the BRICS Brazil, Russia (BR) and China (C) are crumbling but India (I) can stand apart, India (I) can stand out and hopefully can result into collection of more flows from investors away from Brazil, Russia and China.
Anuj: So, we are getting into bad companies. BRICS was a good terms five years back, not any more. Time to take eye out of this and maybe get into some other group?
Shah: Instead of going into other group if you stand on our own and if we can demonstrate to the world that here we have made companies like Maruti Suzuki which has grown bigger than their parents and they have given decent returns to investors probably we will get differentiated vis-à-vis the emerging markets. In fact we have differentiated ourselves vis-à-vis emerging markets in the last three years where we have delivered positive returns whereas emerging market is negative. So, this last three years track record should be highlighted more to create a differentiation.
Anuj: The story of 2015 was, specially the second half, FII outflows and a lot of domestic money flowing in through the mutual funds and insurance companies, do you think that is at risk now specially if our markets go back and break the previous low at the index level? Do you see that kind of panic then resulting in the domestic flows also slowing down?
Shah: We have plan A and plan B over here. So, let us talk about plan A which is domestic flows. Typically in the fourth quarter of the financial year we always receive more flows from the insurance. They get almost 35-40 percent of their business in that quarter and traditionally in the January to March quarter insurance have been bigger buyers of equities. My presumption is that this quarter should be no different from last quarter.
Now, if the equity market continues to fall certainly there will be an impact of slowdown in the domestic flows. Last year mutual fund invested in more than Rs 72,000 crore into equity markets and certainly they haven’t met the expected return. So, if they foresee that there will be more volatility or downside in the market probably the intensity of this flow will slow down a little bit. It will not reverse for sure but certainly there could be a potential slowdown if our markets fail to deliver expected return to the investors.
Sonia: So, what would your advice be to a lot of the retail investors or long term investors who are watching this screen now? What should the equity allocation strategy or asset allocation strategy be for an average investor in 2016?
Shah: For the passive investor we have been recommending and we will recommend Systematic Investment Plan (SIP) into multi cap and large cap funds. Yes, markets will be volatile, they will go up and down but whatever is happening in China, whatever is happening in the rest of the emerging market in some sense is positive for India over medium to long term.
The Chinese slowdown will lower the commodity prices even more. We are net importer of commodity so, eventually we will benefit from this correction. If we see the oil price correction itself we would have probably saved about USD 70-80 billion from the top of the oil price correction and if India was a company and we would have saved that USD 80 billion and we multiply that with whatever price Price-to-Earnings Ratio (PE) you can imagine a significant value creation happening.
So, to the retail investors my recommendation will be that if you are passive investor please do SIP and don’t worry about the volatility. Keep the faith on India growth story. If you are active investor then you can follow asset allocation strategy depending upon your views on different asset classes as well as your portfolio. So, either be an SIP investor or follow asset allocation depending upon your asset portfolio and view on the market.
Anuj: If I were to play the devil’s advocate to your argument, again for India as a company we haven’t done much in terms of having investor confidence in terms of say topline growth. We have seen this anaemic earnings recovery continue all through the last year. There is a chance that that is going to continue for 2 or 3 quarters. So, why should an investor choose a market like India over any other market?
Shah: You are absolutely right in saying that in last 12 months we haven’t shown any definitive earnings growth. However lets us make some concession from at least positive point of view. Lot of our earnings growth is negative because PSU banks are providing for NPAs. These NPAs weren’t created last year, they were created over many years but are now being provided for.
We also saw some of one off events in pharmaceutical sectors which has resulted into earnings getting down in those sectors. If I take this kind of one off events in pharma sector, in banking sector and also little bit of commodity sector out because there we have seen exceptionally lower prices then the rest of the economy is still delivering about 8-10 percent earnings growth which is nothing exceptional but there is 8-10 percent earnings growth coming in non-commodity sectors, non-PSU banks, non-one off events in pharma sector which in today’s scenario where your nominal GDP is lower than real GDP is reasonably okay.
More importantly we are building a foundation, today we have fiscal deficit which is under control, we have trade deficit which is under control, we have inflation which is under control, we have room to cut interest rates, our currency has been remarkably stable viz-a-viz our peers. So, on a macro point of view we have created foundation. It has taken 24 months to build that foundation but if you now give time hopefully we will build a bigger building than Burj Khalifa.
Sonia: Just for the very near term how high is the possibility of India or Indian markets being at the start of a prolonged cyclical bear phase in an otherwise structural bull market?
Shah: I don’t think we should be using this correction to define bear market. Bear markets are probably those markets where the prices are correcting because fundamentals are not in place because valuations have become expensive. In India’s case, we are at a valuation which is about 15.5 times. If market corrects valuation will become even cheaper, that is not a bear market, that is actually the beginning of a bull market because more smart money will come to buy at those attractive valuations.
The second thing is market-cap to GDP ratio. Today we are trading a market-cap to GDP ratio of roughly about 60 percent, that is not very expensive. So, I don’t subscribe to this theory of bear market. In calendar year 2015 we haven’t delivered return expected by the investors but you take two years horizon and we have still delivered 20 percent plus return which is not bad.
Equity market can be linked to Chinese economy or Chinese concepts in one manner that most equity markets are like bamboo tree, you keep on watering for 4 years and nothing happens and in the 5th year bamboo tree goes and touches the sky. In equity market the only difference viz-a-viz bamboo tree is that you don’t know which is the year in which markets will give return. Could it be 1st year, could be it be 5th year?
Anuj: The bigger problem or one of the big problems for our market has been that the market hasn’t got leadership from the two big sectors banking and IT. Banking in fact even private sector banks seeing one of the worst runs that we have seen in some time, specially the leaderships stocks. Even IT has not done much. Where do you think the leadership will come because at the end of the day while midcap story is fine, the index needs to move?
Shah: The leadership unfortunately is happening from an economic point of view into unlisted space. We have seen e-commerce companies creating billion dollar plus market-cap. Unless until those companies come into the listed space the leadership may not come into the index.
The second thing is related to within index private sector banks, material companies, they should be able to provide the leadership. We have also seen fair amount of underperformance in certain petrochemical company, petrochemical giant. Now possibly there could be an opportunity over there as well.
My feeling is that like calendar year 2015, 2016 will be year of stock specific returns. The returns might be available outside of index rather than within the index. That is why we have seen mutual funds delivering 4-8 percent outperformance over benchmark indices and the same trend should continue in 2016 as well.
Anuj: What do you make of what happened in China today and more important and the bigger question, what does this mean for equity markets going forward?
Parker: The first point to make is the announcement of the Caixin manufacturing Purchasing Mangers’ Indices (PMI) from China disappointed expectations and there is increasing scepticism as to whether the official PMI data which have been consistently higher than this Caixin index whether those official data, frankly the credibility is increasingly being questioned by investors. Linked into that, one has to recognise that prior to this move today, that the Shanghai composite had had a significant rally, and if anything, I think it was technically vulnerable to a correction.
So, although yes, we have got reasonably good numbers out for China for retail sales, for the service sector, one should not forget that the service sector PMI numbers were pretty satisfactory. Investors have been focusing on this negative manufacturing PMI number. I think there is also some concern about the downward movement in the currency. The renminbi is currently trading at about 6.5 to the dollar. There is a very clear consensus that as we go into late first quarter, beginning of the second quarter, that we could easily see the renminbi trade between 6.6-6.7. So, that in turn has a negative impact on capital flows into China.
Sonia: The worry also is that the ghosts of last year’s past have come to haunt us once again at the start of this year, so the fear is whether we could head into a bear phase for equities at least in the first half of the year. Would that be a reasonable assumption to make or do you think this is just a one day issue?
Parker: I do not think we are going to go into a significant bear market. And by a significant bear market I am looking at a Morgan Stanley Capital International (MSCI) World down 20 percent or more from current levels. I do think however, we could see in the first half of 2016, what I call a very unsatisfactory market whereby one week up, one week down, obviously, this week we started the year with a significant down week. But, if one looks at the trend for MSCI World as a whole, probably it is going to be a rather flat trend. And we have to recognise that there are some quite serious constraints on equity markets going forward, namely a probably further increase by the Federal Reserve and the Fed Funds Rate in March or April. I think there is some more weaker data out of the States.
The slowdown in China and one has to remind oneself of the International Monetary Funds (IMF) forecast for China this year of 6.3 percent growth. And I think that is a realistic forecast. Plus, the impact on the global economy of very weak commodity prices. Now, there are certain markets and certain economies like Europe and like India which benefit from lower commodity prices, but these low level of commodities are causing quite significant disruption to parts of the capital markets and other economies, such as Brazil which remains in recession.
Anuj: What about India, because we had a fair year last year. The second half was not good, but overall, it was still a decent year. What is your outlook for 2016?
Parker: The outlook for India is fairly benign. Whereas we have got China clearly slowing down I stick to my view that India should hold 7 percent growth and that is one of the few bright points of the global economy. Obviously, positive factors are that inflation in India should stay low. That allows the RBI to keep interest rates low or possibly even go lower. Commodity prices as we mentioned are a significant positive for the Indian economy and most particularly, this low level of energy prices. So, although in the second half of last year, investors were concerned about political events in India and clearly, fiscal issues do not go away, I do think that overall, capital flows should come back into India and a market which looked reasonably expensive six months ago is now looking more fairly priced. So, I think the downside risks on India are now rather low. Having said that, one cannot ignore the global backdrop which is frankly rather mediocre.