“It is this dynamic between what the Fed is doing, what the dollar is doing and what commodity prices are doing – a sort of cocktail – that is negative for India right now. But we are also tracking bottom-up the declining earnings estimates revisions. So, whilst it is not an outright underweight for us India, it definitely is a market that we are relatively cautious on.”
For Morgan Stanley to turn overweight on India the macro environment would have to improve as also lower valuations. The relationship between forward PE or price to book and return on equity in India is one of the more expensive markets in our coverage universe and indeed globally, says Jonathan Garner, Chief Asia & Emerging Market Strategist & Chairman of Asset Allocation, Morgan Stanley
The Fed has moved on expected lines and they have acknowledged that we are at war and we will crush inflation. What does that mean for financial assets?
Well this is quite a moment! The 75 bps hike came after 28 years. However, we are already deep into a bear market, at least in my coverage, in overall emerging markets. It really goes all the way back to early 2021 when our markets peaked. That is the overall EM index. We are a lot cheaper than we were back then and earnings estimates provisions have been negative for some considerable time, So, we think we are actually quite late on in the bear market unlike the S&P which has only really got into bear market this year. But what is not clear to us is how we plot a path to a new bull market. It is much too early to be thinking about a new bull market.
The terminal rate for the calendar year which has now been spiked to 3.4% by the Fed overnight indicates an additional 150 bps rate hike earlier than anticipated. Over the next four meetings, is that going to shake off markets and is that going to continue abated and the bear market to continue?
They’re certainly frontloading the rate hikes now that is very clear and they are doing this at a time when many macro indicators, particularly on the consumer side and the traded good side, are softening. We do think at Morgan Stanley that there are still downside risks and for S&P, my colleague Mike Wilson is targeting 3,400 to 3,500 before we get valuation support. At that level, you would be trading about 15 times forward PE.
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Now again, just to be clear we actually prefer overall emerging markets in Asia to the S&P 500 and so we do not necessarily need to fall as much this year as the S&P, given that our bear market began last year but if we are right that the S&P is falling, it is difficult to think that our markets are actually going to go up.
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Are we in for a protracted period of time-wise correction or consolidation where we may not fall but we may not rise also?
Well, the Indian market is slightly different from the overall emerging markets in the sense that last year India held up much better than China. In fact all of last year, we were overweight India and cautious China. That has changed a little bit towards the end of last year when we felt valuations have become excessive for India.
At the moment, we are tracking negative earnings revisions for India. Commodity export is part of our coverage. Countries like Indonesia or Australia or Saudi Arabia are actually experiencing positive revisions. So for the Indian market, our overall view probably tracks those downward estimate revisions and we have to watch how the RBI responds to the Fed. The RBI has quite rightly begun a rate cycle. There are some modest inflationary pressures in India and the Indian market is probably going to be more correlated with the S&P500 than some of those other markets that have positive earnings drivers, being commodity exporters.
The striking feature for us has been the FII selling. The numbers are large and slightly disturbing. Do you think the FII selling is here to stay in India?
India is not one of our top pick markets. We are seeing other markets where foreigners are reducing positions, particularly in Taiwan and Korea and obviously in China, there were steady sellers all of last year and the early part of this year.
But yes, I would expect the India market to be characterised by continued outflows from FIIs for a little while longer until we get the peak in the US dollar. If the US dollar peaks, which is likely to be around the time when inflation peaks and the Fed frontloading is fully priced in, then the environment can get a bit brighter for India. But at the moment, the trade weighted dollar just globally remains very strong.
For India’s base case to improve and for you to turn bullish on India, would it only be the dollar or are you going to closely watch out for crude as well? While every asset class has come down, crude has not and that really impacts India?
Yes that is right and it is also a positive for some of those markets I mentioned like the Middle East markets, Brazil or indeed Indonesia. It also heavily represents in the index in Australia oil and gas. So yes essentially, it is this dynamic between what the Fed is doing, what the dollar is doing and what commodity prices are doing – a sort of cocktail – that is negative for India right now relative to some of the rest of our coverage. But we are also tracking bottom-up this declining earnings estimates revisions. So, whilst it is not an outright underweight for us India, it definitely is a market that we are relatively cautious on.
For India to become your most preferred market, would you be waiting for macros to turn or would you be waiting for absolute price correction to kick in?
The macro environment would have to improve plus we do need to see lower valuations. The relationship between forward PE or price to book and return on equity in India is one of the more expensive markets in our coverage universe and indeed globally. So precisely because it was relatively resilient in performance last year, it is not particularly cheap on a relative basis now. We need to watch that relative valuation as well.
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