India is part of the ‘Expensive 4’ club as it is among the four most expensive markets in the region. The premium for India had gone above 50% and the valuations have improved, said Sakthi Siva, Managing Director of Credit Suisse adding "it is not enough to upgrade our recommendations".
So far this year, India has been the second worst performing market, added Siva.
On the earnings front, Siva said that for 3 to 4 consecutive years, India has seen earnings downgrade. While others in the region have seen strong earnings upgrade last year.
"However, the house has not always been underweight on India", she said, adding that they had been overweight from 2013 to August 2015.
She also expressed that issues like politics and banking are also areas of concerns, especially if political issues slowdown the reform process.
"The hope is that banking sector issues get sorted out soon", she said.
When asked if she had seen signs of capitulation for emerging markets and Asian equities from the start of this year, she said India is not in capitulation territory yet, while markets like Taiwan and Japan are in capitulation territory.
Below is the transcript of the interview. Sonia: I want to start off by asking you your view on India because you had been underweight on India for a while and now the Indian markets have actually grossly underperformed most emerging markets since the start of the year, what is the call now?
A: We are still underweight at this point in time. The reason for being underweight are firstly valuations and secondly earnings revisions. On valuations, India has been in what we call the expensive four club, which is the four most overvalued markets in the region. The premium has been above 50 percent. So, as you correctly pointed out, India so far this year is now the second worst performing market and as a result the valuation premium has come below 50 percent. So, we are looking at India but it is still in our expensive four. So, I guess my answer to your question is while the valuations have improved at this point probably not enough for us to upgrade our recommendation.
The second reason for the underweight is actually earnings revisions which are very poor. India has had almost 3-4 consecutive years of earnings downgrades, whereas the rest of the region has seen certainly strong earnings upgrades last year and even this year the revisions are flat. So, India is still trailing the other markets in terms of earnings revisions.
Nimesh: Given that you had a valuation concerns for India for a very long time, now that the markets have corrected, the expectation is that the earnings are going to pickup, how much more downside do you see for Indian equities which will make you comfortable from a valuation perspective?
A: From a valuation perspective, for us we tend to make a strong underweight call when the premium is over 50 percent. The premium for India went above 50 percent I think about two years ago - in August 2015. So, we had been underweight for quite a long time. However it is not always that we are underweight. I do like to remind you that after taper in June 2013, India actually joined our cheapest four and we were actually overweight India all the way from 2013 till August 2015. So, it is not so much absolute downside that we are talking about for India, it is more relative. So, we think that while the premium has come below 50 percent, we would like to see it come down a bit more. So, we would like to see probably another 5 percent underperformance relative to the other regional markets before we consider an upgrade of India.
Sonia: Apart from valuations and earnings revisions that you spoke about there are other issues that India has been plagued with as well, one of course is the banking related scams, the other is the political turmoil and the evolving story there, how worried would you be about these issues and do you think they could India down further?
A: Those issues are also there but for us the two factors that we focus on particularly as I said in our regional context are valuations and earnings revisions. With the BJP in the last by elections, the fact that the opposition parties are starting to come together and may be if that slows the pace of reform, that is an additional concern. However at this point as I said our bigger concern is the valuations and the earnings revisions. India has trailed regional markets on earnings revision for now 3-4 years. So, there was always an excuse - it was demonetisation or GST. However India's earnings downgrades preceded these two episodes. Obviously the banking sector thing has also contributed but that also hopefully will get sorted out soon.
Nimesh: You track the flows very closely and while the FIIs are net sellers across Asia since the beginning of this year, still we haven't seen a capitulation so to speak. You talk to a lot of investors at the conference, what is the sense that you pick up? Are the investors now worried about any signs of capitulation for emerging market and Asian equities in the first half of this year?
A: The good news is, on a rolling 12 months, we define capitulation as foreigners being net sellers on a rolling 12 months. At the moment that number is now zero. So, we have not yet got to negative. So, we will also get more excited both about India as well as the region if that number goes negative. The last time we had foreign investor capitulation was two years ago in January 2016 and we made a big buy call at that time. At this point as I said we are still at zero. However if we do get a bit more foreign selling, we actually would officially be in capitulation territory.
Some markets are already in capitulation territory, markets like Taiwan, even Japan. India is still on a rolling 12 months basis still at a positive number at this point.
Nimesh: While FIIs are still positive on Indian equities, the bigger strength for the equity markets locally has been the domestic flows. You talk to lot of our Indian counterparts as well. Any sense of the domestic liquidity can dry up little bit if there is a sharper correction for Indian equities in 2018?
A: I am not sure whether the domestic flows dry up. In fact I think one of the reasons why India did well last year despite quite a lot of earnings misses, I think was the domestic flows. You have also got other markets like Thailand as well where the domestic flows have helped to support these markets. However our view is that it is normally the foreign investor that drives the overall trend. So, we would again be happier to upgrade India if and when we see foreign investor capitulation, if and when India's premium comes down further and if and when earnings revisions start getting less negative. There were a couple of months - in November-December where India's earnings revisions turned positive but they once again turned negative so far this year.
Sonia: What is your sectoral view now because couple of years ago you were very positive on metals and we saw huge rally in names like Hindalco since then. Of course at the start of this year these stocks have come off a bit, but how are you positioned in terms of sectors now in India?
A: Our positioning has not changed much. We like IT as well as metals. So, more in the cyclical sectors. We do like HCL Tech on the IT space, we still continue to like Hindalco.On the materials space, it wasn't so much an argument about demand, it was more an argument that we are starting to see supply cuts and that may help to prolong the commodity cycle.