Morgan Stanley says India growth on recovery path; stocks to move higher over next 2 years

Updated : September 18, 2018 06:04 PM IST

Investment bank, Morgan Stanley, on Tuesday said India is on a growth recovery path and that will translate in to better earnings for the companies.

In an interview to CNBC-TV18, Ridham Desai, India equity strategist, said that over the next two years, Indian stocks to move higher.

Watch: Trade war concerns, high interest rates & oil prices already priced in, says Ridham Desai

According to Desai, there will be a meaningful improvement in earnings for the corporate banks ahead compared to non-banking financial companies (NBFCs).

Edited excerpts:

Q: What has led to this upgrade in Sensex target, what has made you so bullish?

A: I think India is on a growth recovery path, which began a few months ago. It is likely to translate into better earnings growth and I think that is the reason why we think stocks are going higher. We have been in a bull market since 2009, it has been a very long bull market, but it has been a very slow one. We have had several corrections along the way and I think the bull market is now reaching a stage, where it's going to get backed by strong fundamentals.

Obviously, there are a lot of risks along the way and I think everybody is focused on those risks, which is usually a good time to engage in stocks, when people start disregarding risk, that is when I think you get worried. However for now, I think growth is looking good, likely to surprise on the upside and profit sharing gross domestic product (GDP) is at near all-time lows. So, I think we are going to likely to witness a very sharp recovery in corporate profit margins over the next two-three years.

Q: Since it's a one year target, I am not speaking about the next five years. 20 percent compounded annual growth rate (CAGR) in earnings that your report talks about, a 7 percent growth country like ours, one would expect this kind of growth in the medium-term. But next year, we are riddled with some problems, interest rates have gone through the roof that we were 8.2, who would have thought a year ago. Are companies prepared for that and even the weaker rupee initially will create disruptions though later on, it might be a big help of both domestic companies and exporters. So do you think political risk as well as interest rate risk can be very big caveats to your Sensex target?

A: There are lots of caveats and I hate to forecast on points and single digit or single numbers, which of course makes a lot of good media, but is very bad way of looking at things and certainly not a good framework to think about investing in stocks. So, the Sensex target is what it's. I don’t think we should overly focus on this. But I believe you made some really good points. Let us step back for a moment and think about exactly 12 months ago. If somebody had told you that the rupee will be at 72-73 per dollar, that oil will be where it's right now, that the 10-year will be at 8.2, that we will have all these tariff stuff happening around the world, what do you think you would have done with stocks? That is the point. All this is already in the bag, we already know about this and stock markets are forward-looking animals. They have already baked this in the cake, which is why we are getting such a muted reaction this morning to the additional tariff round, because the market already knew that it was coming.

So, I will make one more comment, which is that the market is usually right. It goes wrong about a couple of occasions out of 20 and when it's wrong, it's essentially either over-exuberant or it's in panic. So, we can recall such things quite easily. January 2008 was over-exuberance, March-2009 was panic or in fact all of the end of 2008 and early 2009 was panic, we had similar panic in August 2013. I think everybody can identify panic and over-exuberance. The market doesn’t feel like that right now, it doesn’t feel like it's in panic or it's in exuberance. So, I would argue that stock prices are more accurately reflecting all these concerns than we can fathom.

Therefore, I wouldn’t worry about these things. The stuff that is going to upset the view on the markets or the performance of stocks is something that we actually don’t know that is going to happen in the next few months. All the stuff that we know that is going to happen, I think, is already baked in the cake.

Certainly, there are risks. Election results can go all wrong for India, we can get a global recession, we can get a mistake by the Fed, we can get mistake by policy-makers in India, so many things can go wrong and that is true about stock markets at any point in time. But I think, we have to weigh those things against what could happen to fundamentals, where the valuations are and on balance, it looks like we are in an uptrending market. Give or take a few points here and there, and will the Nifty correct over the next few days? Quite possible. However, I think over the next year or two, it's likely that stocks are higher not lower.

Q: You spoke about election results briefly. But how do you approach that event, because if pessimism does rise ahead of or during the election or with the election outcome, would you still believe that it is a buying opportunity?

A: That is going to be a tricky one, because it's very hard to tell how things will pan out with respect to elections. What our historical analysis shows is that it's not the nature of the government, but it's actually the leadership at the top that matters to the economy and therefore to the market. So, we have had fragmented coalition governments in the past and that has had no impact on stock returns, because the economy has done okay and on other occasions, we have had reasonably strong governments, but poor leadership and that has hurt the market.

So, it's not something that I can forecast with any accuracy, but I think you make a very valid point, which is it's not about what happens in May next year, but what the market starts believing will happen and that is ultimately what is going to drive share prices over the next few months. So, if the market starts getting too pessimistic, then I think it's a buying opportunity. If it gets too optimistic, then you sit on the side-lines specially, if you are in the business of timing shares, which I think is the privilege of a very few set of people. But if you get those extreme views that the market takes on the election outcome, then I think we can ponder about it and make a call on the market. But right now, there is no signal that the market is ready to make such an extreme call. I believe it may happen over the next two-three months, but we will have to wait and watch.

Q: The issue is 70-80 percent of our audience is in that business of timing it. For longest, the trouble with this market was that it was too narrow. There was a handful – just a set of 7-8 stocks, the Bajaj twins, the HDFC twins, which was taking the market higher and the market breadth was getting very narrow. Now, we have seen the leadership stocks correct quite a bit, consumption for example has corrected, the retail banks have corrected. Your thoughts on the kind of leadership shift that we have witnessed over the last three-four months?

A: You have raised two points, so let me make two points. First about timing, so again, I will use another old maxim in the stock market, which is ‘time is more important than timing’. We did this analysis on the Indian stock markets going back 25 years. 100 days of returns account for almost two-thirds of the aggregate index returns. So, there have been about 6,000 trading days in the last 25 years and a 100 days, which is less than two percent of the total time has accounted for more than two-thirds of the total returns that the index has given.

If you are that smart, you could stay in the market for those 100 days and avoid the remaining days. Obviously, you are in the category of a genius and I suspect that there aren’t that many. But for most of us, we would rather miss these 100 days than cash them. I think that is what will happen. So I think it's important to spend time rather than time it. Even for the most, the biggest experts out there, I think it's very hard. Warren Buffet has said time and again and I don’t mind repeating that advice that it's better to spend time than time this. I am using time as a verb and a noun.

Going back to the core issue that you have raised about performance breadth, I think that is one of the important things that we are citing in our report that we wrote last week, which is that we believe that performance breadth will widen from here. So, the winners of the past few months or past few years are going to take a bit of a backseat, relative to the losers, where we think that fundamentals are inflecting.

So for example, take the comparison of the banking financial sector and take non-banking financial companies (NBFCs) versus corporate banks. So very clearly, the trade has been in favour of NBFCs against corporate banks and we think that is going to flip, because we think that the fundamentals for the corporate banks have troughed and there should be a meaningful improvement in earnings.

When I say meaningful improvement, we are not talking about 10-20 percent growth, we are talking about much more magnitude of 40-50 percent growth in earnings and therefore, 40-50 percent rise in share prices given where the valuations of corporate banks are, I think it's a trade, which represents much muted downside risk versus upside risk. So, it's a favourable trade for investors.

In contrast, NBFCs are going through a period, where they will face increasing cost of liabilities, valuations are not that attractive, so they may underperform. So, there are several such reversals in performance that we see over the next 12-24 months, largely summarised as follows, which is that the winners of the past few months or past few years may underperform relative to the losers especially, where the fundamentals are turning. So, I give you one such example, the other could be consumer discretionary versus consumer staples, where the performance may move in favour of discretionary stocks versus staples. Some of it's already playing out in the market, which is the leaders have started faltering and very quietly, the laggards have started gaining performance.

Because the laggards have lost so much share in the indices in terms of weight, they will not tell upon the index performance immediately, over months that will build up. I think a more important thing that we are conveying in our report compared to the index target, which is the underlying nature of the market, which we think is going to change, it's going to become more like a bull market.

In fact, it has behaved like a bear market thus far. Bear markets have concentrated performance, where a few handful stocks account for everything. If I am not mistaken, the top-5 Nifty stocks have accounted for 105 percent of the Nifty performance this year. So, everything else is down or flat.

So, I think that is about to change and in fact, may already be changing. So, there may be some portfolio shifts that investors may have to make. They have to shed their anchoring towards the winners of the past few years and move towards some of the losers especially, where fundamentals are about to inflect.

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Published : September 18, 2018 06:04 PM IST

Morgan Stanley says India growth on recovery path; stocks to move higher over next 2 years

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