Adrian Mowat, emerging equity markets strategist on Thursday said he is tempted to book profits in technology companies in Indian market.
Mowat said, "I think with the Indian rupee moving through 71 per dollar, it's important not to specifically look at the rupee, but to look at it in a broader context of what is going on with the EM FX."
"As I think about risk for 2019 calendar year, it's quite possible that inflation is going to be higher and the consumer discretionary income will therefore be under pressure," Mowat added.
Q: What is your assessment of the kind of currency bashing you have seen? It has also spread to relatively quieter areas like Philippine Peso. I think they are in their fourth rate hike and the Indonesian Rupiah. Is there more turmoil awaiting emerging market equities as well?
A: I think there is for now – the factors are driving emerging market (EM) FX weakness. So if we look at the broader sort of JP Morgan EM FX index, it is down about 15 percent year to date. So, India in that perspective is a modest outperformer. The best relative currency versus US dollar would be the Renminbi, which is obviously quite well managed, but it has been relatively weak versus its trading range.
The extremes that we have got here have been coming through from Turkey plus the Latin American countries. As we look at that situation, there is nothing being resolved as of yet, politics in Brazil and Mexico still looks pretty challenging.
So, I think this environment of weak EM FX is to stay for now. I think with the Indian rupee moving through 71 per dollar, it is important not to specifically look at the rupee, but to look at it in a broader context of what is going on with the EM FX.
A note that you were highlighting that the central bank has come in modestly, I think what investors would like to take from the central bank is maybe managing a bit of volatility, but I don’t think investors would welcome the central bank sort of drawing up a line. The way these EM FX crisis comes to an end is you get an overshooting currencies. One of the reasons why investors stop putting capital back into the countries is because they view the currency to be undervalued as well as the market.
Q: Do you think the equity market has priced this risk inadequately. We have corrected a bit from the top, but for Indian market, we are still very close to all-time highs. We have started to see some of the expensive stocks correct over the last one week or so?
A: Let us look at the fundamentals here. We have got a weak currency and a relatively firm oil price. As I look at the consensus forecast, the consumer price index (CPI) for next year, they are sitting at 4.8. That feels a little bit too low, when you start to look at the consensus on the RBI raising rates or the types of moves, very modest 25 basis points (bps). I know that Uday Kotak came out today and was talking about 50 bps move and that is important for the broader capital markets.
Year to date, what we have seen in Indian equities is - generally domestic cyclicals have done poorly, export has done very well, particularly the IT names, which is logical considering what is happening with the currency. Some of the more defensive plays like FMCG have been good year to date performers. So, as I think about risk for 2019 calendar year, it's quite possible that inflation is going to be higher and the consumer discretionary income will therefore be under pressure. If inflation is higher, then, we need to think about higher interest rates and these higher discount rates are going to be important for expensive stocks.
So the short answer, which I should have given at the beginning is, I don’t think the market is pricing in this inflation interest rate risk based upon local equity prices.
Q: What do you do with the market like India now. Do you stay away entirely or do you book profits and move in to other markets? Where would India feature in your pecking order?
A: I would be tempted to be booking some profits in the Indian markets particularly in the IT names. Some of these within the Nifty are lot more than 40 percent year to date. I think that is where you should take some money out of the markets. I don’t necessarily feel that you should be aggressive in reallocating to other markets at this point in time. We seem to have this dynamic in EM, where we start to get the pressure points of the corrections coming out of the more vulnerable markets. We see more dramatic currency moves and then you get a bit of a rolling correction in EM. We do have an environment, where passive products are very large. Generally, passive products bring large inflows as EM equities did well last year through into January this year, and now that is where you are beginning to see redemption pressure and India is going to be subject to that. And it doesn’t feel like an environment where you are going to attract new capital to these markets until we get a little bit more stability.
Q: There is another probable secular trend playing out of as Indians are investing more in financial instruments. Of course, the movement from gold and land would have come anyway, because the prices of both these assets have fallen, but probably because of demonetisation and GST, there has been a greater financialisation of savings and that has kept the market higher. Although foreign investors have not been investors. In fact, they have taken out money from Indian equities. Does that therefore justify a higher valuation for India, simply because of the march of domestic savings?
A: It doesn’t justify a higher valuation. It may result in a higher valuation, because you do have a large positive to household savings rate in India and if that capital is moving from other assets into equities, then that will spook valuations. I think, if you want to pick one of the country as a good analogy here, it would be Australia, where valuations have moved higher because of the success of the superannuation fund. So, it doesn’t justify them, but it may result in these higher valuations.
Q: You said you are tempted to book profits or you would book profits in the technology names. Any other spaces where you would move out of, everyone seems to be a bit circumspect about consumption now because of the way valuations have moved, your thoughts?
A: It is highlighting earlier a concern that as inflation moves higher, discretionary income gets put under pressure. So, the growth rates for FMCG companies could weaken going into calendar year 2019. I think that is another area for investors to trim, take a little bit of money out of the markets for now and a bit of a wait and see is the correct approach here. You are not forced to always be in the markets. Indian domestic investor has had some very attractive returns in largecap stocks. Take some money off the table for now. I think you will get that Indian equity market issues elsewhere in EM and perhaps you can then reallocate that capital at a slightly lower share price.