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Global risk assets will show the way for the Indian markets: BofA-ML’s Sanjay Mookim

LiveMint logoLiveMint 08-05-2017 Ami Shah

Indian markets are at a record high. What is driving this rally? Is there more steam to this rally, or will the party be over soon?

Much of the recent increase in Indian equities can be attributed to the global and, more specifically, the emerging markets equity rally. Concerns around the economic disruption from demonetisation seem to have been overdone. Domestic flows into equities have been very strong. It is difficult to accurately predict the duration of the current rally. Much will depend on the behaviour of global risk assets in the short term.

Are Indian markets expensive? Why, or why not?

Headline P/E (price-to-earnings) multiples for MSCI India are well above average, while earnings growth for the index remains sub-par. The expansion in multiples is better visible outside of the index. The premium for mid-caps over large cap stocks is at an all-time high.

When and by how much do you see earnings recovery happening for Indian companies?

The total earnings for MSCI India have grown at low single digit rates for the past three years. The collapse in commodities hurt earnings for that part of the market initially. Increased bad loan provisions hurt banks’ profit growth subsequently. Neither of these should recur in FY18. The low base created by weak earnings so far means headline growth for FY18 should comfortably hit double digits (We expect 12% growth top-down).

Where does India stand in your EM/Asia preference? Why?

We are currently underweight India in our EM allocation as other countries offer better proximate earnings growth. India, however, stands out over long periods of time. Fifty percent of the BSE-200 (ex-cyclicals) have delivered 20-year stock CAGR (compound annual growth rate) returns of 20% or more. This yield of compounders is better than most other large economies even when adjusted for the movement of currencies. Indian standards of living should continue to improve: a) Indian institutions are getting better at delivery (India now adds twice the number of doctors each year than it did 10 years ago, for example), while b) population growth is slowing meaningfully. All measures of health and literacy should continue to improve (if not accelerate). With a consumption-driven economy, this increasing per capita income trend means Indian equities should continue to deliver compounding returns.

Will Donald Trump’s tax cut plans impact emerging markets in a big way? How much impact do you see on Indian information technology and pharmaceutical sectors?

Tax plans of the new US administration are still relatively uncertain, and are in the process of being rolled out. This is likely to take some time. Media reports talk of significant controls on US visa issuance and meaningful increases to visa fees. If all of these were to be implemented, Indian IT companies could see double-digit percentage cuts to earnings estimates, some of which could be mitigated by changing operational strategies. Pharma companies do not appear to be at as large a risk from taxation as the proposed border adjustment tax did not appear in the recent list of tax proposals. Increasing generic pricing pressure and FDA (Food and Drug Administration) scrutiny are larger risks, we think.

Are geopolitical risks being ignored by global investors?

Yes and No. Investors seem to be aware of the possible pitfalls, but don’t know which will materialize and when. Global volatility levels are exceptionally low currently, suggesting that many of these risks are not reflected in prices.

What are the key risks to this rally in emerging markets?

There are two key risks: 1) Global (and specifically in the US) bond yields. Higher rates will be bad for EM assets. Tapering of purchases by central banks, or meaningful increases in the Fed Funds Rate could catalyze such a reaction, and 2) Inflation expectations: these have risen recently; and any reduction in inflation forecasts can be bad for EM assets.

Which sectors in India are you overweight and underweight on, and why?

We are overweight financials (as a proxy to the improvement in the business cycle—as we expect will happen), cement (hopes of better volumes) and staples. We are underweight IT and discretionary. We think the market may be overestimating volume growth numbers near term as the effects of demonetisation may still be felt in the March quarter numbers.

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