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We prefer India to other markets: Gautam Chhaochharia of UBS Securities

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?

The Bharatiya Janata Party’s (BJP’s) Uttar Pradesh election win, aiding hopes for the next generation of reforms, has been a key local factor, apart from the usual beginning-of-the-year growth recovery hopes. Local retail inflows are also aiding sentiment and rich valuations. The bigger driver in our view, though, is the positive global sentiment on hopes of a global reflation cycle, driving foreigner flows into EMs (emerging markets). Our upside scenario for the Nifty is 9,700, which suggests limited upside from current levels. Our base case for end-2017 remains 8,800 (for the Nifty) as we expect markets to ultimately correct due to earnings cuts, as current consensus estimates appear too high in the context of India’s growth reality.

Are Indian markets expensive at this point? Why or why not?

At 17.3x 12-month forward earnings, markets are trading near historical highs. And this is based on consensus earnings which are likely to see 7-8% cuts in our view; so, on more realistic earnings, markets are trading at even higher multiples.

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

We expect earnings growth to improve gradually from single digit likely in FY17, to 12% in FY18 and 17% in FY19, considering the set of Nifty firms overall. This is assuming banking provisioning abating and better nominal gross domestic product growth helping earnings.

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

Our Asia and EM strategists remain overweight on India, i.e. they prefer India relative to other markets in the region, given a better growth profile, macro stability, reforms underway and planned, central bank monetary policy path and relative earnings and market outperformance expectations.

Will US President Donald Trump’s tax cut plans impact EMs in a big way? How much impact do you see on Indian information technology (IT) and pharmaceutical sectors from the US visa restrictions and protectionist policies?

We await further clarity on Donald Trump’s tax proposals before assessing any impact. In the near term, we do not rule out cost increases for Indian IT. We price in a net impact of 100-120 bps (basis points) on Ebit (earnings before interest and tax) margins if wages increase to $100,000, with offsets from near-shoring and increased offshoring. Without any offsets, we estimate worst-case margin erosion of 5.6%-8.3% for Indian IT vendors. For the pharma sector, in our view, border tax would increase costs for all generic firms, though to a variable extent depending upon the extent of manufacturing outside the US. We believe this could lead to an increase in generic pricing (at least for products being manufactured in the US) in line with cost escalations.

Are geopolitical risks being ignored by global investors?

Geopolitical risks are anyway difficult to quantify or time. So it’s difficult to say how markets are pricing them in.

What are the key risks to this rally in EMs, particularly India?

Some of the key risks to the rally in emerging markets are 1) global macro shocks; 2) declines in global risk appetite; 3) soaring of inter-country political tensions; and 4) local negative catalysts. In case of India, this could be disappointment on corporate results in the near-term, more than anticipated adjustment-related dislocation from GST (goods and services tax) implementation, and any stark change in government political economy towards populism.

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

Some of our OW (overweight) sectors are consumer staples, IT services , retail private banks and NBFCs (non-banking financial companies). Some of our UW (underweight) sectors are cement, infrastructure and capital goods and small and mid-caps

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