Malcolm Wood, Asia Pacific Equity Strategist at Morgan Stanley feels that India is more vulnerable than other emerging markets. He expects to see more correction in the Indian markets. Wood believes that foreign institutional investment flows remain key driver for the Indian markets.
Wood further states that it is still premature to jump into Indian markets however he is bullish on the Indian healthcare sector. He also sees good value in select PSU banks and consumer staples.
Wood expects Japan's zero interest rate policy to end in July. He also believes that further excess liquidity from Japan would reduce.
According to Wood, flows into mutual funds and hedge funds would normalise and flows to emerging markets might reduce.
Excerpts from CNBC-TV18's exclusive interview with Malcolm Wood:
How much more pain is left; we have seen quite a bit of it here in India as well. Do you think we are anywhere close to the end of the pain or is there much more to come?
We have seen most of the decline in global markets that we would have expected. We think that coming into May, the markets were way too optimistic, on both the outlook for the global growth and the outlook for the end of Fed tightening cycle in the US.
We had a bit of a reality check, obviously things are not quite rosy, and that led to 5-10 per cent correction that we have seen in the global markets. Of course, some of the bear-markets have been down, which reflects the fact that there had been sources of global risk appetite over the last one-two years.
What is the call for emerging markets like India if the risk appetite is waning a bit?
The outlook for India is a little trickier than the average emerging market. The reason for this is that India has been particularly dependent on the liquidity inflows from foreign investors.
If we do see foreign investors pull back significantly, then that will put a lot of pressure not just in the Indian equity markets but also in the Indian economy with implications for growth, not just the simple liquidity flows in and out of the market.
Markets are at 10,000 on the Index. From a strategic perspective, what would you be telling your investors, have we reached a level where you could consider purchases? Do you see a substantial downside for India even from these levels?
We have been underweight on India for a while now. So for us, this is something that we have been looking for. In our view, it is still premature to be looking to jump in. We need to get a bit more clarity on the outlook for the global liquidity cycle.
A lot of the excess liquidity has now gone and we need to get some better valuations in India. But one needs to bear in mind that we have come off the top. Indian valuations relative to the world and to other emerging markets remain at substantial premiums and we think that we probably need to see a little bit of that come off as well.
At what levels would you come back and start buying?
We haven't specified a level but when one thinks of where we are at the moment, for instance 20-30 per cent premium against the global markets, 30-40 per cent premium against emerging markets, these are far higher than the long-term averages for India. If one wanted to paint a picture, it would say significantly lower.
What is your gut feeling and what do you hear from your strategists in other parts of the world in terms of the liquidity tightening? How much could we see by way of either hedge fund selling or money flowing out in quarters like Japan?
I think Japan is an interesting place to start. We are expecting a zero per cent interest rate policy to finish in Japan in July; that is the little way off but not far. So we expect a gradual increase in interest rates in Japan.
I guess an important thing from a Japanese perspective is that the credit demand within Japan is now rising. So, we should presume that the days of massive excess liquidity coming out of Japan are largely behind this; not to say that it is a disaster coming but just that the liquidity driver is no longer there.
As for the US, our view is that the Fed will raise rates again a couple of times later in the year. India that is predicated on the US coming through this soft patch unscathed and improving a little, obviously, it is going to be data dependent as the Fed puts it.
But from a liquidity perspective, if investors conclude that the outlook for equities is not quite as fast as it's been over the past 2-3 years, one has to expect some of the inflows into mutual funds and hedge funds tomorrow right back to normal levels. This will suggest that the liquidity inflows into Asia would be lower than it has been over the past 6-7 months in particular.
Where does currency fit into that entire picture and how much do you expect that liquidity pipeline to tighten by?
Currency is an important part of the picture. From a global perspective, we have been looking at Asian currencies to be firm this year and for it to be the year of Asian currencies.
So far, we had a strong rally early in the year and then more recent correction as US dollar found a bit of a footing. But India has been an exception to that and has under performed its other Asian peer currencies, which would be suggestive of some differences in the liquidity picture there.
This comes back to the key point as to why global liquidity conditions matter for India. India, versus rest of Asia predominantly has current account surpluses and relatively strong foreign direct investment inflows.
India obviously has current account deficit and relatively lower foreign direct investment inflows. So it is quite dependent on a continuation of the portfolio inflows. So, India has to get money from elsewhere and we think that will tighten liquidity conditions in the domestic economy.
In India, has anything reached levels after this correction that seem relatively defensive and relatively attractive?
The only exposure we have kept in India from a regional perspective is in the healthcare sector. We have been quite defensive in that sense.
Analysts are still positive on select names in health care sector but certainly from a bottom up perspective, our analysts are finding good value in select opportunities. We have recently gone more positive on select public sector banks after number of years.
After the pull back, we have seen on the consumer staple names, we see some opportunities there as well. From a regional perspective, we think it is still appropriate to be underweight about India.
How have you read the correction in commodities across the world? How do you approach that space in India market in specific?
I think the commodity boom is largely behind us. So we are underweight on material stocks across the region. Obviously, it includes India and from this perspective, one has to be wary on commodities where the underlying commodity prices are being heavily influenced by financial investors.
The prices in many instances have gone parabolic like in copper and nickel. At the same time, we are seeing signs of global growth beginning to decelerate.
It is certainly happening in the US and we think we are also at a peak in Europe. From our perspective, that sort of combination is not the one that we want to be in and so we are underweight on commodities and material stocks.
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