With foreign investors having bought stocks worth more than $16 billion already this year, it?s not surprising that the Sensex is back at 20,000. Indeed there are those like
Philip Poole who believe that there?s a case for a re-rating of the emerging markets. The global head of macro & investment strategy at hsbc Global Asset Management, tells Shobhana Subramanian that for now, however, valuations in the Indian market appear stretched.
You have been saying that there is a case for re-rating in emerging markets? Why is this so?
Firstly, there?s the fundamental story. To begin with relative growth rates are much higher in the emerging world and the crisis in the western world has exposed the weaknesses in the developed world and the relative strengths in parts of the emerging world. In particular there are the debt metrics; the government debt to GDP in the US government has gone from 55% in 2000 to more than 80% currently. In the UK, the corresponding numbers are 45% and 72%. In the UK, household debt to GDP ratio in 2000 was less than 80%; now it?s over 115%; in the US it?s around 100% of GDP. These numbers for the US do not include the municipal indebtedness and issues of contingent liabilities. So the debt overhang is going to be very significant on the developed world growth to an extent it will be a constraint on the global growth as well.
So are fund managers upping their India weightages?
To reflect those underlying changes what?s happening is a portfolio shift in money out of the developed world into the emerging world. This in a sense is lagging the underlying changes. I would argue for a re-rating because the world has changed, things are different post crisis, and therefore relative valuations need to reflect that. Having said all of that of course we need to be very careful because this will be a cyclical process as well as a structural process; so at times the markets will get overvalued and at times it will correct, despite the fact that this is a medium to long term positive story for India or for the emerging world. We need to focus on value at the market level we need to focus on value at the company level.
To what extent do you think economic growth will translate into earnings growth?
The relationship between economic growth translating into earnings growth is, in many markets, quite weak. The thing therefore to focus on, more than the economic growth per se, is valuations. If you look at valuations, the metric that we generally use for our funds is price to book. And so we look across the world to see what looks cheap and then we look for companies that deliver earnings growth. So a combination of price to book relative to return on equity should give you a good idea of where the value is and the companies that are delivering returns for shareholders rather than just top line growth. That is becoming a much more important distinction that needs to be drawn given that obviously markets have moved up a long way already.
India is trading at relatively high premium to peers, is this justified?
Indian economy is growing too rapidly and there?s a case for additional measures to slow that growth and the evidence of that really is in inflation. And so there?s a need to tackle that problem . There?ve been some other measures as well but to my way of thinking the economy the risk is that the economy is actually overheating and that?s something if it?s not tackled becomes a problem for the equity market. I think it?s much better to be dealing with that than allowing it to potentially become a bigger problem. In a sense the Chinese have been trying to cool their market particularly the property market asset price bubbles concerns and there have been measures that have been introduced.
But in terms of the micro environment we think that banks look particularly expensive in India, tech looks expensive and consumer staples also look expensive. India is a good consumption story but how much should you pay for that is the question.
So from the top down perspective is India a very expensive market?
You have to look at it in two ways. And probably what?s most important is the multiple relative to its own trading history. If you look at India and where its trading relative to its five year average then yes it?s looking expensive on a forward PE basis. It?s somewhere at around 19 compared to 5 year average of 16, on a trailing price to book basis it is slightly below the five year average. But there?s no doubt that because of the dynamics of the market and the lack of correction due to the ongoing inflows which we?ve seen, it does look toppish in an emerging market context. For example, China is trading pretty much in line with its five year average on a forward PE basis and is also slightly cheap on a price to book basis.
Many of the global funds are underweight in India.
Yes, that?s right. The portfolio shift will continue and India is going to be a core part of portfolios in the future whereas in the past it hasn?t been. It?s hard to say how much the weightage will go up but there are a lot of funds in US and Europe in particular that have very little exposure to emerging markets including India and there?s a realisation that this needs to change. However, there?s going to be a limit to what funds are prepared to pay. So I think the strategy for for entry into markets like India, that start to look stretched, is to wait for correction. What the lag demand means is that the downside for these markets is relatively protected. If the market corrects on the downside then it brings that money in.
Do you see fund flows into India continuing at the current pace?
A couple of things would be important in this context. Inflation in India is a matter of concern, the wideining current account deficit is a matter of concern, the valuations are stretched, there are some macro concerns but there?s no doubt that that money is likely to flow in the medium term. I would take the view we might see inflows at the same rate, but they will become more price sensitive in the future.
Which are your favourite emerging markets?
The markets that we like best include Russia?Russia looks cheap to its previous trading history and that?s at a slightly lower level than it is in India. We even like the frontier markets from a value point of view in places like Africa, the Middle East, for example. So if you take a view as I do that the world won?t double dip, then some of these markets look attractive.
What are the chances of deflation in the US and Europe?
What?s tending to happen is that people are looking at US concerns in terms of double dip and then they translate those concerns into a global double dip concern. And I think that?s stretching the point really. For sure, there is an overhang. But double dips are quite rare events, there have only really been two double dips in the developed world in the post war period. Other parts of the world are, of course, growing pretty rapidly India being one, China being another, Australia and interestingly Germany. Core Europe has looked to be in better shape than we would have expected. There is weakness in the developed world and Japan and people then translate that concern into a deflation risk. The fact which is different from Japan, where we?ve had a deflationary overhang for many years, is the policy stance that the Fed has adopted. The Fed is focussed on making sure there is no deflation. The recent FOMC statements says the Fed stand ready to do what is necessary and linking that to an inflation target. That?s the difference. The Japanese policy makers did not do enough to tackle deflation and that?s a mistake that Fed is very keen to avoid. Also, what?s helping the cause of US is that demograhics is much more favourable compared with that in Japan.