India is a fantastic destination in the long term but valuation is still too high, Krishna Memani, CIO, Oppenheimer Funds, tells ET Now.
Edited excerpts:
There are a lot of global worries centred around trade wars and European crisis. Do you think 2018 will be a tough year for emerging markets?
The underlying trends in the global economy are still extraordinarily strong and the growth outlook for emerging markets is quite good. Growth outlook for even Europe is reasonably good and in the US things are accelerating. At the end of the day, it is those things that are going to drive where the markets end up rather than temporary political issues that we face in Europe. Recognise that we have faced these issues in Europe ever since the financial crisis and we have found ways of getting over them.
We have dealt with the Greece issue and a larger issue with Spain where unemployment was extraordinarily high. The point I am trying to make is there are more important issues that can make a dent in the sentiment in the market but at the end of the day, we will find ways of dealing with these issues in a reasonable time frame. The markets are probably going to go higher rather than get bogged down in the political issues.
How do you analyse the market in the medium term and what factors according to you are at play right now?
As far as the Indian markets are concerned, there are a couple of issues: one, growth in India is reasonable and at the company level, the outlook is quite good. The challenge India faces today are two-fold; one the higher oil prices clearly have implications for inflation and current account deficit and the strength of the dollar. Although the dollar is not very strong, but it clearly has strengthened and that puts a dent in all emerging markets not because emerging growth is going to slow down but the rather investors desire to invest in emerging markets slows down. These are the two key issues facing the Indian markets in the near term. The underlying fundamentals are relatively stable.
From a longer-term perspective, the outlook for Indian market is critically dependent on the outlook for Indian consumers and that in turn is critically dependent on job growth and the quality of job growth that is going to manifest itself over a decade or two.
Did you read the quality of earnings in Q4? Do you see the momentum which some of the companies have reported that is here to stay?
That was indicated earlier at the micro level. At the company level, things are looking reasonably good. If you aggregate, the growth outlook in all those companies is stable. Also, the consumption picture is looking decent, but it is being driven more by the decrease in savings rate than an increase in income growth. These are some of the challenges that we will be facing in 2018 but to some extent, the larger challenge in late 2018 and 2019 are going to be political in nature and that is what the government is going to do. The critical election in 2019, is going to be the primary driver of the investment sentiment in India. It is not going to be driven that much by earnings from what I can tell.
The Modi government completes four years in office. How is it that you see the work done so far and what should have been done differently in your view as an FII?
In economic policy terms, the Modi government has implemented quite a few interesting and forward looking initiatives. Some of them have worked out reasonably well and some of them are works in progress. The things that have worked out or are continuing or looking much better today is the implementation of GST.
GST was implemented from a resource mobilisation standpoint for longer term funding. It was a critical initiative that needed to be implemented and they have successfully implemented it despite the challenges.
From a rural policy standpoint, they have implemented quite a few initiatives and that certainly has helped the income growth in rural populations and consumption in rural populations so I think those things are helping.
There were a couple of self-goals as well — things that they did not need to do but which they did and ended up hurting the Indian economy. We are done with most of that but it is worth noting that demonetisation tops that list. It is something that was done hastily and perhaps was not fully thought out and it caused the disruption in the Indian economy. We are finally coming out of it but it did not need to happen the way it actually happened. So, on balance, they have implemented quite a few policies. Some of them are working but from a longer-term perspective, from an economic policy standpoint, they definitely are on the right track.
What is the FII stand on India right now, versus other emerging markets?
The outlook for India is driven by two things – the longer term consumption driven economic growth that is going to manifest in India over the next few decades. At the same time, the current valuation levels are equally important. On that front, relative to other emerging markets, Indian markets are just not that cheap. If the financialisation of the Indian economy continues, that is probably going to be the case for the foreseeable future. We as investors like the long-term trends but we just do not like the valuation that much. That is the sort of issue we are dealing with.
Do you see a cyclical recovery coming in earnings anytime soon?
Yes, of course. So the point I am trying to make is if you are a long-term investor and want to invest in a country for the next few decades, India is a fantastic destination and that is the approach most of us have taken. We want to be invested in emerging markets and within emerging markets, we want to be invested in India because it has the best demographic picture and hopefully it gets the demographic benefit by creating new jobs and growth in consumption.
These are longer-term stories. Near-term outlook for India really depends on the cyclical recovery. Valuations and cyclical recovery is playing out okay, stable, it is not accelerating in a big way. Valuation in India relative to other emerging markets is on the high side and that is the biggest negative in the near term.
Private banks like Kotak, HDFC Bank and IndusInd Bank are at a record high. What is your call there?
Private banks are one of the better opportunities in the Indian markets despite their high valuations. And the reason for that is relatively straightforward; the financialisation of the Indian economy continues and there is a lot of growth opportunity in that space. And the public sector enterprises in that market opportunity have not been able to deliver and they continue to struggle with their NPAs and things like that. The outlook for public sector enterprises is improving in the banking sector because of the NPA resolution regimes that the government is putting in place.
From a longer term perspective, the biggest beneficiary of the financialisation of the Indian economy are going to be the private banks. There is an enormous opportunity on that front. Just look at the size of the banks in countries like the US and China. As long as the economic growth is there, the size of the banks are going to be gargantuan and we are just beginning that journey.
What about auto stocks, especially given the kind of strong numbers that we have seen? They are sustaining the monthly sales data but how do you see the valuations of some of these auto stocks?
The story there is again stable but nothing extraordinarily exciting. Having said that, we focus more at a company level rather than sectors. The consumption story in India which is the driver of the auto sector is actually quite decent but at the end of the day, for that sector to get to the next level, you need income growth to accelerate and for that you need job growths or quality jobs to accelerate. Things are okay but they are not spectacular.
The FMCG stocks stole the show for the quarter gone by because of strong earnings growth. What are your thoughts there?
Instead of talking about specific sectors, we try to do with companies in emerging markets in general and specifically in India we focus on individual companies rather than sectors. And the reason is very straightforward. A company can shine even in a beaten down sector where the growth outlook is not very good.
What about pharmaceuticals and IT? Is the worse getting over there?
Oh, very much so. Very much so. Again, we believe that those sectors probably offer the best value because you can find really good companies executing very well in a very challenged sector and from a longer-term perspective, those end up being the best investments you can make.
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