Electronic board indicating the latest stock figures are reflected in a glass facade at the National Stock Exchange of India. (Photographer: Dhiraj Singh/Bloomberg)

Indian Market Must Fall 20% To Hit Fair Value, Says UBS’ Geoffrey Dennis

A significant amount of foreign investor flows have already left the Indian market which is now holding up largely thanks to domestic investors, said Geoffrey Dennis, head of global emerging market strategy at UBS.

He remains optimistic on India in the long term despite current uncertainties. “India is the best growth story in long term in the emerging markets and we will retain overweight in the equity market for the long term,” he told BloombergQuint in an interview.

On Indian equity valuations though, Dennis is far more circumspect. According to him, only a 20 percent decline would provide a comfortable entry point into the Indian market. But such a correction is hardly “a realistic expectation”, he clarified.

Watch the full interview here.

Here are edited excerpts from the interview.

Is the rising tension in the Middle East and rising oil prices a big concern for emerging markets?

I suspect that the Middle Eastern tensions will themselves have not have a direct impact on the emerging markets. There is scope for more conflict in the region and rest of the region too. Yes, we have conflict in the Middle East for the last six years since the Arab spring. But you are right to focus on risk of oil prices and what that could do in terms of an impact on the emerging markets. Rising oil prices tend to be positive for emerging market equities, as long as the price increase is driven by demand factors. With the change in Saudi Arabia recently, there have been concerns that supplies might be restricted. So, if we see a spike in supply, it will be a negative for asset class overall.

But the best bet is that oil prices will start to subside in to the high 50s and that risk will subside with it.

India Outlook

What about your view on India? India was a top overweight position in emerging markets. Does that stand true?

We are overweight on India within the emerging market portfolio and we will be talking about that to investors. India is a good deal more complicated at the moment. The positive side is that the markets have had a very good year. It outperformed in a year when investors might not have expected it to happen. We think that is because a lot of money has come into the market, from players in the local economy who have been put off the property sector, for example, by the impact of demonetisation in India. Also, you have slowdown in the economy in the current fiscal year which is causing some uncertainty about what the growth story will be like in India for the long term.

Our view is that the economy will recover with a 7 percent growth in fiscal 2019.

We, therefore, think that it is right to be long term overweight in India. But the challenges in the short term are very clear. The market is very expensive. Earnings growth have been disappointing compared to the momentum of earnings growth elsewhere within emerging markets. It is worth pointing out that while India has been a consensus overweight for the emerging market investors for several years, that overweight seems to have come down.

A fair bit of foreign money has already come out of the Indian market because of the increased inflows from domestic investors. As a short-term outlook, it is uncertain. But we believe that India is the best growth story in long term in the emerging markets and we will retain overweight in the equity market for the long term.

Key Risks

What are the factors investors have started to worry about?

We have a very high number of foreign investors in the conference this year. I suspect they are checking what the risks in India are and they are also seeing the long term growth potential of the Indian economy and Indian companies. The short-term risk which the market was focusing on..one was the rise in oil prices which is always negative for India because India imports virtually all its oil. Secondly, there is some slippage on the fiscal side and some concerns around the widening of the external deficit.

Our economists worry that ahead of 2019 elections, you could see more fiscal expansion which will threaten the budget deficit number.

But we think that the budget is in reasonably good shape in the long term. You will ultimately get the benefits to the budget of the introduction of GST. Fiscal and monetary policy in India remains favourable. RBI has done an excellent job and may even have the scope to reduce interest rates for the next several months. I think these are the risks which are there. I am not sure that the risks will derail the market, and certainly not derail the market over the long term.

Comfortable Entry Level?

At the current levels, what quantum of correction will make India a comfortable market to start investing back into?

We think that India is trading at 96-97 percentile in terms of valuations today compared to history. So it is stretched. Valuations are high across the emerging markets but elsewhere you see much better earnings performance relative to expectations than you see in India. Indian strategists have commented regularly that earnings have been disappointing.

I don’t think it makes a lot of sense to say, ‘look if you do down 10-50 percent then it becomes a value opportunity’. To a great extent, Indian market will be driven by global events and global events have been very uneven over the last couple of months. Some of the riskier markets elsewhere in emerging markets such as Latin America and EMEA have pulled back significantly because the currency has been weaker.

In Asia, particularly in China, Korea and Taiwan where the tech cycle has been strong, the markets have done relatively well. The best answer would be while we are always worried about currency risks and the rupee has come down, we don’t think the rupee is particularly vulnerable, having come down to 65/$ and as long as global markets and emerging markets do not pull back from here, the Indian market will hold up relatively well.

But if you ask where we have to go to hit fair value in India, it could be 20 percent lower than where we are today. I don’t think that is a realistic expectation because India will be driven by global events as much as by events at home.

Bank Recap Impact

Is there money to be made in the PSU banking space?

We think that the recapitalisation of the public sector banks is an important development for India in the long term. Naturally, the markets reacted very positively when the news came out. Everybody knows, both within India and people investing from outside, that public sector banks have balance sheets problem and did need this reform.

First, we have to see its fiscal implications which is negative, it will cost money to recapitalise the banks. You need to see how long the process takes and what the impact is on the behaviour of banks themselves and behaviour of the market and the economy. It is very good news for public sector banks in the long term and also for the financial sector in India . You may get an overreaction in the short term. But we need to follow the fiscal impact and see how quickly it recovers. But this is one of the major imbalances, structural problem that India has got and, to that extent, it can only be seen as good news for the long term.