Morgan Stanley’s Jonathan Garner On The Bull Case For India
A pause in rate hikes by the U.S. Federal Reserve and the Chinese central bank, rollback of trade protectionism, and Morgan Stanley’s oil forecast going awry – these three conditions will constitute the bull case in India, according to Jonathan Garner, chief strategist for Asia and emerging markets at the global financial major.
Morgan Stanley has a “small overweight” on the Indian equity market even though its not “strategically bullish”, Garner told BloombergQuint in an interview. Higher oil prices and political uncertainty ahead of the general elections next year are the key risk factors for India, he added.
Corporate earnings, however, could improve in India relative to other emerging markets, with about 20 percent growth as the impact of demonetisation and rollout of the Goods and Services Tax wears off, Garner said.
Watch the interview here
Here are edited excerpts from the interview:
In your recent note, you spoke about how there are 3-4 indicators which needs to be struck for you to turn tactically positive on emerging markets. What’s your near-term tactical view on EMs and where is India placed?
If you look at where we were at the end of January, we actually hit 1,270 on the MSCI EM index and we have come off now to about 1,120. So, we have come off by 12 percent. So, our target is 1,160. That’s a 3-4 percent upside. So, we could get a bounce here, particularly, as the dollar is no longer so strongly bid. Also, oil prices have come off a little bit which is helpful to Asia.
But from a strategic perspective, we still are faced with the fact that China and U.S. are tightening monetary policy. That is a big headwind. The earnings expectations are too high. They have started to moderate but they have to come down further. So, 1,160 is the target. We got to 1,120. We have come off a lot down four straight months. So, we can get a tactical bounce but we think it can run out of steam.
Everybody is hoping that earnings season in will be different. Could that be different for India?
Across emerging markets we had very strong earnings growth last year, about 30 percent in dollars. India didn’t really participate in that because of various reasons. There was a very aggressive fiscal and monetary tightening, then we had GST implementation and then demonetisation.
But now India should be at a different phase of the business cycle with earnings growth maybe as much as 20 percent or so, maybe much higher than the rest of EMs which is now in a deceleration phase. The countries which were encountering headwinds from dollar, that have a significant export orientation sectors like auto or tech, are where we are getting cautious. But there are risk factors for India. The oil prices is one of them and there are upcoming elections next year which we have to think about too.
Do you sense extreme election-related volatility and do your clients also talk about that as the big factor?
Volatility in EMs was exceptionally low late last year, about 8 percent annualised volatility. That was when valuations also concerned us, when we got to 95 percent of the long-run range. It is not only India having elections, we also have a lot of political turbulence and change in EMs recently. Some of them have led us to get more constructive on markets. For example, the change in leadership in South Africa. In other cases, we are watching closely in terms of whether we move maybe from a centre-right of political dispensation to something which is less market friendly. It is unclear which way India will go. That is the choice of citizens to make next year. But it is a factor which we will watch for carefully.
How does oil impact your call on India?
India has got the third highest oil import-to-GDP bill of the 28 countries we look at. We do not want to overstate it because the current account is in a reasonably good position right now. But it is potentially a headwind. We have been assuming $75 average for Brent this year. But we recently increased our forecast, for the end of 2019, out into the 90s.
That’s resulted in a tight inventory situation, as we see it. It is likely to be sustained. As that happens, that creates a challenge for monetary and fiscal policy. Not an enormous one, not enough to cause a meaningful downward revision to the forward earnings expectation given the economy is currently performing well. But it is something to watch. So, we end up overall with broadly similar upside for Sensex as we have for the EM index, up about 2-3 percent. And small overweight on the Indian markets. It is not our largest overweight. But we are more worried about macros and the effect of oil in some of the other markets that we cover.
The belief among people is that we can see two rate hikes. What does that do to equity watchers?
We have seen some emerging countries already hiking interest rates unexpectedly. Indonesia did that in May. At the moment our base is that India makes one hike in the fourth quarter. So we will be surprised if there is a hike in this particular meeting. If you look at the valuations, then broadly they are appropriate for India right now versus the rest of EMs.
So, we are tracking that the PE will be at a 30 percent premium next year to EMs with this earnings recovery and the forward PE at about 25 percent premium. It is not like from a global investor perspective, it is a fundamentally mispriced market. That’s consistent with a modest overweight.
In India if we do not see earnings go off meaningfully but stay higher and if oil doesn’t shoot up in a dramatic fashion in FY19, do you believe India stands a chance of outperforming the EM pack, by and large, as earnings will work for India versus the other EMs?
The bull case for India is a world where the Fed stops hiking for whatever reason. Little bit like after the taper tantrum, when Yellen came in, for almost a year, we didn’t get more aggression from the Fed. China might also cease tightening. Trade protectionism might also recede. And we may be wrong in our oil forecast. Then that becomes a favourable world for India.
It is still a good enough base case environment, that we recommend a modest overweight here in India. But it is not a market where you can be bullish, or any of the countries in EMs. So, the big headwinds are ninth year of a global economic expansion, oil is up, central banks are tightening policy, trade protectionism has been a new factor to the negative in the market this year. So, we are not strategically bullish on either India or EMs.