After global central bankers sounded dovish and lower rates — the US Fed desisted from hiking rates — fund flows into emerging markets (EM) are rising. There is also a glimmer of hope about the recovery in demand globally, especially EM, which has led to a recovery in commodity prices. Speaking to Bloomberg TV India, BNP Paribas Securities Head of Asia ex-Japan Equity Strategy, Manishi Raychaudhuri, said the dovish mindset among the global central banks is likely to continue for some more time and the Fed might not hike rates at all in 2016.
Foreign fund flows seem to have picked up into emerging markets. What’s your view? Do you see the EM attractive now? Do you see renewed action in the EM basket?
Fund flows are always difficult to predict. But I think that this current spate of recovery in emerging markets fund flows are likely to continue for some more time. If you look back at the reasons why the fund flows recovered and accelerated, there were possibly two or three key factors. First, global central banks turned significantly more dovish than what the markets have been expecting them to be. It started with the Bank of Japan and then with the European Central Bank…in between the Bank of England, and then it culminated with the Fed statement and the reluctance to hike in mid-March.
We think this mindset among the global central banks is likely to continue for some more time. In fact, our base case estimate right now, aggressive though it may be, is that the Fed won’t hike at all in 2016. I think that was one important factor.
The second was that there is a glimmer of hope about the recovery in demand globally and in emerging markets, which is exemplified by the fact that commodity prices have recovered slightly. It is unlikely to be a runaway recovery in commodity prices because ultimately China is slowing down in terms of manufacturing and fixed asset investment (FAI). China still consumes 50-55 per cent of most of the hard commodities.
But we think that this current stabilisation of commodity prices and mild recovery could sustain in the medium term. So I think based on these factors, it would be correct to conclude that the flows into emerging markets may sustain for some more time.
And the biggest beneficiaries of this, if you look back at last week’s data, have been Taiwan, Korea and India, in that order, and then some small bits and pieces in the South Asian markets. I think that also may continue but we could also see a trend change in favour of India at least in the near term. In case of some of the stocks, especially those of North Asia, which have got significant influence — particularly semiconductor exporters of Taiwan — some of the fundamental concerns are still unaddressed. In contrast, we are seeing some kind of economic Goldilocks scenario for India, which could actually sustain strong influence in the medium term.
What are the key risks for India? Does the kind of vulnerability we are still seeing in banks and financial sector seem worrisome? What are the economic indicators or pockets of markets that you feel pose a risk?
The biggest risk in my opinion is possibly on the balance sheets of the banks. It’s not just in Asia but globally, and particularly in Europe and Latin America. If you look at where these balance sheets of banks are stretched, it’s possibly because of their huge lending to the commodity sector — oil and gas and other commodities in particular. And in those areas, we are not only seeing corporate profitability declining rapidly but also corporate capex and willingness to spend coming down very sharply. And those stretched balance sheets of the banks in Asia and the extensive and massive leverage that companies have taken constitute the biggest risk today. Apart from that I would think that this glimmer of hope about global demand recovery turns out to be fault, that would possibly constitute the second risk though we would get a sense of that over the next two-three quarters.
Finally, if this new found dovishness on the part of central banks evaporates too early in contrary to our expectation, we do see a Fed rate hike, either in April or June. We have noticed that some of the Fed governors actually argued in favour of the rate hike in April. Then that would constitute the third risk, which could again bring about the appreciation of the US dollar, which has ebbed for now, and could in turn lead to the stoppage of flows into emerging markets.
What are the challenges you have in investing in EM? How do you take that opportunity and drill it down to a stock? While institutional investors talk about infrastructure, when you look at their portfolio they are really sitting with some safe stuff like banking and financial services… So there seems to be some disconnect between what they say is driving India and what they seem to be doing on the ground. In India’s context, how do we do it?
One can’t really blame institutional investors in this regard because while the macroeconomic situation in India seems to be improving on the ground — we are seeing more and more projects coming, not only being announced, but also being executed, particularly government-sponsored projects — we are also seeing some degree of economic growth recovery. And at the same time there is a possibility of interest rates coming down further, which constitute the classical economic Goldilocks scenario — it somehow is not translating into corporate earnings. If you look at the last three or four quarters, earnings have disappointed. Earnings estimate across all sectors, except possibly IT, have declined considerably. And, as a consequence, investors have taken this very cautious attitude of investing in the cash generators or the deleveraged companies or the top front-line companies, which have good corporate governance and are well searched, which is exactly the phenomenon we are alluding to.
I think in the near term, it’s unlikely that institutional investors will move away from this kind of a portfolio positioning. For them to move away, we need to give a reassurance on corporate earnings recovery. I personally think it’s only in the second half of FY17 that we can see some degree of recovery based on two or three factors. First, we have seen severe slowdown in domestic demand, particularly on the rural side, which could recover if we have a good monsoon.
We will get a sense of that somewhere around May, June or July. Second, consumption will be helped somewhat after the disbursal of the Seventh Pay Commission award.
And third, we are seeing some recovery in government-sponsored projects, which would obviously have a multiplier effect with some orders flowing down to the smaller and second tire industrial companies. So, I would think that slightly risky or high beta portfolios will come into being only around the second half of 2017. But prior to that it would only be safer to play with private sector banks, particularly those which are focused on retail credit.
Among industries, we would recommend companies which are diversified into various areas and which are deleveraged. In fact, these deleveraged balance sheets of companies are the recurring theme that we have been talking about. And of course the cyclical, which are in a sense good quality — whose return on capital has been higher than cost of capital over the last couple of cycles, and again which are deleveraged. We have recently come out with a screen across Asia, which recommended some of these.
Just to give you an example, some of the building materials companies in India squarely fall in that category. So I think these are some of the areas, apart from some of the consumer discretionary companies and IT services, which have remained our favourite for sometime and which investors should use to play in India in the near term.