India is a consensus overweight among foreign investors: Geoffrey Dennis

As the markets head into a new calendar year, GEOFFREY DENNIS, managing director and head, Global Emerging Markets, UBS Securities tells that calendar year 2017 (CY17) will see a modest pick-up in global growth and expects the US Federal Reserve to hike rates twice in the calendar year. Edited excerpts:

What is your assessment of how calendar year 2016 has panned out for the global financial markets, and what is the road ahead for 2017? What are the key triggers and risks?

The main feature of markets in 2016 was considerable volatility on a series of political events, but with a supportive backdrop of ample liquidity. Markets fell sharply in early-2016 on China currency and US Fed rate hike fears. Easing concerns over the Fed (which raised rates just once in 2016 when 4 hikes were expected at the start of the year) then drove a strong equity market rally. The initial response to the Brexit vote was very negative, but markets rallied soon after on the realisation that the vote would force major central banks to remain very accommodative. 

Similarly, there were fears that the Trump victory would push markets sharply lower but, in the event, hopes for tax cuts and general fiscal expansion raised hopes of stronger US growth and pushed the US market sharply higher.  The key features of 2016 were sluggish global growth; a falling dollar; rising commodity prices; and ample liquidity creation.

For 2017, we see a modest pick-up in global growth, but with only two rate hikes from the US Fed. The USD will stay weak against other developed markets (DM) currencies, but a touch stronger against emerging market (EM) currencies as a whole. We expect modest gains in EM equities as earnings per share (EPS) grows around six per cent (USD) in the year. Key risks: i) Upside: stronger global growth with little rise in inflation; ii) Downside: sharp rise in inflation and bond yields; 'populist' victories in key European elections.

Do you see tighter monetary policies by major central banks across the globe in CY17, and will they pose a threat to the global equity market rally? What about the dollar’s strength and bond yields?

We expect the Fed to raise rates twice in 2017; we expect the European Central Banks (ECB) to begin to taper from early-2018 onwards. This is a fairly benign backdrop for global equity markets. The USD will stay weak against other DM currencies, but a touch stronger against EM currencies as a whole. We expect US 10-year yields to fall back to 2.25% by end-2017 again as the US economy grows at just 2.4 per cent next year.

How are foreign institutional investors seeing developments in India? What are their key concerns? In terms of their pecking order for emerging markets, where would India be?

Foreign investors are still generally positive on India as it is the best growth story in the EM (GDP growth, EPS growth, ROEs). The reform program continues to advance - even if slowly and erratically. The demonetisation reform is seen as a major short-term hit to the economy, but is positive for growth in the long-term. Low inflation and interest rates, plus confidence in the Reserve Bank of India (RBI) is another advantage. Sharply lower current account deficit leaves the market less worried about the Rupee, which is now much more stable than it was, for example, in 2013.

However, there are some concerns as well. Valuations are rich at 15.4x forward versus its long-term average of 14.6x and EM at 11.5x. Besides, we don’t know how bad the hit to the Indian economy from de-monetization is. India is a consensus overweight among foreign investors. We, too, are overweight India within the EM.

What's your advice to someone who wants to invest with a year's perspective? Is it a good time to invest or can they get stocks cheaper six months from now?

We do not make short-term calls; we are overweight India within global emerging markets (GEMs) and so we are cautious buyers now.

What is your analysis of the government’s demonetisation programme? Could it have been timed and handled better? What are your expectations from the government as regards policy-related reforms in CY17? 

This is our economists' call. We look for a sort of 'middle ground' with GDP growth slowly to six per cent in FY17 and then rebounding to eight per cent in FY18; it is always hard to implement such a sweeping reform with no warnings and there will be short-term disruptions (as in this case); however, we are bullish over the long-term results of the de-monetisation reform. We still see the April 2017 target date for the implementation of the GST as doable.

What is your assessment for corporate earnings growth in India given the demonetisation? For how many quarters will the growth be impacted? What are your revised estimates for FY17 and FY18?

Roughly, we expect two quarters to be hit by the demonetisation process. The Nifty FY17/18 EPS forecasts of our Indian strategy team, on our base-case scenario for the effect of de-monetisation (above), are 5% and 14% respectively; our prior estimates were 10% (FY17) and 14% (FY18) and so we have cut estimates by 500 basis points (bps) due to demonetisation. 

Street estimates are at 13.4% (FY17) and 19.7% (FY18) respectively (all in local currency) and so the FY17 estimates will have to come down. The CY17 and CY18 consensus forecasts are 8.5% (FY17) and 19.2% (FY18) in USD and also look too high. 

Which sectors are you overweight and underweight on right now in the Indian context? Do you plan to the allocation strategy as we head into 2017?

Our Indian strategy team is overweight in consumer staples, auto parts, coal, media, retail private banks, non-banking financial companies (NBFCs) and telecom. They are underweight in autos (two-wheelers), corporate private banks, infrastructure and capital growth, IT Services, SMID (small and mid-caps) and cement sectors.


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