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People in Delhi have too much preference for rating agencies, they are not that important: Chris Wood, Jefferies

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Updated: Dec 11, 2019, 09.22 AM IST
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Highlights

  • The collapse in growth this year in India has been dramatic.
  • People in Delhi have too much preference for rating agencies. They are not that important.
  • DeMon and GST were short-term shocks but they are long term positives.
The Indian economy could pick up in four quarters and we would be pleasantly surprised if it happens earlier, says Christopher Wood, Global Head of Equity Strategy, Jefferies. Excerpts from an interview with Nikunj Dalmia of ETNOW.

What would you say about India's growth worries?
The collapse in growth this year in India has been dramatic. I was in India seven months ago and clearly the clouds on growth since has surprised everybody -- be it the government or the private sector and that collapse is best reflected less in real GDP but in the decline in nominal GDP growth and decline in private sector activity. That clearly raises the issue why this collapse in growth has happened and the most plausible explanation is that it is basically a bit of a sticker shock in response to the great, dramatic structural reforms implemented by the Modi administration since 2014, combined with some complicating factors.

We are moving from one way of doing business to another in India. These reforms include the Bankruptcy Code, the combination of DeMonetisation and GST. The NBFC liquidity squeeze still continues. We have the RERA in real estate but there is another issue right now which is to do with late payments in the system because the collapse in growth. But the collapse in tax revenues is equally dramatic and clearly is blowing out the fiscal.

Since the government counting system is cash based, it apparently has led to payments slowing down throughout the system. This has created a ripple effect from the central government to states to corporates to small SMEs.

In the third quarter calendar year data, we did see a big pick up in government’s spending. Maybe that is seeking to make up for that but the bottom line is there is an issue right now on which the market is focussing because most people in the market believe that the fiscal deficit has gone up to nearly 5%. The government is still committed to the official 3.3% target. My own personal opinion is that the stock market and the bond market would be relieved if the government just said this is a bigger growth slowdown than we have envisaged and the fiscal deficit is going to be much higher this year. I do not believe the markets would sell off dramatically on that because the markets are already assuming that. But I am not sure that markets psychology is understood in Delhi.

Would you say that if India this year and even next year, compromises on fiscal deficit target, it is not going to disturb rating agencies and strategists like you?
Frankly, I do not know about the rating agencies. I do not think that is relevant. I think people in Delhi have too much preference for rating agencies. I personally do not think the rating agencies are that important but from the market psychology standpoint, the market is already assuming that fiscal deficit is 5%. If that is the case, you just want to admit it. Now obviously you can try and rush sell PSU stakes; personally I think it is great that they have made the decision to sell these PSUs for strategic reasons. You could sell PSUs for strategic reasons but you should not sell PSUs on a short term basis to fill a hole in current spending in the Budget.

Another unfortunate thing is the corporate tax cut. It is extremely positive but if you understood market psychology you would realise that there is no need to cut the corporate taxes for this year. If the message had been sent loud and clear that the corporate tax cut was going to happen in the next fiscal year, that would have as positive an impact on the market as what was announced a few months ago. Then you would not have the problem of filling the hole this year.

Old timers like you who have tracked Indian markets and Indian economy for 20-30 years, are telling me that this is one of the ugliest patches they have seen. The only exception was 1991.
I could agree with that but my point is that the slowdown here in my view is a large part due to the shock effect to the structural reforms. Demonetisation clearly hit the SMEs traders. Then there was GST. That combination is a bit of a shock and they are long term positives.

The Real Estate Regulation Act combined with demonetisation again was a massive shock. Most of the black money was in real estate. That means there has been a massive consolidation among property developers. Then came the NBFC funding crisis, which basically moved all those loans. The big loan growth from 2015 to 2018 came from the NBFCs and now they are disappearing. We have had one major failure so far in the NBFC space. Clearly, people are worried more failures may show up in this sector.

Indian benchmark indices are at an all-time high. The economic print is at a decade low. Why is there such a big disconnect between what stock markets are doing versus the underlying real economy?
One very important point is that the midcap and smallcap indices are well below their all-time high. If you believe the economy is recovering that is where you buy.

Do you think the economy is recovering and how soon would that happen?
No, I don’t think the economy is recovering this quarter. All the evidence shows the economy is still weak. If you are being conservative, my basic view is you should hope the economy is picking up in four quarters and we are pleasantly surprised if it happens earlier.
The slowdown here in my view is a large part due to the shock effect to the structural reforms.

-Chris Wood



Are you making a case that stock market investors are not in for strong double digit gains for the next 12 to 18 months?
No because the economy recovers in four quarters. The small, midcaps will move before then. But against your point on the index, I completely agree it is remarkable how well the benchmark blue chip index has behaved. I have some stocks in my Asian portfolio in India and luckily my stocks should be holding up. But obviously part of this is just ETF flows into emerging markets. It is also a fact that the best companies have just not been hit as much and in a big picture, they are going to benefit from consolidation.


You have always been a long-term advocator of Indian stocks. You had double overweight and triple overweight. Currently also, in your model portfolio you have overweight stance on India. Are you looking at changing that?
No I am just double overweight India right now, but the key issue we got to watch is at this point is on the fiscal. One thing globally which will affect India and other emerging markets right now is whether we get US-China trade deal. If we get a US-China trade deal and if the dollar seems to have peaked, then we will get more flows into emerging markets. This quarter we have got foreign net flows into India. Now it is not clear why foreigners are buying India. Probably a lot of that buying is mechanistic, ETF flows into emerging markets some of which is coming into India.
Do you think that ETF flows could be here for another 12 to 18 months?
No, that will purely depend on whether we get a trade deal in which case it could be. If we do not, there would not be. And it will also depend on whether the dollar peaks because if we get a trade deal, that could include a currency component where China agrees not to engage in competitive devaluation against the US and that would allow Donald Trump to declare victory because interestingly, on the currency, neither the Chinese nor the US want a big devaluation of the renminbi against the US dollar.

10 years ago you called two large trends. First you said Indian private banks have a long way to go and so your model portfolio included Indian private banks and HFCs and they still are there as part of your portfolio. Now, 10 years ago there was curiosity around them but now some of the Indian private banks and HFCs are over-owned. You still feel that these stocks would give double digit returns for the next five, six, seven years?
Yes but right now, my portfolio is more inclined to corporate banks with more of corporate lending buyers than pure consumer banks.
Why is that?
This is because of the provisioning cycle for the loans to the infrastructure, energy space. The loan problem Prime Minister Modi inherited in 2014 is now being largely provided for.

But if you are bearish on or if your view is not that constructive on economy, do you think corporate banks may not give good returns? Corporate banks do well when the economy is booming and the credit cycle is moving higher?
Yes, but the first instance is that the problems are being cleared up. As we saw on the reaction to the Essar Steel case, that is positive for banks. But I also have life insurance in my portfolio and one should consider mutual fund companies in the portfolio. I would not have it all in private sector banks.

Can insurance do in the next 10 years what private banks have done in the last 10 years?
Potentially, definitely.
Even though the real estate sector in India is in a downturn, you have Godrej Properties in your model portfolio. You have been bullish on real estate stocks for a while now.
I am just bullish on the stocks which have got clean, good balance sheets because the point is, it is a consolidation story. If 90% of the developers are going bust, that is very positive for the 10% remaining ones.

How come there are not too many consumer names?
The consumer names which I view are highly valued to me. People say there is really high valuations in India and that is the area.

Where are you on debate of good businesses at higher prices or medium businesses at low prices? There is a lot of chatter on the Street that the good companies in India are priced to perfection?
Yes, but in this environment, that is entirely understandable.

Do you think this trend where very few stocks or a lot of money will be chasing very few stocks, is here to stay?
Yes, until there is evidence of a cyclical pick up that will be the story. But in case of cyclical pickup, the money will go in the small and midcap area.

My question for 2020 is, what to your mind are the biggest moving parts for 2020 -- is it Fed, is it the US election or is it the central bank policy action?
No, I think the first key issue is the US-China trade war. Either a deal is done or Mr Trump raises the tariffs, as threatened. If he raises the tariffs, it is extremely negative but my base case is he would not raise the tariffs and he will do a deal. But we just have to wait and see. So, that is a key issue.
Then on the monetary policy, the key development that happened in the first quarter of this year was the Powell Pivot. The Fed went from being hawkish to extremely dovish. I would say a key thing to understand what I know is that though the Fed has put the rates on hold, it has now resumed balance sheet expansion. Now it is not calling the balance sheet expansion QE, but the markets are viewing it as QE in all but name. That is helping propel this current risk-on environment. Clearly, the other big thing will be the US presidential election. In my view there is no point really thinking about that until you know who the candidate on the other side is.

Let us talk about asset allocation for 2020. Would you lean towards emerging markets or developed markets more?
My view is purely contingent on what happens on this trade deal. I have got no deal on 2020 until after this tariff deadline happens. There is no point having a deal until then because the important thing short term is what happens on this trade deal.

The 1970s and 1980s belonged to Japan, then came the US tech stocks; last decade was governed and ruled by markets like India and China. In last 10 years, the US has got it completely right. The next 10 years belong to which asset, which business, which county, which region?
You are talking about the financial markets?

Financial markets.
The big trend in the US in the last 10 years was QE-led and resulted in asset price rises, suppressed rates and that in the US context, has driven this whole boom in passive investment and indexing and that has driven the boom in ETF. The market has also been propelled by the share buybacks where US corporates buyback their company stocks and boosts the EPS. But the buying back was leveraged. So, while it has worked, I would not say it was healthy because the quality of earnings in the US is very questionable. I can show you charts showing the macro trends of US corporate profits which is flat and the S&P profits are going up.

But one trend in money management, which is gaining momentum right now though I guess it is not in India, is ESG. We are getting more and more assets into so-called ESG funds on environmental concerns. But the fund management industry in the western world can charge higher margins on these ESG funds than on regular funds. They are being attacked by ETFs and that is why ESG is gaining momentum.

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