According to Morgan Stanley’s emerging markets strategy team, the rally in emerging markets was nothing but a bear market rally with the risks of a reversal now building yet again.
The report in Business Insider stated that the pillars that supported the rally earlier this year seem to be crumbling, as risk conditions have turned and have started to expose weak fundamentals and structural imbalances once again. The strong USD trend has resumed and Chinese data is deteriorating.
However, the bank believes that India's beta to MSCIEM has significantly reduced since the government change in 2014 to only 0.80 times currently. The note also stated that it sees a sign of de-coupling between MSCI India performance versus the rest of EM, evidenced by the decreasing correlation.
So while the bank has downgraded emerging markets’ bonds, India is now overweight in its Asia Pacific equity portfolio, while Australia is underweight.
The reasons given for this stance are:
1) MSCI India consensus forward P/E relative to MSCI EM is currently trading within its historical standard deviation band (from 56% premium to 36% premium), due to India’s underperformance versus EM since the start of year. GEM fund managers are turning less overweight in India, with their overweight position coming off to only 5.4% from a record high 7.9% in 1Q2015. Meanwhile, domestic flows proved resilient through a difficult 1Q.
2) MSCI India F12M dividends per share is on a consistent rising path post GFC, and its dividend yield relative to EM is now reaching an historical high level.
3) Supportive macro environment: a) Little deflation threat, favourable demographics, low overall debt, and possibility of productivity-enhancing reforms. b) Further rate cut by another 50bps in F2017, according to our economist Chetan Ayha. c) GST bill likely to be approved this year, according to our India Equity Strategist Ridham Desai. d) Monsoon rainfall is expected to be above normal.
Earlier this month, Morgan Stanley released a note stating that Indian companies will likely resume growth in the coming quarters helped by lower debt, positive cash flows and a better economic environment signaling the end of the corporate debt crisis in the country.
HSBC too is positive and has upgraded India from Sell to Neutral. The reasons:
1) While India remains expensive at 17.9 times 2016 earnings, after this year’s underperformance, its equity premium relative to the region has come down to its historical average. This is especially true considering India fetches a handsome 15.7% return on equity.
2) “Green shoots” are emerging in the Indian economy. Demand for cement, long steel consumption, and power. Commercial vehicle sales and construction equipment sales also suggest domestic demand is picking up.
3) People are no longer crazy about India, which means its stock valuations are no longer as stretched. Current exposure to Indian equities is as low as it has been over the past few years.
4) Market liquidity is improving. For instance, the Reserve Bank of India reduced the daily maintenance limit of cash reserves to 90% from 95% previously, allowing banks to withdraw additional funds from the required cash reserve ratio and lessen pressure on interbank rates when liquidity is tight.
5) India is a relatively defensive market. Market volatility is significantly lower than in other markets such as China, Korea, or parts of ASEAN. Only Singapore and Malaysia exhibit lower volatility in the region.
