Broader index expensive, subsets attractive: Mark Matthews

The Indian benchmark indices are expensive, but there are several subsets of the Indian market that are quite attractive, said Mark Matthews, the Singapore-based head of research, Asia at Julius Baer. In an interview with Sanam Mirchandani, Matthews said the benchmark indices may continue to head north, as markets elsewhere are rising on the back of global central banks reducing rates amid signs of revival in the global economy. Edited excerpts:What is your outlook for the Indian equity markets? Is there a case for more upside? There are two things happening in the world that are positive. First, the trade war is getting better. Second, leading indicators are showing this year’s manufacturing slowdown is probably already behind us, and purchasing manager’s indices will rise in the coming months. So, the global backdrop is positive. What's happened in India is also positive. In the past few months, there has been a 180-degree turn on reforms. We see that with the corporate tax cuts and the progress made in the bankruptcy courts. I am talking about Essar Steel, of course, but DHFL looks like it’s heading the same way. So the reform is on a positive trajectory. Add to that four interest rate cuts, and I think the backdrop is generally good.Are you worried about polarisation of gains in the market? Only a dozen or so very large stocks are driving the Nifty50 higher, and those stocks alone are over 60% of the index’s capitalisation. Each of those very large stocks has its own reasons for moving higher. For example, corporate banks are moving on the back of the Essar Steel judgement.Another one is Reliance Industries, because Aramco is indicating it's going to take a stake in its refining business, and because Reliance Jio is hiking its tariffs.The problem is that the index is expensive now, at 22.6 times forward earnings. The good news is that India will reach a bottom in GDP growth this year at 5.5% for the full year. Next year, we see it back at 7%. We also see earnings growth at 22%. If that’s true, it will be great. But remember this time last year the consensus was also looking for over 20% earnings growth — and look what happened.If we take those dozen top stocks out of the Nifty, then it would look a lot cheaper. That's why the Nifty Juniors are one place to look, in other words selectively in the midcap space, and also in some of the sectors that have dropped a lot for various reasons so they're no longer overvalued, like pharmaceuticals and utilities.And if government is serious about privatisation, the PSUs are interesting, and the CPSE ETF is only trading on 7.5 times earnings with about a 4.3% dividend yield. My message is the broader index is expensive, but there are several subsets of the Indian market that are attractive.So, at an index level, you don't see much upside from current levels?From a valuation perspective, I would say that’s true. I don't think it should go higher. But given the state of affairs globally, where 26 central banks have cut rates this year, and the ECB and the Fed have started expanding their balance sheets again, the trade war is getting better and there are signs that the global economy is picking up … then all markets are going to go up. India will be pulled in that direction, too, regardless of its valuations.Are flows into emerging markets likely to sustain?There is a better feeling toward EMs now than, say, six months ago. If we look at the big ones, people are speaking positively about Brazil. Its valuation is low relative to history; commodity prices are stable, and the government is pro-business. One could say that India is in a better place than it was six months ago.And people are becoming more interested in China as they realise it is becoming a very large asset class in its own right, and it has got a large and vibrant technology sector. Having said that, the main thing that keeps really big money coming into the asset class is the dollar.It’s still showing no real sign of weakness. And so dollar-based investors still worry they might lose money in currencies. But I would say, gradually the reasons are increasing why the dollar should peak out. The biggest one being, signs of a global recovery.How would you rate India within the emerging market basket?For the next 12 months, others are more attractive. Brazil has had a good run but still looks interesting. Company earnings were 50% higher four years ago than what they are today, but the recession is over now. They’ve had huge progress with pension reform, and tax reform is coming. I’m not recommending it, but Russia has a twin surplus — so, its currency should be fine, and it has an 8% dividend yield from well-run companies.China is much cheaper than India but is making big advancements in life sciences and technology.In India, the valuation is expensive, and every week it seems there's some new NBFC or broker we find out about where they have run away with client money. That's not good publicity for India. The only good thing we can say is it seems to be being dealt with very proactively now. For example, DHFL is being referred to the NCLT, and Sebi banned Karvy from executing trades and taking on new clients.Private banks alone can't satisfy the credit needs of all of corporate India. So, the really big missing piece in the picture is for the financial sector to be healthy again. It’s still not clear how many more skeletons are hidden in closets, and when the sector will be healthy again. That’s why the high frequency data is indicating the GDP growth rate will probably be below 5% for this quarter. But then again, a lot of things have been done to encourage growth. So this quarter will probably be the bottom, for growth slowdown.We will probably get some more reform news. I think they haven't finished with the reforms yet. And we are looking for one more rate cut in December. The RBI is clearly on board trying to accelerate economic activity, and inflation is still well within its targets.Do you see the government meeting its divestment targets for this year?Yes, but many of the assets are frankly not appealing. People will be mainly interested in the crown jewels, and most of the PSUs will probably be sold at low prices. But then they can become better-run companies with more productive assets when they are in private hands.Which are the sectors that you are bullish on?We like corporate banks, midcaps selectively, pharma and utilities for their valuations.

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