Talking about the China market, which analysts say fell last week on concerns of signs of tightening monetary policy, Adrian Mowat, chief Asian and emerging equity strategist of JPMorgan, said markets do get nervous on the first signs of monetary policy tightening. In an interview, he added: “But once the interest rates start to move up and the investors realize that this is a sign of a strong healthy economy, the markets tend to perform very well.” Edited excerpts:
What do you make of the turbulence that has cropped up led by China?
It is a very interesting situation at this point in China. The Chinese economy has recovered very nicely led by domestic consumption and also by government investment, so we have had a strong period of growth now, we have got very strong car sales and retail sales, which is a good thing to see, particularly in an environment where the exports have been weak. Now the investors are questioning whether China will begin to increase interest rates, because the economy is now growing strongly. We think that it is rather misplaced, but there is some confusing policy going on, insofar as that the China government does worry about asset inflation and it is beginning to micro-manage the property market and that is upsetting another asset market, which is the equity market. We saw Asia, as in China, falling some 20% from its recent highs. Do bear in mind that this is a retail momentum market, it is a huge market but it is very much driven by retail investors. So the global investors are a little anxious that perhaps the momentum has turned negative in this big Chinese market.
Going strong: JPMorgan’s chief Asian and emerging equity strategist Adrian Mowat. Ashesh Shah / Mint
We are going to look at this on a fundamental basis, though it is a mistake to start to assume that China or any other emerging market is going to start to tighten monetary policy. If you look at inflation in China, in India and elsewhere in the emerging world, it is either negative or very low at this point in time, so there is no need for the investors to be worried about the start of the tightening cycle...
The general pattern of markets, when normalization occurs, is that in a couple of months ahead of the first interest rate increase, you see the market underperforming and going down a bit and the investors fret about that. But once the interest rates start to move up and the investors realize that this is a sign of a strong healthy economy, the markets tend to perform very well regardless of whether it is Standard and Poor’s or the Sensex or the Asia index in China. We don’t think we are in that stage yet and I still believe that central banks are going to continue this aggressive easy policy at this point in time and so is the buying opportunity.
So people sitting in India who wake up to the Shanghai every morning and take cues from there should regard this as just a 20% correction, which will be used as a buying opportunity as you say or would you say that there is a growing disenchantment about the China story that might peg it lower, in which case we need to worry out here?
It is very important to distinguish between the two markets here. We have the onshore Asia market, which is driven by the retail investors in China, and then we have the Hong Kong market, which is predominantly driven by the global institutional investors. These markets can drift apart to a large extent and at this point of time the Asia market has got a big valuation premium versus the Hong Kong market...
And I think India has actually got two things going for it in terms of generating a good opportunity to accumulate Indian stocks. The first is what we have already talked about with the China’s market weakness but the second is that I think there is excessive pessimism in the Indian market with regard to what is clearly a bad monsoon. But the monsoon in itself does not guarantee poor performing equity markets; on the contrary, in fiscal year 2003 and 2005, the Indian market did well and even beat other emerging markets despite a relatively poor monsoon.
Do you believe that world equity markets are ripe for that 10-15% kind of a pull back that a lot of the commentators have been talking?
It is a mistake if you think that the markets are going to go down meaningfully; if you look out over the balance of 2009, you have three very powerful drivers for the global economy. The first is the delayed monetary stimulus. Credit spreads have come in dramatically—they are still high versus the long-term average, so we think they are going to continue to narrow. We have high-grade corporate bonds in the US yielding just about 5%, which is actually a historic low level. So the funding cost in the US is now meaningfully lower for the corporate sector, so this monetary stimulus is coming through and that is a global event and it is a great news for India, as India needs to import capital from abroad to grow rapidly.
The next thing that is going on is that the profits are a surprise on the upside and that would mean that there is less business retrenchment and that the non-farm payroll and the unemployment statistics will not be deteriorating as poorly as they have been, so that takes away a very important drag.
The final point to make is that when we look at the GDP (gross domestic product) of the second quarter globally, you are going to see the biggest ever decline in the inventories. We are now beginning to see the industrial production cycle turn even in the US... In our view, you have got an absolute textbook economic recovery occurring. Maybe what is not normal textbook is that the global economy was synchronized on the way down and it is also going to be synchronized on the way up.
What was also unusual was the amplitude of recession, and I think people are going to be surprised by the amplitude of the recovery. In that environment, I want to own risk assets and equities and I won’t try to be too cute in hoping to get a slightly better buying opportunity when I am more likely to find out that I miss out on the ongoing powerful rally.
So in your mind you are quite clear that this global economic recovery is for real.
We are in one of the biggest bull markets that we have ever seen; you have got some incredibly powerful factors at work here. We had some excessive risk premium at the start of this, those risk premiums are compressing and we have a global synchronized recovery trade, GDP numbers are being revised up from very pessimistic levels as are profits and earnings projections again from incredibly pessimistic levels, if you look at the global data. So these things coming together is what is driving the markets today. Then let’s not forget that the US interest rates are effectively zero and the US long bond yields are 3.4%. When your risk-free rate is that low you are going to get overshoot on the upside. Can you imagine India with policy rates below 5%? That is what we have got today, you have got to rethink your valuation paradigms when that is what is happening with the risk-free rates.
So in your book it is just a matter of time before we get to the new highs for most of the Asian equity markets. Should it happen late this year or next year sometime?
I feel pretty confident that, for instance, the emerging markets index, which peaked on 1 November 2007 at around 1,338, will be back at that level...
So do you see India at 21,000-plus in 2010?
That is quite realistic. We recently upgraded India. That was quite an amusing call because everyone said that you have missed it. I think you need to understand what our job is. Our job is to outperform emerging markets. We said that we are very bullish on the emerging markets and we positioned ourselves neutral in India up until a couple of weeks ago and that worked well. Now we think that India is going to distinguish itself because there are two very important trends that are gong on in India. The first is the external cost of funding is falling, it is falling very fast. India needs to import capital in order to achieve 7%-plus GDP growth. They need to invest a lot in infra (structure), into expanding capacity in its economy and that requires cheap longer-term funding...
Onshore, we have the record low policy rates and if you look at the 10-year bond yields, yes, they have moved higher but in a historical context, they are still quite low in India. The final point that I would make is that the Indian inflation is very low and some of the WPI (Wholesale Price Index) recently have been negative. That will be very positive for the urban consumer and there is a big focus understandably on the rural consumer, who is challenged in an unfortunate way with the problems with the monsoon...
Currently, what are the best sectors to position yourself in India?
There are a couple of things we are playing, this issue about the change in the price of money, it’s making you go and buy into companies with leveraged balance sheets. Perhaps all those companies you didn’t want to own last year. Some of the companies that were involved in global M&A (mergers and acquisitions) activities and there was a great deal of concern about their ability to refinance debts, so that’s one important theme.
The next important theme is long-term fixed investments, so you are thinking about your infrastructure stocks; you are beneficiaries of infrastructure spending... We had been very positive on consumer discretionary in India... We are seeing some pull back in these stocks because of concerns over the monsoon. As that pull back continues, it’s probably time to re-enter these companies.
Property clearly looks attractive... Mortgage rates are going to be at record low levels in India and the long-term funding costs should be much more modest in the most currently projected analysts’ numbers...
Banks we would also like because of the volume growths that they should build. But you tend to get a timing issue here. You don’t want to eye banks when their net interest margins are falling, which they tend to as interest rates fall. Then you want to buy those banks as those lower interest rates stimulate more volume. We are almost there with the banks at this point in India, so there is quite a lot I want to buy. What I want to avoid are the more defensive sectors...where I think you are going to continue to see those types of stocks underperform. We also tend to have a slightly greater exposure to the rural areas, to the low income consumers in rural India.