00:00 We have Jonathan Garner, Chief Asia EM Equity Strategist
00:04 at Morgan Stanley, who's joining us on the show.
00:06 Jonathan, good morning, and thanks so much for joining in.
00:07 Good morning.
00:09 Nice to be on your show.
00:10 Right.
00:11 Jonathan, let's start-- get off the bat
00:13 by talking about the metrics that you think are favoring
00:17 India at the moment.
00:19 Well, I think the first thing to begin with
00:21 is the very strong domestic growth environment.
00:24 Nominal GDP growth is running 12% to 15% right now.
00:28 So just to contextualize that, that's
00:30 just about the highest in the world.
00:32 It's three times the nominal growth rate of China.
00:36 And the Indian stock market is full of domestic demand stocks,
00:39 which can benefit from that underlying buoyant domestic
00:42 growth environment.
00:43 So India has far superior earnings per share growth
00:47 compared to the rest of emerging markets.
00:50 Right, Jonathan, but you are not too
00:52 concerned about valuations at the moment
00:54 when it comes to India?
00:56 So valuations are high on a historic basis,
01:00 so historic price book of about four times
01:03 and historic P/E of probably mid-20s,
01:06 depending which index you use.
01:08 But it's all about that ability to compound
01:10 earnings per share growth.
01:11 And the work done by our team in India, led by Hridam Desai,
01:15 suggests that we're looking at least to 15% to 20% compound
01:19 EPS growth in rupee terms over the next three years or so.
01:23 So that brings the forward P/E multiple down
01:25 quite considerably.
01:27 And so, yes, it's true that India is to some extent
01:30 expensive versus other emerging markets,
01:32 but it's never had such strong fundamentals
01:35 relative to emerging markets as it has now.
01:38 You are overweight on India.
01:40 What are the factors that determine your overweight
01:42 rating as far as Nehru nations go?
01:46 Well, we look at a lot of different factors.
01:48 We just spoke about some of them,
01:49 earnings, growth, and valuations.
01:51 We also look at medium-term ROE trends.
01:53 And again, there, the story in India is positive.
01:56 It has actually the highest ROE of any major market
02:00 in the world other than the US.
02:02 And we look at long-run sovereign risk and policy
02:05 characteristics.
02:06 And again, if you look at the current account
02:08 position of India, the FX Reserve situation,
02:12 the fact that the currency and interest rates
02:14 are much more stable than in the past, this is all attractive.
02:18 Jonathan, can you talk to us about your expectations
02:21 when it comes to interest rate trajectory,
02:23 the kind of environment that you're seeing at the moment?
02:26 The Reserve Bank of India has not
02:28 indicated anything at all when it comes to, well,
02:32 bringing rates down.
02:34 But your view, perhaps some sense that you can give us here?
02:38 Well, I don't think it's as important, frankly,
02:40 not just for India, but for other markets,
02:43 the interest rate trajectory.
02:44 Ultimately, stock markets are about corporate earnings
02:46 and valuations.
02:47 But we would expect Indian interest rates
02:50 to broadly track those of the US in the upcoming down
02:54 cycle in US rates.
02:56 But that down cycle in US rates will be quite slow.
02:59 And it will begin in the summer.
03:01 And any down cycle in Indian rates will be relatively slow
03:06 and may begin at some point this year.
03:07 But that's not the reason why we're
03:09 bullish on Indian equities.
03:11 Jonathan, then let's talk about sectors.
03:14 What sectors do you like at the moment as far as India goes?
03:19 So we have overweights on three sectors, financials,
03:22 industrials, and consumer discretionary.
03:25 So all three are in that domestic demand grouping
03:27 that I referred to earlier.
03:29 So their direct plays on the underlying
03:30 buoyant economic environment.
03:33 And we're more cautious on classic defensive sectors.
03:36 Right, Jonathan, off late, we've seen a little bit
03:39 of a divergence between state-owned banks in India
03:43 and the private sector space.
03:46 How were you placed here?
03:47 And what are the financial themes
03:50 that you like specifically if you were to cut it up further?
03:55 Well, I can name a stock that's in our focus list, ICICI Bank.
04:00 So we obviously lean on the work of our domestic team
04:03 and our domestic banks analysts.
04:05 And that's the name that we currently prefer.
04:08 Other mega caps that we have in our list
04:10 include Reliance Industries.
04:13 We also have recently added exposure
04:15 to the real estate sector, which is something
04:17 we've not historically had exposure to in the form of DLF.
04:21 So again, I wouldn't be the best person
04:24 to talk to about the nuances of state-owned banks
04:27 versus private banks in India.
04:28 But the one that we like is ICICI Bank.
04:31 Fair enough.
04:32 Jonathan, what is it that you like in industrials?
04:35 And why do you like that as a theme?
04:37 What do you see in here in terms of what could potentially
04:40 work for this particular sector?
04:43 Well, again, India's very much in this phase
04:46 of urbanization, industrialization,
04:48 public and private capex, which helps industrials.
04:51 So Larsen & Toubro has been a name
04:52 that we've had in our focus list.
04:54 And I mentioned also Reliance Industries.
04:57 And again, this is in sharp contrast
04:59 to what's going on in another market in our coverage, which
05:01 is China.
05:03 So these are the two opposite sides of the story,
05:06 really, where China's underlying growth engine is not
05:10 functioning as it did in the past.
05:12 So the same sectors that we favor broadly in India,
05:15 we disfavor in China.
05:17 For example, Chinese financials, real estate, industrials,
05:20 and consumer.
05:21 These are all things that are struggling
05:22 in that other large market in Asia.
05:25 Next, Japan.
05:26 Well, I do want to talk about China in just a bit.
05:28 But before that, as far as the India consumption story
05:31 is concerned, at least the staples hasn't done well.
05:35 It's not showing up in earnings.
05:37 But you do have a positive stance
05:38 as far as discretionary is concerned.
05:40 Again, themes that you like here,
05:43 and why you expect this particular sector to do well.
05:49 As incomes rise, typically within the consumer budget,
05:53 people start to spend more on discretionary.
05:55 And the relative spending on staples, the relative spending,
05:58 tends to decline.
05:59 So this is something that we saw play out
06:01 over two decades in China.
06:04 But in India's case, Maruti Suzuki
06:06 is a name that we include in our focus list.
06:09 So that's a classic play on this process of households
06:15 actually being able to increase discretionary spending.
06:19 Jonathan, then in that case, I want to shift focus to China.
06:22 And of course, we've already seen a substantial correction
06:26 in the indices here.
06:28 What are the challenges with respect to the economy, one?
06:31 And second here is that, does that
06:33 mean that we will continue to see an outflow of funds,
06:37 foreign funds, from the Chinese markets going in?
06:41 Yes, so the issue in China is what we call the 3D problem.
06:45 So debt, demographics, and deflation.
06:49 And that's leading to a structural decline
06:51 in corporate return on equity, which is now
06:53 far below that of India.
06:56 And so what you're seeing, again,
06:57 is investor reappraisal of the long-term growth
07:00 prospects for the market.
07:01 And that's driving a multiple derating.
07:05 So the low forward P/E multiple on China, in our opinion,
07:10 is actually warranted.
07:12 Indeed, it may move lower because the market as a whole
07:15 is no longer capable of generating
07:18 earnings per share growth.
07:19 To some extent, it's become a value trap.
07:21 Right.
07:22 And yet, do you see any positives,
07:26 as far as China is concerned, for investors to stay there?
07:31 Well, we're waiting to see if there's any stimulus,
07:33 particularly targeted at the consumer.
07:35 We think there needs to be quite a major kind of like anti
07:40 deflation package, to put it that way.
07:43 Given where household expectations now are,
07:47 households in China are starting to pay down
07:49 debt for the first time ever, reduce mortgage debt.
07:52 They're very unwilling to engage in discretionary consumption.
07:57 Whereas, of course, the opposite is true in India.
07:59 There's a long road ahead for India in household leveraging
08:04 up and discretionary consumption spending.
08:07 So unless some measures are taken in China
08:09 to re-stimulate the consumer, it's
08:10 very unlikely the market will turn around on a sustained
08:13 basis.
08:14 Sure.
08:15 Jonathan, also, you mentioned Japan in your report.
08:18 And of course, we've seen contraction and GDP come in.
08:21 That said, today, we have seen Japan move up a benchmark.
08:26 The last time we saw that benchmark come through
08:29 at the level of the Nikkei, that at 38,000, was back in 1990.
08:33 What are the factors that are playing in favor of Japan?
08:37 So Japan and India are our two bull markets
08:40 within the New Era thesis that we have.
08:42 At opposite ends, obviously, of the GDP per capita spectrum.
08:45 But the Japan market's quite different from the India market.
08:48 About half of market cap is globally engaged
08:52 in sectors like technology and capital goods
08:55 and many others, pharmaceuticals as well,
08:58 with quite a large exposure to the overall global macrocycle.
09:03 And those leading sectors in Japan
09:05 have actually been improving operating margins, net income
09:09 margins versus global peers.
09:11 Just on that GDP point, you have to be very careful about that
09:15 because of the way that the Japanese economy moved
09:18 through the COVID reopening.
09:20 The first half last year was very strong.
09:22 And there was some slowdown in momentum
09:24 that we think is temporary in the second half.
09:26 But for the year as a whole last year,
09:29 Japanese nominal GDP growth was around 6%,
09:33 which is a 30-year high, and certainly higher
09:36 for the first time ever than China.
09:39 So the biggest story here is that actually domestic growth
09:42 in Japan is also perfectly fine.
09:44 So it's no surprise to us that the Japanese market's
09:47 making further progress, as you were highlighting on your show.
09:51 Right, Jonathan, a final question then.
09:53 When it comes to near-term challenges in India,
09:55 if any, or potential risks, can you enumerate some of them?
10:01 Well, my colleague Riddham has written
10:03 about a likely pickup in volatility
10:05 ahead of the elections.
10:07 That's as far as we can go in our comments on that, clearly.
10:11 Obviously, if there was a very rapid slowdown in the US
10:15 economy, that could be negative for markets generally.
10:19 But again, that's not our base case.
10:21 On that point, though, I would say that the beta of the Indian
10:24 market to the S&P and global markets
10:27 has reduced substantially in recent years.
10:30 And that's testament to a lot of the things
10:32 we talked about earlier in this interview, just
10:34 the strength of the domestic economic story, earning story,
10:37 and better sovereign balance sheet position
10:40 than we've had historically.
10:41 So things are set very fair for Indian equities
10:45 to continue to do well, in our view.
10:47 Right, Jonathan, we'll leave it at that.
10:48 Thank you so much for joining us and taking us
10:50 through your report, as well as your observations.
10:53 Well, that's Morgan Stanley telling us
10:56 about the view on India and Japan,
11:00 and of course, India leading the emerging pack,
11:02 one of the preferences, along with Mexico and Poland,
11:06 among others.
11:08 [MUSIC PLAYING]
11:11 (music)
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