Jonathan Garner, Chief Asia & Emerging Market Strategist & Chairman of Asset Allocation, Morgan Stanley, says “portfolio investment is moving towards India at the moment which means that though the multiple in absolute terms is about 20 times one year forward PE, they look higher compared to emerging markets at about 12 times. The superior compound EPS growth and portfolio equity inflows likely keep the market very well supported.”
Garner further says, “Ridham Desai and the team in India have a target for Sensex at 68,500 and an upside bull case target of 80,000. That is the absolute returns upside that they see. Many of our clients who have a mandate to invest across emerging markets, care more about that relative disparity.”
In your latest Emerging Market Strategy note, you have moved overweight on India, downgraded Australia to underweight and Taiwan and China to equal weight. What is the thought behind increasing India’s weightage from 6 to 1 at a time when your notes specify that valuations are less attractive right now versus what they were in the month of October?
India rises to number one out of 27 markets that we cover in Asia, ex-Japan and emerging markets. We also like Japan but that is a separate developed market decision. Valuations have cheapened up for India since last October in relative terms quite considerably as other markets in North Asia, like Taiwan and Korea, have outperformed the Indian market quite substantially. So there are better relative valuations than there were.
But if we zoom out, the medium term story is what excites us so much about India. We are starting to see a trend of superior US dollar earnings per share growth over the cycle versus other emerging markets and particularly versus China. We are also seeing the Indian rupee sustaining a real exchange rate trend that is stable to positive at a time that the Chinese renminbi, for example, has become really quite weak.
So portfolio investment is moving towards India at the moment which means that though the multiple in absolute terms is about 20 times one year forward PE, they look higher compared to emerging markets at about 12 times. These superior compound earnings per share growth and portfolio equity inflows likely keeps the market very well supported.
Is India in your book a buy both in absolute and relative terms because what you have referred to right now is not absolute comparison. It is more like a relative comparison?
Yes. Our colleague, Ridham Desai and the team in India have a target for Sensex at 68,500 and an upside bull case target of 80,000. That is the absolute returns upside that they see. Many of our clients who have a mandate to invest across emerging markets, care more about that relative disparity. I guess that I discussed this in the answer to the earlier question.
In 2022, we saw mass outflows out of India to China. When we started the year, that pattern was at play. But since April, FIIs have come back into India, both by the portfolio route and by the FDI route. Do you think this could be a multi-year trend in making? Should we get accustomed to strong flows by institutional investors especially FIIs into Indian equities?
Yes, we do. What we know now is that the economic recovery in China has been very lacklustre. Certainly there is a debate amongst investors as to whether it has reached an important multi-decade transition. Its demography is quite adverse and that is in contrast with India, in terms of the population age distribution. That matters not just for themes like consumer, industrials, financial stocks, earnings, but it matters for the demographic that can now buy equities in India.
So again, for China, the near-term issue around leverage and the property sector issues is causing a real challenge for policymakers, and that is weakening the currency. On my recent trip to India in June, I was struck just how strong the economy is across the board in manufacturing and services, PMIs and real estate transaction volumes and activity in inward FDI and infrastructure construction. For us, India is a very interesting story.
Specifically to one factor which you have alluded to in your report is that we are in a profit cycle and it is only halfway through with profit share in GDP from a low of 2% going up to 4% and eventually 8% in four to five years. If that had to happen, where profit as a percentage of GDP will go from 2% to 4% and 4% to 8%, what will do well and what will not do well?
That is what has been done by our colleague Ridham and his team. We would certainly concur with that. I think the engine of growth is going to be on the consumer and industrial side in particular.
Though India has some very powerful export earning companies, that is not where you are going to see the biggest compounding in earnings per share growth on a go-forward basis particularly bearing in mind this point about local currency earning streams being more supported by a structurally stronger rupee and that is exciting. It means that India’s earnings per share growth is now compounding much faster than peer group emerging markets in US dollar terms.
Your report explicitly talks about where China was in the past, India will be in the future. Now, that is a very powerful comment and I love when somebody says such good things about India being an Indian. But can you elaborate more on that?
If we simply look at metrics like GDP per capita for India, we are standing at around US$2,500. China is about US$13,000. China’s growth model is running into trouble. India has a long way to run. Household leverage overall in the economy in terms of debt ratios to GDP, are still extremely low, a feature that is shared with Indonesia.
But it is in stark contrast to the situation in China or North Asia more generally. And again, we know that in this multi-polar world dynamic that is ongoing, India has significant optionality there in terms of the way that firms from the United States, Japan, Taiwan, and elsewhere are relocating at scale their production platforms into India. So there is an awful lot of room to run here in India’s growth model. We are very excited about it.
If China continues on this glide path of earning contraction and economic contraction, what do you think it means for the rest of the world – both in terms of commodity pricing, the manufacturing and the supply chains?
In terms of the world generally, what you are seeing is near-shoring and on-shoring and manufacturing FDI relocating to geographies that are less challenged by, let us say, hegemonic rivalry between the US and China. India is a beneficiary from that but so is Mexico and countries like Vietnam and to a lesser extent, Indonesia. So this is a very important structural theme and it is very different from the emerging markets theme, the more convergent world that we lived in, let us say, two decades ago.
In this transition, as money migrates from China to India, could we be looking at serious changes in terms of capital allocation? We could be seeing serious changes in terms of MSCI allocation because China still has the largest weightage and largest component?
We are seeing that money is moving from China towards India and we think that move towards India has considerably further to go. What we are starting to see is the development of the emerging markets ex China product. India is a very large weighting within that index and so when we look at portfolio flows generally, we are seeing that structural change that is underway. It is also ongoing into markets in ASEAN, like Indonesia and Singapore as well but India is set to benefit significantly.
What could be risks to your thesis? What could be the risks to the scenario?
Traditionally, economic cycles in India have been interrupted by, in particular, rapid increases in the oil price but we are not anticipating that on a go-forward basis and the external position is much stronger than it used to be in terms of the reserve coverage of imports, for example. The current account deficit overall is at a very low level for India. Another longer-term issue which many countries face is climate change and the impact of climate change on the agriculture sector. That is an issue a number of emerging markets have to deal with.
We have an election in India next year, then there is the US election – two of the largest democracies in the world. Could that be a potential event of volatility, but not risk?
We do not comment on election cycles in any geography but I would say that what matters is policy continuity and policy mix and the policy mix recently has been very favourable from an equity investor perspective. That is why we are attracting far higher portfolio flows into equities and bonds than we have seen before, as well as foreign direct investment inflows. That is the way that we would look at that particular question.
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