markets: India’s earnings slowdown cyclical, expect recovery by mid-year: Jonathan Garner

“I think there is a minority opinion that this is a more structural slowdown in earnings for India. We do not agree with that. But there are certainly people who have that view,” says Jonathan Garner, Morgan Stanley.

Every time you have come on our channel, we have always asked you your outlook on India, your outlook on emerging markets, your outlook on flows. So, where shall we start with?
Jonathan Garner: Well, I was actually in India all of last week and it was a really interesting trip, obviously seeing things on the ground and talking to local investors, I think where the debate is right now, both with local investors and global investors, is really about the trajectory for earnings. We have had quite a marked slowdown in earnings growth at the back end of last calendar year and into beginning of this year. And earnings revisions, particularly in November and December, turned really materially negative. Now, that comes after a very long period of superior earnings growth and revisions that really extended through the prior, I guess, three years. We are pretty optimistic that by the June quarter end and that earnings down cycle will be over.

And I certainly think, again, having visited last week, that the budget and then the interest rate cut on Friday, a part of a sort of counter cyclical easing that will help that earnings recovery story. And obviously, this week, we have Mr Modi in the United States, which is something again, that many clients want to talk about.

So, you are of the view that the slowdown in India is cyclical in nature, it is not structural. So, if it is cyclical in nature, when do you think markets will start getting optimistic about earnings recovery? Right now, the chatter is earning slowdown, nobody is focusing on the good part, which is that after a slowdown recovery comes.
Jonathan Garner: That is right. So, obviously, there is a debate about this. I would say that the majority of the clients that we talked to last week in India were optimistic about that June quarter end, which would mean the market should start to stabilise frankly roundabout now and obviously, we just had the monetary and fiscal measures last week, so that would be the base case.

I think there is a minority opinion that this is a more structural slowdown in earnings for India. We do not agree with that. But there are certainly people who have that view. I do think again, on your question around flows, which we were asked a lot by local clients in India, it is well worth bearing in mind that emerging markets generally are struggling early on in the Trump administration, we have a very strong dollar, the US Federal Reserve is effectively on hold now and so that is causing pressure across other emerging markets and it is certainly leading to outflows by foreign investors. But again, a point we have made about India many-many times is that the market ultimately these days, is not driven by foreign investors, it is driven by local investors and local mutual fund flows, which are holding up pretty well.

Would you say that the markers for India are also positive? I mean, starting off from the budget, then the central bank moving on rate easing as well by 25 bps point and like you said, the earnings, yes, there were concerns earlier around earnings and valuations, but if you look at the net pool of at least the Nifty cluster, the numbers are largely in line to above estimates.
Jonathan Garner: Yes, I think that is right. And again, on valuations, we have had quite a big valuation adjustment from last June. If my colleague Ridham Desai and Sheela Rathi, who obviously work on the market, they pointed out that at this valuation level it back tests for a 10% or so medium-term return on the market. So, again, if one had had perfect foresight, then last June, July, seeing where valuations were and the earnings slowdown, it was not a great time to be accumulating India.

We have actually moderated our overweight, we were more overweight India a year ago than we are now. But it is still for us a core overweight holding. And I did come away from the trip last week and wrote about it. I wrote about it in a note on Monday feeling that it really does deserve that core overweight position and more likely than not as the year goes on, the market will perform better and better over time.

Let us try and understand the sequence of events in your view which could be at play. Six months out, hopefully we would get clarity on the tariff fall. Six months out, hopefully we would get clarity on the slowdown in India. Six months out, hopefully we would get clarity in terms of where the China comeback trade is moving. How do you see the sequence of events now moving in the first half of this calendar year?
Jonathan Garner: Well, the most important thing to remember is that the underlying trend nominal GDP growth environment in India is just about the highest in the world at 10% to 12%. And we have had a cyclical slowdown. But if we are right, these policy measures that we got last week are really quite important. And if you are growing that strong on a trend growth basis, then you will revert back to trend.

The other part of it, as you mentioned, the geopolitics, as things stand right now, there have been really quite material increases on tariffs on China, that has actually happened and China has responded vis-a-vis the US and there are other tariffs coming forward obviously on the aluminium side and steel side. If we are right, we think the trip by Mr Modi to the US will go pretty well, that actually happened for Japan last week.

Ishiba, the Japanese premier visited the US and that visit went well. So, we do not think that this is something where either India or Japan particularly have to be concerned about getting caught up in this overall tariff and non-tariff barrier escalation and I think that will gradually become more obvious as the year goes on. The other swing factor, obviously, traditionally for India is oil, but oil is extremely well behaved from an India perspective right now. It is not strong at all and that will also help the cyclical recovery. So, yes, I did come away feeling that globally and locally the outlook remains constructive for India.

India has always been a stock picker’s market if you will. So, tell me, given that you are bullish on India within the emerging market pool, where is it that your sectoral overweights and underweights are?
Jonathan Garner: We are overweight working with the local team financials, industrials, and to a lesser extent consumer and we are more cautious on the defensive parts of the market.

I guess, a sort of, I suppose a broadly neutral stance on the IT services names, that is how we put it together. And India financials are a core holding in the underlying growth environment that we have in India. And again, their valuations have adjusted somewhat lower in the last few quarters, so that is interesting to us.

Given the fact that for India you still hold a positive view and on China you are not that positive and you have increased your underweight, I believe. Can you rank the Asia emerging market for us in terms of which one is the most preferred market right now and which one would you prefer the least? And I am just interested to know that where would you place Indian markets in the pecking order?
Jonathan Garner: So, our key overweights are Japan, India, and Singapore. Now, there are different drivers of those three markets. They are really quite different from each other, but they are the overweights. We are underweight on China, as you mentioned, but we are also underweight on Korea and Taiwan and the semiconductor and technology hardware sector. I think on that sector, it is well worth pointing out the valuations peaked last July at the height of the euphoria about the AI infrastructure build out and we are now moving on to what we call AI adoption.

So, AI adoption, the beneficiaries are firms in the financial sector globally, sectors like healthcare, particularly healthcare insurers and that shift from infrastructure kind of enablers to adopters is ongoing in global markets on a sectoral basis really since last July. So, we do have these very profound divergences within Asia in terms of the favoured and disfavoured markets.

Also tell us that with the new US administration and President Donald Trump taking the charge, is there any change in the view with respect to the emerging markets context as per se? Is there any impact or any changes that you have made with the new government taking over?
Jonathan Garner: Yes, we wrote extensively about all of this, both before the US election, right down to the sector and stock level and also afterwards. And it is what we call multipolar world ascendancy as a thematic. We certainly started the year dramatically in that regard. I do think it advantages India and Japan. These are actually security allies to a greater or lesser extent to the United States.

They can do more business with the United States, that is part of the success of the Ishiba visit last week was a lot of connectivity around business and that is what we expect to be seeing from India. And ultimately, you cannot get away from the core phenomenon that the US and China are to a greater or lesser extent hegemonic rivals and that is not the case for the US and India or US and Japan.

I want to go back to the point that you were making about, your sectoral stance when it comes to India markets. And I am curious to know, I understand why the overweight financials, because everything is working in their favour, but why the neutral on IT?
Jonathan Garner: Well, the question around IT, which obviously in India is IT services, not hardware, is they are logical beneficiaries of this phase we are now in around AI adoption.

They are extremely busy right now on obviously implementing these solutions across the entire global corporate landscape.

But the question is the terminal value of these businesses because after all, the AI thematic is to some extent about using AI tools to do what has been done historically by some parts of the India IT services firms.

This is not to say that they are challenged near term. They are not doing the simple kind of work that is done, let us say by a Philippines call centre.

But there is this debate about the terminal value of these companies. So, at the moment, we are neutral and watching it very closely, but their near-term earnings profile is good.