market rally: Can India sustain market gains despite earnings slowdown? Chetan Seth answers

“If you look at the index target that our India team has on India, it has got very limited upside. And there are reasons for that. But our view is that, look, if there is a cyclical downturn in the economy and let us say earnings and let us say stocks to come off, we will be buyers on dip. So, I would say generally we are constructive,” says Chetan Seth, Nomura.

Just going by the latest note in your outlook overall, I wanted to understand how you are looking at why India emerges as an overweight and what really are some of the factors that is leading to this stance?
Chetan Seth: Well, for the record, we have been positive on India since I think September of last year and back then when we upgraded the market, we said there was a little bit of a window of opportunity that investors could find to get constructive on India. And since then, our view on India has been consistently and very clearly it has been that you buy on any dips in the market. And at this stage, our view remains the same, that this market still looks quite well positioned in the emerging market universe as well as in the Asia ex-Japan universe.

Now, of course, this cannot continue, so I am not here to suggest that things will always go up. If you look at our index targets for, let us say Asia ex-Japan markets, which is what I cover, we have got very limited upside.

If you look at the index target that our India team has on India, it has got very limited upside. And there are reasons for that. But our view is that, look, if there is a cyclical downturn in the economy and let us say earnings and let us say stocks to come off, we will be buyers on dip. So, I would say generally we are constructive.

Our stance is if we get weakness, we will be constructive. But on the global front, there are lots of risks and challenges that we need to keep into mind.

How do we stack up then as compared to the rest of the globe and I wanted to understand your thoughts actually, I would rather get in your view on what the liquidity situation is, because no doubt domestic investors have been the key support for our own markets. It has been touch and go when it comes to the foreign institutional investors. When do you believe that that conviction will really come back? And is it really necessary for our markets to be propped up?
Chetan Seth: So, the way we think about India flow story is the following. I think there are three pillars to this India flow story if I have to just simplify it. The first one, as you rightly said, that the domestic liquidity is quite strong. If you look at your domestic flows from retail investors to domestic equity mutual funds which includes SIP, that is fairly well known and fairly well socialised theme, so that is still there. On top of that, the other story is the foreign investors, regional investors who have mandates to invest across markets. When we speak to many of these investors, they are still quite, I would say, positive on the structural outlook. If there is any concern which is holding them back is essentially valuations. And actually, if you look at the latest data and this is quite interesting, that most of these investors actually have an underweight stance in their portfolios on India.

Now, this underweight stance is not because they are negative on India, it is just that the markets have rallied quite hard and they have not been able to keep up with the momentum.

But our view is that it is essentially signals that, look, if there is a drawdown because of cyclical concerns and not a structural concern, then I think some of these investors would look to probably buy into it. But the third pillar of this flow story, which is very-very interesting and I think which is less understood generally as far as investors is concerned, is the rise of the India dedicated offshore funds.

And just to give you one statistic here, since the start of 2023, we have estimated that almost $20 to $21 billion have gone into some of these new funds and even existing funds which are available to investors outside India, now that number is quite sizable and just for context, your domestic flows is around 40-41 billion since the start of 2023. So, I would argue that this is almost these dedicated funds, India dedicated offshore funds are almost half the firepower of the domestic flow story. So, on the flow outlook, it is quite exciting and so long as these flows continue, our view is that valuations will probably remain supportive.

Not growing in tandem with the market, which is that in last three months markets are up 15%, earnings are growing at a much subpar rate. If earnings are not growing, how long do you think this PE multiple would sustain? Can one really invest in the market only because there is visibility on flows?
Chetan Seth: Well, I will just go back to the original point and again, do not get me wrong, I am not suggesting things will only go up. As I said, that if you look our index target, it is slightly below where the Nifty is as a house, even our regional Asia ex-Japan target is slightly below where the market is, so not suggesting but again if let us say there are concerns build up on the global front that, hey, the US is heading into this recession and if you remember two-three weeks ago there was a big scare for the markets, then India will also come down and then the long-term investors will probably take this view that look, it has given me an entry point, a better entry point to be a bit more constructive.

So, I agree with you, in the end it is all about fundamentals and earnings and if I just look at the consensus estimates for India, for MSCI India for next year, I think we are looking around 16-17%, this is the consensus number. Even if you shave, let us say, two-three percentage points from this, 13-14-15% in a regional context is still quite exciting in my view.

The biggest moving part is interest rates in the light of where interest rates were, where they are likely to move, how do you see that moving in terms of a decider because historically we have seen that when Fed rates have peaked out, flows come back to emerging markets. Do you see the same playbook at play again?
Chetan Seth: Well, it is definitely happening and we track both emerging market flows as well as emerging market ex-China fund flows and we have clearly seen funds coming back. But what we have also seen this time around is that the laggard markets are seeing more inflows, specifically in our part of the world it is essentially the Southeast Asian markets.

India has been a bit of, I would say, a laggard because it is just largely because of valuations, for other Southeast Asian markets there is a lot of support. But generally speaking, you would argue that when you have the Fed embarking on a rate cut cycle, you would see some bit of flows coming back to emerging markets.

The only caveat to that view and this is quite important and this is something we are thinking a lot in our heads right
now is do we see some sort of a mild recession in the US in the months ahead, in which case you have to be a bit careful of deploying a lot of money into stocks because if there is a recession and even if it is a mild recession, you could see a pullback in global stocks and I think India would also be impacted there.

But our baseline view as a house is that we are still calling for a soft landing. But like the market, we are also watching high frequency data in the US like a hawk to assess if it is really time for us to turn decisively defensive on markets.

What are the other high frequency data points indicating to you about the health of Indian economy? When I say high frequency data points, auto sales, GST, what are those data points indicating in terms of a trend?
Chetan Seth: Well, as you may have noticed the latest GDP print was lower than the previous quarter, I think some of these numbers are clearly suggesting things are slowing down. But here is the point. The point is that if you believe this is a cyclical slowdown from a very hot economy or from high base and it is not a structural slowdown, in other words it is not the start of a multi-quarter trend in quarter on quarter growth rates, then I think the outlook for stocks is still positive.

But let us say if you believe it is start of a multi-quarter slowdown, then you need to be far more cautious. But clearly car sales are slowing down. I think rural seems to be doing okay in India, that is what at least I see as a regional strategist and I think that is what the market is also looking at quite closely.

I also want to talk about what the globe is looking as such and distinct of India or rather not, I mean, this morning you have got China wherein the manufacturing has slumped to a six-month low. We have been continuously debating about the health of the US economy. It seems like a Fed rate cut is inevitable in the month of September. What is the global dynamic looking like because even in the US the markets are at an all-time high, so it seems like a kind of a rising tide phenomena, ex-China, of course.
Chetan Seth: Well, things are generally slowing down. I mean, China, I would say the recovery has been tepid, but the PMI prints, as you rightly said, were on the soft side. In the US, clearly momentum is slowing down. The question is whether this is the beginning of a long drawn out slowdown in the US which leads to kind of a recession, in which case it would be quite negative for stocks or alternatively we just slow down but the US eventually manages to a soft landing. So, things are slowing down.

And as you rightly said, stocks are close to all-time highs, even for India markets and that is why going back to the point I made right at the beginning, we do not have much upside on index targets.

Our view is that, look, maybe in the near term, very near term, because of the momentum or because of this excitement about Fed rate cuts starting from September, it might lead markets to overshoot temporarily our index targets.

But as we approach the year end and specifically the US elections, we expect some bit of consolidation. And our view from a strategy perspective is you need to focus on areas where you have margin of safety or generally, you can you can call it value or you can focus on stocks or like idiosyncratic themes rather than take a beta call or just take a big call that look index will be up another 10%, 15%, 20% from here.

In terms of this entire China effect, how crucial is that for the economy at large because we are talking about second largest economy, high debt in China, high leverage in China, financial markets are in a disarray and it is engine of consumption in terms of at least in this part of the world. Do you think somewhere China could surprise us on the positive side or it will continue to surprise us on the negative side, like it has done in last four-five years?
Chetan Seth: Well, I would say where we are, the chances of China actually surprising on the upside is actually higher than going further down from here.

And actually, if you look at the valuations and all as well, it is much more muted compared to India. But just from a regional perspective, I mean one thing which is really supporting India is that things are quite slow on China, I would say beyond the economy, the other thing which has been a bit of a challenge for our investors as far as China investing is concerned is this entire issue around geopolitical trade tensions, which is essentially keeping investors away from China investments and what is happening is some of the other larger markets such as India are a big beneficiary of that.

So, one of the numbers we quote in our conversation with investors is, if you look at the number of stocks in India, which trade more than 10 million a day, that number is more than 300, that is more than 300. If you look at, let us say, Southeast Asia, you can also paint a great story about Southeast Asia from a top down but some of these markets have just 10 stocks which trade more than 10 bucks a day, 10 million a day.

In China, we still have 2500 stocks, which trade more than 10 million a day but again there are challenges there and the key point I want to make is that for investors who are looking for investing money, India is an alternative because this market has the depth, the liquidity, more and more interesting companies are coming up through the IPO market and there is a lot of interest from investors. What is really keeping investors away from India is valuations.