‘Mid-cap valuations still look stretched’

PALAK SHAH Mumbai | Updated on June 27, 2018

RIDHAM DESAI India Head — Equity Research, Morgan Stanley   -  BUSINESS LINE


Ridham Desai, head of India equity research and India equity strategist, Morgan Stanley, spoke to BusinessLine. Desai believes that global growth could stay strong for the next couple of years and there is no fear of stagflation. On India, he is of the view that despite short-term pain, earnings may pick up strongly and the equity indices are still not pricing in multi-year growth cycle. Overall, Desai’s view is that when valuations correct in the near term, upside potential was more for the stock markets with a three to five year perspective. Excerpts:

There is anticipation that economic and corporate earnings growth would pick up in India within the next 1-2 years. But given the fact that markets have witnessed a sharp rally since the start of 2017, are you comfortable with buying India at current levels and expect it to deliver higher returns?

Year 2017 was a strong year globally and not just for India. Yes, the broader market (mid- and small-cap indices) fared better than other global indices but the performance of the large index (Sensex/MSCI India) was broadly in line with the global indices. On corporate profits, our proprietary models point to robust earnings growth in the next three years. Profits could surprise significantly on the positive side given the low starting point of profit share in GDP, which is almost at 2002 levels.

Our Sensex base case is at 36,000 for June 2019, a 5 per cent USD upside from current levels compared to 1 per cent we see for the EM index. For equities to break this range on the upside, growth needs to accelerate. Simultaneously, we do not think the narrow indices are pricing in a multi-year growth cycle, implying meaningful upside potential over three to five years.

We prefer large-caps over mid-caps. India’s relative valuations are attractive and around average, but mid-cap valuations are still looking stretched despite the recent draw down. Equities do not look compelling versus long bonds. Valuations, on their own, unless at extreme points, rarely give a clue of where stocks are heading.

Is India at the start of another interest rate hike cycle?

The MPC hiked rates 25 bps but maintained its neutral stance. We expect two more rate hikes in this cycle. This should bring real rates back above 2 per cent, based on our inflation forecast.

We had previously expected the start of the rate hike cycle in 4Q18. However, reflecting this earlier than expected move, we now expect the rate hikes to be front-loaded. Specifically, we expect rate hikes in the August and October meetings but that the total quantum of rate hikes will remain at 75 bps for this cycle.

Would we be staring at stagflation globally in the coming couple of years?

We do not expect global stagflation as our base case in the next couple of years. Instead, we think that global growth will stay strong at an above-trend pace at 3.9 per cent y-o-y in 2018 and 3.8 per cent y-o-y in 2019, sustained by strong investment and improving productivity growth.

On inflation, we do expect it to rise in both developed as well as emerging markets, but it would stay around central banks’ targets with limited risk of overshooting. Taken together, the global expansion cycle should have more room to run over our forecast horizon, and a stagflation scenario appears unlikely.

You have said Indian equity markets were a defensive bet even when global equity markets go for a toss. Why?

We think a mix of macro stability and growth drive India’s performance relative to global markets. India’s current macro stability is by far the best seen in the recent years. Going forward, we expect macro stability indicators to broadly remain in check as the economy is on track to entering a productive growth phase.

You have given a target for Sensex at 36,000 for FY19. Can we call it the most bullish scenario?

36,000 is our base case target. Our bull case target is 44,000 and that can be achieved if there are better-than-expected outcomes, most notably on policy and global factors. The market starts believing in a strong election result. Earnings growth accelerates to 29 per cent in FY-2019 and 26 per cent in FY-2020.

Published on June 27, 2018

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