India's expensive, but a long play: JP Morgan

by Gaurav Pai ET
India’s soft-capital is its competitive edge, which includes highly-trained workforce. Equities continue to offer the highest long-term real (after inflation) earning per share growth. The country’s infrastructure is a competitive disadvantage. There is a need to plan for growth.

Indian equities are expensive at the moment but they should sustain their high valuations over the long run, Adrian Mowat, chief Asian and Emerging Markets Equity Strategist at JP Morgan (Asia Pacific) said in an interview with ET. Mowat is bullish on select technology, industrial, health care and energy stocks, and says that performance within the same sector could vary sharply. Excerpts from the interview.

What is your assessment of the valuations of Indian equity markets vis-à-vis other emerging markets?
The Indian equity market is expensive, both absolute and relative to other markets. Using the MSCI indices, India is the second most expensive equity market we follow after Japan. On ’07 earnings estimates, Japan’s PE is 17.6, while India’s PE is 16.6. But remember that Japanese 10-year bond yields are 1.7%, less than a quarter of Indian 10-year bond yields of 8%. There are good reasons why Indian equity markets should sustain a high valuation. JPMorgan remained positive on this market longer than many of our competitors based on our BharatPE theme. This theme identified that local long-term investors needed to switch part of their assets from cash and bond in order to meet their long-term liabilities, this switch would drive up valuations. Other reasons for a premium valuation area higher RoE of 24% versus the emerging market average of 18%, again these are 07 estimates. Indian equities continue, in our view, to offer the highest long-term real (after inflation) earning per share growth.

Which sectors are you looking at for investment purposes at the moment?
Currently, we are preferring sectors with better earnings visibility and beneficiaries of a weaker rupee and are positive on select technology, industrial, health care and energy names. Note the word select, it is likely that stock performance will diverge within sectors.

What are India’s strong and weak points compared with the rest?
India’s economy has numerous positive characteristics. India’s soft-capital is its key competitive edge. That is to say a large, in absolute terms, highly-trained workforce, plus a highly entrepreneurial business sector. The reforms in the 90s have liberated this soft-capital to meet the pent-up demand of both the consumer in India and the need globally for highquality competitively-priced services. However, India’s physical infrastructure is a competitive disadvantage. There is a need to plan for growth, than to adapt inadequate current infrastructure to cope with today’s needs.

Do you see a slowdown in the economy, and if there is a slowdown, what are the likely implications for India?
This is a very topical question. JPMorgan’s view is that the current slowdown in the US housing market will not spread to the broad economy. Note that corporate profits in the US are at a record high. The labour market is healthy; creating jobs and enjoying strong income growth. We are forecasting 2.8% US GDP growth in 07, down from our forecast of 3.4% in 06. This is a benign outcome for the Indian economy. But there are risks. Core inflation in the US is still rising. We forecast that the Federal Reserve will increase interest rates to 6% by March ’07. There is, therefore, a risk that the US economic growth slowdown may be more marked in late ’07.

Do you expect further hikes in interest rates in the US to affect portfolio inflows into emerging economies including India?
Yes. A higher risk-free rate makes risk assets such as equities relatively less attractive. However, higher US interest rates make US equities less attractive relative to non-US equities. We continue to be positive on emerging market equities. Currently, we see more upside in other markets (other than India) with stronger currencies and a greater chance of further PE re-rating.
Additional Readings:
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Parting Thought:
  • As far as I am concerned, the stock market doesn’t exist. It is only there as a reference to see if anybody is offering to do anything foolish. – Warren Buffett
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