India is our biggest underweight market: Credit Suisse on Money Control

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Though Indian market has been one of the favourites among the emerging markets, Credit Suisse feels otherwise. Sakthi Siva of Credit Suisse feels that India has a very crowded trade.

She said, “If I look at India on valuations back in September-October, when we downgraded India to our biggest underweight, the premium on India versus global EMs was like 40%, it has now come down to 15% and the long run average is about 20%.

According to her, outflow of foreign funds from Indian shores is a matter of concern fir India. Inflation too is worrisome, she reiterated.

Here is the verbatim transcript of her comments. Also watch the accompanying video.

Q: You spoke about two-third of the tightening been done, is it the same for India as well?

A: China started to tighten in August of 2009 and India was second. So, India started in March of 2010, so there is about a nine months gap. I was marketing in India two weeks back, so I did the same exercise for the Sensex. Is the Sensex starting to move up despite the Reserve Bank of India (RBI) tightening, the initial answer is still no.

So if you do look at the performance of the Shanghai Composite, it is very clear, after tightening, Shanghai is trying to go up. If you look at the performance of the Sensex, it is still falling despite the tightening. So our view is India probably will bottom second but it is still nine months between August of ’09 and March of ’10.

If I look at India on valuations back in September-October, when we downgraded India to our biggest underweight, the premium on India versus global EMs was like 40%, it has now come down to 15% and the long run average is about 20%. So if it is purely valuations it will be almost starting to upgrade especially because India now has been our biggest underweight market and we are sitting on something like a (-) 5% on India.

My concern on India is more of the fact that it is very crowded trade. There was almost USD 29 billion of inflows last year and so far less than USD 2 billion has gone out. So, if I look at inflows on a rolling 12 month basis, India has gotten almost three times what it deserves to get on a weighting basis. I

 feel it is quite difficult for India to have a sustained rally because foreign investors don't seem to have sold during the correction. I am worried, you cannot get a sustained rally in India when you have such a heavy weighting in India compared to its benchmark.

Q: You were tactically underweight on India. Currently, according to you what needs to change dramatically or what needs to change given the macro-environment for you to atleast to become a neutral or overweight on India?

A: If you look at valuations, the average premium for India is about 20%, we are now at 15% but I would prefer a smaller premium. I tend to go for cheap markets. Secondly, getting closer to the peak in inflation, so that is obviously quite important but for me the thing that worries me as I said most about India is the fact there is still a crowded trade. I would like to see atleast the greater degree of foreign investor capitulation. If I look at Korea, net foreign selling in February and March is about 0.6% of marketcap and in emerging Asia it is 0.3%. I think in India it is about 0.1%.

I am not saying that USD 29 billion is going to reverse, last year’s inflows. We would just like to see a greater degree of capitulation on the part of foreign investors. So, atleast that gives us a sense that the market may bottom but also it has a chance of a sustainable rally.

The problem today is if you do get a rally and that is why if you look at the recent Indian market, it seems to be bottoming around 17,500, where every time you get to 18,500, there is selling. To me that is going to possess as long as you have this degree of crowdedness on the Indian market.

China is basically our third biggest overweight. We have been suggesting the upside for China should be atleast closer to 20%, just given the size of the overweight.

Our view is that Chinese banks are very cheap. It’s the cheapest sector within China. It’s a 40% discount within the region and so what we feel is normally in a tightening environment, particular when its RRR hikes rather than interest rate hikes, probably the Chinese banks traditionally do not do that well but we feel that  some of the other factors that caused China’s underperformance and Chinese banks underperformance last year are starting to reverse.

So for example if you look at the month of March, Chinese banks had their first earnings upgrade. I should say the first upgrade to consensus estimate in about nine months. It was the strongest upgrade in about 15 months because that upgrade was 0.7% in a month.

Another factor that was negative for China and for Chinese banks was the amount of equity supply last year. As you know we had Agricultural Bank of China huge IPO. We had AIA which is obviously not China, it is more Hong Kong but it comes from the same port and you also had China banks doing a lot of rights issues. So, last year China accounted for almost 70% of the equity supply in the region and lot of that came from the banking space. We feel this year going forward there are IPOs in China but it is not going to be 70% of equity supply.

We feel that, yes you do have tightening and China has got more tightening but given the fact that the Shanghai Composite is holding up quite well, its actually starting to rally despite the tightening. With time some of the other negatives like earnings downgrades in Chinese banks are starting to reverse.

If you look at equity supply, that is also starting to be more moderate. So China is actually a market that we have spent a lot of time thinking about. To be frank it was the only cheap market last year that didn’t perform very well for us. All the other cheap markets whether it was Korea, Thailand, Indonesia or Philippines did very well for us.

Even if you look at not just Chinese banks, even if you look at China, one of the factors that held back China last year was its earnings revisions were quite poor. Last year, the region had earnings upgrades of around 8%. China only had earnings upgrades of 2% but if you look at February and March, not only are we seeing earnings upgrades in China, it has now got the strongest earnings upgrades of any market in the region. We feel it is cheap together with a powerful catalyst in the form of earnings revisions and the fact that we are more than half way through the tightening process, coupled with Shanghai trading at quite close to trough valuations, the combination of those four factors makes China look more attractive. Which is why we have increased our overweightage.