Pramerica International Investments’ John Praveen talks about the factors influencing global capital markets, risks that the markets may face in coming days and why emerging markets like India hold interest for overseas investors.
John Praveen has 30 years experience in capital markets. He leads the Pramerica International Investments Advisers team, which oversees $75 billion assets under management based out of Newark, USA. Praveen is also part of the board of trustees for DHFL Pramerica Asset Managers Pvt Ltd. He spoke to Mint about the factors influencing global capital markets, risks that the markets may face in coming days and why emerging markets like India hold interest for overseas investors. Edited excerpts:
Is there a liquidity-driven bubble in global risk assets?
To a large extent, the rally is being driven by liquidity and low interest rates. However, the way you have to consider this is that if it is only liquidity—are valuations stretched? Yes, the price to equity (P-E) multiples are above average (globally), but not stretched. If you see the S&P 500, the P-E multiple is slightly over the long-term average. Another way to compare valuations is to look at stocks versus bonds: bond yields compared to equity yields (inverse reverse of P-E multiple) have a big gap—which shows that equities compared to bonds are quite cheap. So compared to other asset classes, equities are cheap and that’s the reason I am not too concerned about a specific P-E multiple. Also, multiples will likely start to come down as earnings recover.
How big a risk does the US election pose for global capital markets?
Let’s go back a few months. What happened with the Brexit vote? Markets were pricing in the scenario that the UK exit won’t happen. Even on the day of the vote, opinion polls indicated a vote to stay. A couple of hours after the voting ended and counting began, the outcome really went the other way…. The reaction was negative immediately after the event, as there was uncertainty about this unexpected outcome. But how long did this last? Within a couple of weeks the markets completely wiped out the Brexit-related losses and recovered. Maybe people realised that it’s not going to be so bad or that the impact of Brexit will be felt only in the years to come or maybe that the impact on the UK will not be as bad as people expected.
Something like the Brexit result can happen in the US elections. At the moment, markets are expecting and probably hoping for a Clinton win—not for any other reason but that she is a known political figure and the uncertainty around her policies is lower. Like Brexit, there could be a negative knee-jerk reaction if the result is otherwise. However, any knee-jerk reaction will probably be short-lived.
What happens when the liquidity tap turns off? Is that priced in at all?
Is liquidity going to be turned off? No. The Bank of Japan has kept the stimulus going. The European Central Bank (ECB) is probably going to expand quantitative easing in December. The question of liquidity drying up doesn’t arise. Even if the US Federal Reserve raises rates, it’s a normalisation of rates rather than tightening because you don’t need rates to be so low. I don’t view this as the start of a global tightening cycle, and the liquidity tap is not being turned off.
How do you view Indian equities relative to other emerging markets?
In our portfolios (Asian, emerging markets), we are overweight on Indian equities. What we like about India is not just the strong growth rate that is likely to go up even further, but also the sector mix of the Indian market. When you compare the mix of sectors in the Indian market with China, Mexico, Brazil, Russia, South Africa and Turkey, what you see is that India has a good mix of all sectors. India has good IT, consumer discretionary and staples, health care sectors, and so on. In Russia, for example, there are two big sectors—energy and materials—if these sectors are doing well (with high oil and commodity prices) then the market does well, otherwise it goes down. When we are building an Asian portfolio or emerging-market portfolio and want representation from different sectors—where do we look? Indian markets are placed favourably, as there is a lot to choose from. Hence, there is a built-in sector bias to the Indian market compared to other markets. Moreover, there is political instability in some of the other markets, like Turkey and South Africa.
Indian asset management products are fairly simple, is there room for more sophisticated product baskets?
If you look at the product choices in international markets, it’s not just the domestic products but there are also products that give exposure to foreign markets. In the US, investors have access to portfolios made with securities from European or Japanese markets. In India the appetite for investments from outside India is probably limited and it’s understandable. If your market is giving a high return, why should you go elsewhere? However, there is a case to be made for diversification.
When investor appetite for global stocks and bonds increases, you can probably have more products. Further, the bond markets are somewhat narrow in India. If that broadens in terms of government securities, regional securities and different types of corporate bonds then we could see a lot more combinations in products. But, first you need an increase in investor appetite for different kinds of products and then a broadening and widening of the market before thinking of more types of products.
There is some debate about the costs of mutual funds. How do the expense ratios of domestic mutual funds compare with others globally?
In the US, there is a big shift from actively managed products to passively managed ones, which is driven to some extent by the lower cost structure. Further, active fund managers are finding it harder to generate alpha. Finally, there is product innovation with smart beta and multi-asset funds widely available to investors. In the Indian mutual fund industry, active managers are still outperforming the benchmark. When that changes, concern about cost will rise.
This is seen in other emerging markets as well and not just in India.
In Europe yields on long-term bonds have turned negative, that’s short-term positive for money to shift to equity—but in the long run is it a reflection of slower global growth?
The negative interest rates in Eurozone is turning out to have a lot of unintended consequences. Fact of the matter is there is still a lot of liquidity to support growth in Eurozone, which should enable it to maintain a GDP (gross domestic product) growth rate of 1.7-1.8%. In fact, Eurozone is not capable of growing much faster than that, so they are not too far from what they are capable of growing.
The ECB has also said that Europe is in a steady growth phase and the stimulus they have provided is working. The ECB seems to think that the economy is on the right track. However, there is concern that negative rates can have an adverse impact on bank profitability and thereby lower their ability to pass on the benefits of stimulus to the real economy.
There is a lot of focus on P-E valuations. How critical is this metric? What other analytical ratios should one consider?
You have to consider P-E and how far is it from fair value, just slightly above or widely different? Some companies have expensive valuation based on earnings potential rather than delivered earnings. If the expectation for earnings growth is high, one is not too concerned about the price as you know that E or earnings is going to move higher, or catch up. You also have to look at non-financial aspects like economic growth and the specific competitive positioning, product proposition of that company, and outlook of the market where the products are consumed. Earnings are big drivers, but you have to look at other factors to understand how far earnings can grow.
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