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Value and cyclical stocks to outperform as global economy accelerates next year: Mark Matthews, Julius Baer

Among EM assets, India does not rank very highly as it is very expensive.

ET Now|
Dec 04, 2019, 01.17 PM IST
Mark Matthews2-Julius Baer
There will be an inflexion point within the next 12 months. The dollar will start weakening and we can get some meaningful outperformance out of the emerging markets, says Mark Matthews, MD, Julius Baer. Excerpts from an interview with ETNOW.

The world market can be very fragile. One comment from Donald Trump saying that he is going to wait until after the elections next year to seal a deal with China, has really cracked up world markets?
Two points; a) The US stock market has had a very good run and it is technically over-extended. It needs to build a base at about 2,900 which is around 5% lower, so that it is technically over-extended. b)On the trade war, either Donald Trump just spoke off the cuff or he is very clever. I actually think it is more the latter. He is trying to save the juice for the market for next year. The most important time for him as far as the stock market is concerned is the three months leading up to the election in November 2020. He is keeping the trade war on a low burn and then he can come and do a big deal around August of next year and take the S&P to a new high just before the election.
Do you expect heightened volatility in the market? Do you see an impact on fund flows in terms of what we have seen for the past month with regard to emerging markets?
Broadly, volatility will increase next year, though perhaps not so much in the emerging markets. The way the markets moved yesterday is a good thing for emerging markets because the US treasury yield came down from about 1.86 to 1.72 and the dollar softened a little bit. What has really kept the emerging markets from firing on all cylinders is the dollar. Strengthening of the dollar is bad for Emerging Markets and if S&P can track sideways at about 2900-3000 level and the dollar is gradually softening, that is a very good place for Emerging Markets but with volatility, it is likely to happen more in the US because of the election next year. It is a binary -- the Republicans or the Democrats. We do not know which one it will be and that should naturally increase volatility in the US next year.
What about India? Some fatigue is setting at the top after we clocked a fresh all-time high on the index. It has been a very narrow rally. Only 10 odd names have pushed the index higher. Then GDP growth for Q2 has come in at a six-year low of 4.5%. Are the two ends going to tie and what is happening with the economy would happen in the stock markets as well?
Though people blame demonetisation and GST for the state of the economy, all that happened some time ago. It is clearly the problem in the non-bank financial companies (NBFCs) that has led to uncertainty and unwillingness to lend and the public banks not being adequately capitalised, have not been able to extend a lot of the new credit.
What is holding the economy back is definitely the credit cycle and there is no immediate answer. But the government has done what it can and taken a 180 degree turn in the last two months in terms of the corporate tax cuts and the accelerated privatisations and the rejuvenation of the bankruptcy code. RBI has cut rates four times this year and there is another one coming this month. All those things added up, will lead us into a better 2020. The consensus is looking for over 20% earnings growth next year. I really do not know how reliable that number is, but if it is true, then there is a case for the broader market beyond those top 10 stocks performing well next year.

The trade war in a sense rolled in from March 1, 2018 with Trump announceing his intention to impose 25% tariff on steel and a 10% tariff on aluminum imports. Since then, we saw outperformance in developed markets. The MSCI Emerging Market Index during the same period is down. Are we looking at yet another bad year for emerging markets?
Two things have hamstrung the emerging markets over the last decade. The first is the emergence of mega technology companies in the US, the FANGs, which are not just Facebook, Amazon, Netflix and Google. There is a whole bunch of other stocks as well and these have made massive inroads into the private and corporate lives of people around the world.
So, first is the disruption the big US technology companies have made in the global economy. Second, is the strength of the dollar over the last seven years. The dollar started strengthening from 2011 because of those big technology stocks and also the US economy which has been leading in innovation and earnings growth. People have been putting money into the US economy and that has driven up the dollar.

But every decade is different and I am not saying that when the clock strikes 12 on December 31, we will wake up and everything will be different. But I do believe that within the next 12 months, there will be an inflexion point where the dollar will start to weaken and we can get some meaningful outperformance out of the emerging markets.
Underneath the Nifty, there are a lot of good things including corporate banks, utilities, pharmaceutical companies and PSUs selectively because of the privatisation programme.

-Mark Mathews

When it comes to the conviction with which investors are perhaps looking at India right now, where would it focus given that we are still counting down to the budget. Currently markets are still trading at those record levels, but earnings have not caught up?
Within the emerging market asset class, I do not think India ranks very highly right now because it is expensive. The Nifty is at about 22 times earnings. Now if the earnings growth that people are forecasting next year is right, then clearly that price earnings ratio will drop, but it is high and the other emerging markets are not. Brazil and Russia are extremely cheap. Russia has well run companies. The dividend yield in Russia is 8%. Brazil corporate earnings are still 50% below where they were before their terrible recession in 2015-2016. They have a pro-business government even if their president is eccentric. They are having a very good reform programme and then China’s at around 12 times is so much less expensive than India. It also has a very vibrant technology and life-sciences sector.

I would not put India at the top. It would be at the bottom but underneath the Nifty index, there are a lot of good things and that would include the corporate banks, the utilities, the pharmaceutical companies and the PSUs selectively because of the privatisation programme.

Nassim Taleb says the next decade will not be about gains, it would about capital preservation. Buy gold, do not buy anything else. It is better to preserve rather than lose cash. In the next 10 years, are we in for an ugly fall where we will be remembering the basics again?
Within the next 10 years, it is almost inevitable that we will get some bad ugly fall because we have had a 10-year expansion in the US, up until now. Typically, the expansions do not last on an average beyond five years. But I cannot say it will happen when the clock strikes 12 on December 31. When it happens, it would not be that day, it will be some point further away.

Actually the US economy is still in good shape. One thing that one can observe looking at their cycles is that they are growing further and further apart. They are becoming longer probably due to technology; inflation is low and so there is no need for the central bank to raise interest rates there. Their technology companies are still doing phenomenally well and the major problem there would be if very left wing Democrats win the election next year. But I do not think that is likely to be the case. So the outlook is still favourable and I would not sell before the top.

Any particular sectors that you are bullish on or are watching more closely for a recovery or to lead the rally?
We think the global economy will accelerate next year and it is a function of the fact that 25 central banks have cut their interest rates this year compared to only five that have raised their interest rates. The European central banks started quantitative easing in September and the Federal Reserve did the same in October.

We believe that the global economy will accelerate, it should be starting right now and historically, what does well in that kind of environment is value and cyclical stocks. These are two pockets where we think over the next six months there will be outperformance.

If the world is uncertain, if there is a little bit of trade war, some degree of base effect would kick in. China is unsure, Japan is not healing; what is the underlying fundamental factor for cyclical stocks to come back?
The manufacturing sector has been in recession throughout the world this year as a result of the trade war. But there has been much stimulus provided by central banks starting in March. The Reserve Bank of New Zealand was the first bank to cut rates, but 24 others have done the same since then. The markets are a function of liquidity in large part and this liquidity is very big. That will push up manufacturing activity and be responsible for the outperformance of the cyclicals and the value stocks.

Coming to PSU disinvestment, you believe that while people may be interested in the crown jewels, most PSUs would probably be sold at low prices.You are treating it more as a distress sale, aren’t you?
Yes. There are a few good ones but in general they are badly run. There is a lot of corruption but when you put them in private sector hands, they will become better run and there are plenty of examples. You can go back to Hindustan Zinc or earlier when were divestments of very large PSUs. They have been turned around and investors have made money on them in the stock market. I think broadly that would be the case because the CPSE ETF is around 7 times with a 4% dividend yield. To me, that is already pricing in the fact that they are badly run but it is not pricing in the fact that they are going to become better run if they are divested.

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