Arjun Divecha, Head - EMs Equity, GMO LLC believes that though a significant amount of economic bottoming out is priced in and the market is cuurently not cheap, there is a good scope for better gains.
"A lot of the cyclical companies' earnings have been kind of at a fairly low level for the last few years. So, those companies I think really have the potential to increase their earnings quite substantially. So, we are kind of guardedly optimistic," he says in an interview to CNBC-TV18.
Furthermore, Divecha believes the emerging markets (EMs) are moderately attractive right now as the markets forced the countries to enforce better policy-making. He is positive on Indian growth and China where he expects slow growth, but positive nonetheless.
Below is the verbatim transcript of the interview.
Q: Let me start by asking you about your view as far as emerging markets (EMs) are concerned? We were in conversation with a bunch of other market voices Ruchir Sharma, Rajeev Bhaman and both of them believe that EMs look a bit mixed at this point in time given the geopolitical risks and other factors. What is your own take on EMs and whether they look stronger today or not?
A: They look stronger than they have in the last 3 or 4 years. That is partially because of two factors, one is that for the last few years a number of EMs have performed rather poorly both from an economic and stock market point of view primarily because of what I consider to be bad policy-making in a lot of these countries.
The good news is that we had this fragile five phenomenon last year and what that did was force a number of countries to kind of make adjustments. So, markets have kind of enforced an adjustment in a number of these countries. Also, in a number of the other cases like in India and Indonesia, we have had elections which have led to more reform oriented governments. So, between market forces and politics, I think we are in a better place today than we have been in the last few years.
Again this is by no means unequivocal, this is not across the board but net-net when you add it all up, when you couple it with relatively reasonable valuations I think the emerging markets actually look moderately attractive.
Q: Let me ask you about India in specific and I go back to my conversations with Ruchir and Rajeev and Ruchir said that he is feeling nervously optimistic about India at this point in time because there is no contrarian voice on India and that is making him nervous. Rajeev believes that the Indian markets have the potential to double over the next 5 years as long as companies do the right thing and of course the government implements the promises that it is articulating. What is your own take on the strength as far as the Indian market is concerned?
A: My view basically is that even had you not had this particular election outcome, even if you had a different election outcome, India was kind of bottoming out from a cyclical point of view anyway. So, you would have got a cyclical growth coming out sometime this year or next year. Hence, we would have seen the kind of cyclical bounce anyway, to the extent that the government is successful in implementing more reforms that will go even further than that. So, therefore I would say over the next few years certainly over the next 4 or 5 years I am actually quite optimistic that the economy will in fact recover and do quite well.
The question then becomes how much of it is priced into the market? The market certainly is not cheap however I agree with the point of view especially with a lot of the cyclical companies earnings have been kind of at a fairly low level for the last few years. So, those companies I think really have the potential to increase their earnings quite substantially. So, we are kind of guardedly optimistic.
As far as what Ruchir said about being kind of nervously optimistic I would say one of my favourite sayings is that the herd is not always wrong, it is only mostly wrong. So, this might be one of the cases where the herd is actually right.
Q: Let me ask you about the India China comparison because you track China closely as well. At this point in time there are question marks on just how much lower we are actually to see China slow down. We have already seen GDP forecast being cut for China whether you give that enough credence or not is a different story altogether but between India and China today what would you much rather bet on?
A: They both look quite attractive from a stock market point of view because in China you have had a situation where growth has been slowing and people have become quite negative on it and you do have a number of sectors in the Chinese stock market that look quite attractive from a valuation point of view. There is really some good value to be had over there. So, on one hand growth is slowing but I don't see some kind of a crisis. I don't see that China is going to fall off a cliff. If that was going to happen obviously you don't want to be invested in that stock market. So, we think that Chinese growth is going to continue to slow over the next few years but we don't think that there is some catastrophe in the making over here.
Valuations obviously matter a lot. So on one hand I would say India's growth is going to increase but the market to some extent reflects that. In China's case growth is going to slow but the market to some extent reflects that. So, I see opportunities in both places.
Q: You said that this time around the herd may probably get it right as far as India is concerned. Would you consider then upping your allocation for India given the fact that at this point in time it looks to be the relative outperformer as far as the emerging market basket is concerned?
A: I don't care about who has been the outperformer so far; that is not important. What is important is what it is going to do from here. We have increased our allocation to India over the last year. So, if one goes back to September a year ago, we had very little money in India and we were quite negative on the country.
Over the last few years we have increased our weight, so, in various areas we have decent weighting in India. I wouldn't say we are massively overweight, we don't have a huge weight on India but we certainly have quite a bit more than we did a year ago and basically to the extent that we see reforms starting to take hold, we would certainly be inclined to become more positive.
Q: Which are the sectors that are looking attractive to you both from a valuation perspective as well as the possibility of the reform agenda being pushed forward from this government? Which are the sectors that you would be most confident about investing in at this point in time?
A: There are number of different sectors that are interesting. Again, taking a bit of a longer view rather than kind of forecast what is going to happen in next three or six months, I will say look at five years.
The sectors that are particularly attractive to people like us are what I would call kind of the domestic cyclicals. So, these are the companies that benefit when the domestic economy does well as opposed to the export economy or metals or mining or things like that.
So, these are the kind of metals, the construction companies, people like that. These are the companies whose earnings have been quite depressed over the last few years and one has to be very selective about picking them because some of them have a lot of debt and they may not be able to recover from the levels of debt and things like that. So, one has to be pretty selective. I wouldn't blindly be buying in entire sector but in some senses it is the whole domestic economy that we see starting to recover quite a bit and that is where we want to be placing out bets
Q: I was looking at your sectoral allocations across your funds. Banks are pretty high up there in the pecking order. Do you like the banking story in India and are you willing to look at PSU banks or would you only stick with private sector banks?
A: Included in my domestic recovery story, banks are the highest leveraged play on this phenomenon. In some sense if you are going to get this kind of industrial recovery so to speak, banks are the highest leveraged to that particular play. So, I see banks as being the most attractive place within that. If one looks at it, we have one of our funds that focuses purely on domestic opportunities within emerging markets and within that the biggest sector that we have is Indian banks.
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