Stocks Portfolio | Chris Wood: In long term absolute return portfolio, I have about 20 stocks which are still dominantly India: Chris Wood
You have been a long term India bull and over the years has always advised his clients has always had an overweight rating on India. But given the recent bout of outperformance, and where China seems to be headed, is it time to now go market weight on India? How should one read into the current risk-on rally?
In the recent weeks and months, India’s valuation over China has reached unprecedented levels in terms of India having been remarkably resilient during this year of monetary tightening. When I say India, I mean the stock market. In China, we have had a lot of body blows and so tactically, there is definitely a good case to reduce India and add to China but structurally, I still remain firmly of the view that India is the best story in a 10-year view in Asian emerging market equities.
The first half of this calendar year was dominated by fear of rising interest rates and fear of a slowdown. There was geopolitical tension as well but the second half of this year looks like all the concerns are getting diluted. Has the world seen the peak of inflation and peak of interest rate hike?
In my most recent quarterly report, I wrote that we were near the peak of monetary tightening expectations and US dollar strength. What I wrote two or three weeks ago in Greed and Fear is that my base case is that monetary tightening expectations peaked with the last press conference by Fed Chairman Powell following the last FOMC meeting. I am not saying there will not be more rate hikes, I am saying that monetary tightening expectations in the money market have peaked.
I mean that proves indeed to be the case and is likely to mean that the US dollar has peaked but the one caveat to my base case is if we go real material escalation in Ukraine and there was another surge in energy prices, then I would be wrong. But in its absence, that is my base case. I am not saying inflation is going to collapse. I am saying inflation has probably peaked for now but my other base case is at some point in the first half of the year, the Fed will fudge its 2% inflation target. What do I mean by that? I mean it will stop tightening even though inflation has not yet reached 2%.
If interest rates have peaked out and if there is a fear of a recession, do you think equity markets have not factored that in? As of now, global equity markets have rallied when they got a sense that interest rates are nearing its peak and when they got a sense that US CPI inflation had peaked out. But do you think somewhere markets are not factoring in chances of an earnings decline and possibility of a recession in the western world?
That is right. If you are talking about the US equity markets, I completely agree with you that the markets have started to price a peak in monetary tightening expectations not completely but then started to price then which is why we will have this rally. Oftentimes equity markets rally into yearend commonly year end then normally when it is particularly when you have had a year of big declines in prices but I think this year, the issue facing equity markets was monetary tightening and that is why the high PE growth stocks were the most vulnerable.
But next year, the issue for the US market is the overwhelming risks, earnings downgrades and given there is a growing likelihood of a recession, given that the US has had very aggressive monetary tightening this year, the monetary policy works with the lag. So the best way of calculating the earnings downgrade risk is that S&P 500 listed companies profits trading at 20% premium in the macro measure of corporate profits in America, published quarterly by the Bureau of Economic Analysis in the US.
Traditionally when you have such a divergence between the macro measures and the listed credit companies profit measures, what happens in a downturn is the listed company’s profit convert with the macro measure. So to me, that is the risk for equities next year but right now, in the short term, the markets can celebrate whether there will be a peak of monetary tightening expectations. I am saying monetary tightening expectations have peaked. I am not saying there will be another rate hike by the Fed…
Early in November, there was a big comeback in Chinese equity markets and China A shares on Hang Seng. Given that China is revisiting Covid restrictions again, how do you see Chinese stocks moving and what impact do you think that will have on emerging markets?
It is wrong to say China is revisiting Covid restraint as China never formally ended its Covid policy although in recent weeks, it has signalled a gradual relaxation of that Covid policy. I believe there is a gradual relaxation going on but I have to emphasise the key word is gradual.
Right now, we have a surge in Covid cases in China. They probably do not have cities being completely locked down in response to that like we had in Shanghai earlier this year. But we have all kinds of restrictions on activity in these cities. So it is the newest policy, it is certainly not a complete opening. The best reason for taking a more constructive attitude on China equities this year in terms of this quarter vis-a-vis the Covid policy is the simple fact that President Xi has since October started appearing in public without wearing a mask. To me, that is an important signal.
Now the other thing that prompted this rally in Chinese equities was I was expecting the Chinese government to come up with a package or a policy initiative to try and address the issue of these unfinished residential property projects, which the private sector developers did not have the funds to complete.
We have seen in recent weeks the package trying to get more liquidity into these private sector developers. That is a reason for the big market rally but it does not mean that China has fully opened up and truly on a three to six months view, the key issue will be whether the Chinese middle class will be willing again to buy properties from private developers because confidence has been badly damaged during this year.
You have been a long-term India bull and even after the recent run up, you are still overweight on India. What will prompt you to bring that weightage down and what would make you maintain or increase this weightage?
My weightage is very marginally overweight because the neutral weighting got up a lot. So my relative return is marginally overweight China and India. But in my long term absolute return portfolio, I have about 20 stocks which are still dominantly India because that is long term, So in the short term, the more you should want to underweight India, the more long term you are, you should just stay structurally overweight. It all depends on your time horizon.
But the key point about India so far in calendar 2022 is just how remarkably resilient the stock market has been in the face of negative correlation offshore, given the decline in US share prices and in the face of quite significant monetary tightening in India.
If I look at your long-term thematic portfolio and especially look at the ideas and the names you like in India, you have always liked private banks. There is a bit of insurance play and then real estateBut I do not see too many consumer names or exposure to IT. Why is that?
I have got nothing against owning IT names. They have had a boost up from the pandemic and I have no problem with the consumption names either. It is just a question of choice. For me, the key positive developments in India in the last two years there has been ongoing evidence of continuing rebound in the residential property sector which has all kinds of positive multiplier consequences for the economy. That is the key development.
I think that explains it to a significant extent the market resilience this year and I am hearing a lot of anecdotal noise of growing hopes that with corporate debt having significantly come down in recent years, balance sheets being cleaned up and the last NPL cycle now behind us, there is growing evidence of a capex cycle.
Meanwhile, there is another positive long-term story for India which is now increasingly visible and it was not visible in the last five to ten years. There are growing hopes that India can attract a significant amount of foreign direct investments in the manufacturing area as a result of a natural desire of corporates to move production out of China.
In the last 10 years, the country that benefited most from this so called China plus one strategy has been Vietnam but going forward, it seems that India if indeed can come up with a credible policy to attract manufacturing which it appears to have done with this production linked incentive schemes, India has one unique advantage over these south-east Asian countries. It offers access to a big domestic market on a 20-year view with strong demographics.
What would you tell the naysayers who are of the view that India is a great story but valuations are not strong and supportive? It is like saying that you are buying perhaps gold at the price of diamond?
Now that there is no doubt, the valuations have been expensive or expensive relative to history but compared to the valuation prevailing in the US in the last several years, they are not so expensive.
I would say first and foremost the market has been extraordinarily resilient and it has had two tests this year. It has had a record foreign selling in the first six months of this year and it also had more monetary tightening than was anticipated at the start of this year. So the resilience of the stock market is really pronounced. Basically this has been a year of consolidation but one should not think India is the best performing market in Asia this year. The best performing market is actually Indonesia which I have also been overweight on.
So this is a year of consolidation where India has behaved very well in the context of monetary tightening and negative correlation. When I was in India in April, all were expecting a significant correction in the Indian stock market this year. So far, that has not happened and that shows resilience.
We have seen an absolute rout in global internet and technology stocks. Do you think that the selling in some of the new-age technology stocks both in India and globally is unjustified?
No, that was always going to be the risk. If we had a monetary tightening cycle and the monetary tightening cycle has been more aggressive than I would have anticipated this time last year. The Fed has been under political pressure to address the inflation issue that political pressure came from the Democrats because they realised a year ago that inflation was the number one issue on the opinion polls for Americans and the opinion polls showed rightly or wrongly that the Biden administration was being blamed for the inflation.
So the Fed had to be seen to be doing something about this ahead of the midterms. The monetary tightening is being more aggressive and all the high that has been very negative for the profitless tech theme also being very negative for crypto and we have also seen FAANG stocks start to break down.
FAANG stocks show the S&P market cap peaked in the summer of 2020, it is now breaking down quite sharply. I am firmly of the view that the FAANG share of S&P market cap will continue to come down so long as monetary tightening is happening. There will be relief for the new technology and the crypto space. I think this area is a long-term story but the relief will come when the monetary tightening ends or is seen to be ending by the market.
