BackIndians need to invest more in domestic equities
Geoff Lewis says that it is the improvement in the economy which is getting reflected in the market
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Geoff Lewis, global market strategist, JPMorgan Asset Management, argues that it is the improvement in the economy which is getting reflected in the stock market and he is not worried about higher cyclically adjusted price-to-earning (P-E) multiples in the US. However, he is in favour of normalization of monetary policy in the developed world and says that quantitative easing (QE) does not deserve a permanent place in a central bank’s monetary policy toolkit. He also sees India as an attractive investment destination in the medium term and suggests that Indians should increase allocation towards equities. Edited excerpts from an interview:
Bank for International Settlements in its annual report highlighted a disconnect between the real economy and asset prices. The World Bank has trimmed global growth forecast and valuations, as the much-tracked Shiller P-E (cyclically adjusted P-E ratio) looks stretched. Are equity market levels justified, especially in the US?
If investors were to aggregate these concerns, it will keep them out of the market. So you could say that we are in a situation where the global economy is strengthening. The Purchasing Managers’ Index in majority of the G-20 countries is above the expansion line. We would say that after a weak first quarter, the US will be stronger. The US Federal Reserve will only raise interest rates gradually from the middle of 2015. Investors point to low volatility as a sign of impending doom; this means they are complacent. In the past, you had periods of 3-4 years where volatility has been at lower levels. I don’t think that volatility has been a good predictor of market returns. Low volatility is not the reason for investors to be out of the market, unless we can think of something that is likely to deteriorate in a significant way. There is tension in West Asia and problems between Russia and Ukraine. But these have not affected equity sentiments. Yes, the Shiller P-E looks a bit uncomfortable for the US. But the Shiller P-E taken back over the last 10 years—which includes the global financial crisis—we think that invalidates the reason for putting too much reliance on it. During this time, you had the largest financial and banking crisis, collapse in earnings and the deepest US recession since the 1930s. This makes the Shiller P-E a backward looking gauge.
Is the global economy more vulnerable today than it was in 2007 as the scope of policy intervention is limited if we were to witness another shock? Central banks in the developed world are already pursuing a zero interest rate policy.
I would agree. It does make the situation little more vulnerable. If the bigger economies are pursuing zero interest rate policy, and should another shock come along in the not too distant future, central banks would not have the policy scope for easing or taking steps to offset such a shock. Having said that, the counter to that argument from the central banks would be that if they hadn’t taken the measures that they have taken, then we would not be coming out of recession, which many people see as the gradual normalization of the economies. So, yes it is a vulnerability, that is why we have been arguing for last 12 months that the US Federal Reserve should get on with normalization; it should start raising rates gradually. Historically, that has not been a threat to the equity market. We don’t think that QE3 has been particularly helpful.
For how long can monetary policy push asset prices?
You cannot keep equity markets afloat without earnings growth and now is the time to “show me the money". We believe that expectation for earnings in 2015 is about 9% for the S&P 500 and about 10-11% for the euro zone. These are not unrealistic. We think we are starting off with a relatively realistic number, provided we see continuation of the cyclical pick up in the US and the euro zone economies, matched by better revenue and profit growth. We will see an improvement in earnings in the US which is not dependent on cost cutting, rather will be a reflection of stronger sales. This is the point where you need to see the improvement in revenue growth and it is questionable whether monetary policy alone could produce further re-rating. We were not in favour of prolonging QE; we were not in favour of QE3 in the first place and we would not like to see a QE4. As a team, we don’t see QE deserving a permanent place in the central bank’s monetary policy toolkit.
How do you see India as a global investment opportunity?
It is a very good investment opportunity for the medium term. We think this is an inflexion point in terms of India’s economic performance. Foreign investors don’t expect to see a rapid return to very fast growth. They probably don’t want to see 8-9% growth. But they do want to see 6-7% and International Monetary Fund and other bodies tell us that with sensible government policies and revival in capital spending, this kind of growth is possible in the medium term. We might see some improvement, say, by 2016. The good thing about “Modinomics" is that it is not based on extreme economic ideology. It is basically about good administration. Foreign investors would be looking for (Narendra) Modi to work successfully and closely with large and important state governments.
Your advice to investors in India
You are too underweight on your domestic equity market. You are not going to get returns from gold over the next 10 years similar to what you had over the last 10 years. Looking at the overseas bond markets, they are unattractive relative to your bond market. So you have a better choice than most investors. You have a good option in the domestic government bond market. But you should also not ignore the opportunities from diversification that overseas equities offer. But more than anything, you need to increase the domestic equity weight as that is where the real returns will come over the long run.
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