Chaotic shutdown in India makes FII sentiment more bearish: Christopher Wood

Market will see selloff if lockdown is extended, says global head of equity strategy at Jefferies.

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If we stay in lockdown, there is a very good chance that we test new lows.
Let me first start with your world view. Global financial markets have made a reasonable comeback of 15% to 20% from the recent lows. Do you think the strength is here to stay?
I have a slightly complicated view right now. My base case in recent weeks is that we expect it to have a snapback rally. Personally, I would be surprised if we do not see a sell off again, which was near the previous lows. But having said that, I believe the key issue right now is when do governments start to try and get their economies going again. My big picture point is that a big buying opportunity for Asian equities should present itself in this current quarter because my base case is that the virus infections will peak out in Europe in the middle of this month, which is about now, and hopefully in the US, by the end of this month, but earlier in New York. My base case is that activity will start to resume next month, which means that hopefully in June things will return to normal and that should represent a buying opportunity for equities.

However, if I am wrong on the normal life being resumed, clearly we can sell off to lows again. What has repelled the markets on this bounce is first and foremost the policy response but we have also seen some encouraging news that the curve is flattening in Europe and we have also seen encouraging news in New York and clearly world markets are correlated around Wall Street and clearly the epicenter of the virus so far in America has been in New York city.

Why do you think markets will sell off and we could retest lows? If you think the improvement on the virus front and on the lockdown front is going to get better, what calls for the markets coming down?

There is a risk we do not retest the lows but we will definitely retest the lows if my assumption is wrong and the governments keep the lockdown in place. So we have not had that up till now because until now, people have been very focused on implementing the lockdowns, slowing the rate of infection and trying to allow hospital systems to cope with what they call flattening the curve; so that has been the focus. But in my view, if I am right and it becomes clear that the curves are flattening and infection rate is slowing, then the key question will become how quickly activity is returned back on. There will be a debate between the medical people arguing for caution and politicians like the US President Donald Trump wanting to reactivate activity sooner.

If the medical people win the argument and we stay locked down, there is a very good chance that we test new lows. So I think that is the key variable. India is a good case in point. India I believe is coming to an end of the three-week lockdown. If India imposes another three-week lockdown, the Indian markets will see sell off. There is a tradeoff between fighting healthcare and the economy.

Why do you think Indian markets this year are underperforming global markets even though the lockdown so far on the medical front has worked? The number of confirmed cases in India are much less than other countries. So on the medial front if the news is good, on the crude front if the news is good, why is India selling off much more than others?
The Indian market was doing badly even before this medical issue appeared because we continue to have a complete lack of evidence of a cyclical recovery in India. We had a disappointing Budget. We have had no evidence of a capex cycle returning in India. There has been a lot of evidence that the NBFC problems, which have been going on for years, continue to have collateral damage on the financial system. We have had a very delayed resolution of the YES Bank issue, which is still really not properly resolved. All this has led to bear sentiment on foreign investors towards India.
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What is remarkable is that it is an indication of how bearish foreign investors are towards India; the Indian market did so badly even when the oil price is collapsing and we had this health scare and we had the shutdown in activity which appeared to foreign observers to be quite chaotic. So that has further reinforced the bearish sentiment. But I do not know how bad this virus really is in India. It is not clear to me personally although I am not a medical expert but it is not far from proven that this virus flourishes in hot tropical climate since it is a flu-like virus. Again in the northern hemisphere in China, I can see it can flourish in air conditioned offices and office buildings. But to me, it is not proven that this virus flourishes in tropical climate. If it does not, then it is a limit to how bad it is going to get in India.

But the point is, during lockdown in activity in western economies, you have the health systems in place and you have huge fiscal room for maneuvering and you can introduce policies where you pay employees to do nothing for three-four months when the health crisis is in place. It is much harder to implement policies in India; so there is a real risk in developing countries like India. The measures taken to protect the population from the virus actually end up being more negative than the virus itself in terms of the impact on the economy and people’s welfare.

According to your model portfolio, you are still overweight India. Within India, your model portfolio always has been tilted towards private banks, insurance and HFCs given that financials are a leverage play. Do you think they run the risk of underperforming massively because financials are underperforming and leverage plays in an economic slowdown are always hit the hardest?
I reduced my ratings in India since last summer; so I am just above neutral. My model portfolio is different than stocks but in my country portfolio, I am marginally overweight India.

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What is your view on financials because you have been long bull on Indian private banks, Indian insurance and HFCs?
The risk in India right now with the lockdown in activity is the asset qualities in the banking system, which was very much in the developer space and housing finance company space as a result of the NBFC lending squeeze. The risk is that we now have an asset moving into the consumer lending space. So I believe that is a risk facing the Indian market now which has definitely been composite by this lockdown in activity.

So I am personally hoping that the lockdown in activity in India is gradually eased and I am hoping that the names in my portfolio will have the best quality consumer loans but there is clearly a risk to the consumer lending portfolios in India right now.
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Where do you think the global risk is headed if everybody is printing more money? If interest rates are going to remain low, I wonder what will happen to things like fiscal deficit and trade deficit? What kind of economic imbalance do you think we could be staring at given that central banks right now will only do one thing, which is print more and more money?
Yes, so the risk is both positive and negative. So the world has embraced most dramatic stimulus measures in a response to this health crisis. It could be argued that the world has basically panicked. You have had in the western world, policies introduced which are basically very less weighing policies. They are sort of policies which would have been advocated by Bernie Sanders and by Jeremy Corbyn in the UK. The policies that have been implemented have not been labelled by the people implementing them as left wing. They are just saying that they are doing it because of the crisis but the reality is that they are not very different from the pseudo policies Sanders and Corbyn would have recommended.

So the risk in the longer term is that when this virus has disappeared from the headlines, we still have these policies in place and the risk is it may be harder to remove them. In my view, it is totally justifiable to be paying small for governments to come out with schemes to pay small businesses money, to pay the wages for three-four months because the governments mandated this lockdown in activity but obviously if that policy is still in place in nine months time will be a different story. Similar with giving banks exercising forbearance to not collecting mortgage interest, say for three months, during the lockdown and that is probably justifiable again but if forbearance schemes are extended, that becomes a long-term negative.

The Fed has now gone into unlimited quantitative easing. The Federal Reserve is now buying corporate bonds in America, the Fed never did that during the global financial crisis. The Fed buying investment grade corporate bonds has led to a significant decline in credit spreads in the US since the Fed commenced buying but what was incredible is that last Thursday, after the very strong rally on Wall Street, the Fed announced that it would start to buy top graded high yield junk bonds. So to me, all these policies while in the short term definitely have helped markets rally, create long term risks.

In the big picture, it is also important to understand that the Fed has now started to finance the Federal government directly engaged in financing or monetisation. In my view, once you enter these policies, it is hard to pull them back and in the very big picture, the odds are now growing that we are seeing the beginning with these policies will mean the beginning of the end of the bull market in treasury bonds in America, which began in 1981. So in my view, this medicalcare crisis will mark the catalyst for the long-term change where bonds will henceforth dramatically underperform equities.

In your global sovereign bond portfolio, you have a 50% weightage to China where the yields are at 2.5% and only a 10% weightage to India which offers a yield of 6.5%. So given the fact that Indian yields are high and the scope for interest rate cut is very high, why do you have a 10% weightage to Indian bonds in your sovereign bond portfolio?
This portfolio was designed for global bond investors and the message that Fed has been braced for direct monetisation and because the G7 central banks have become even more committed to extremely unorthodox policies are not bond market friendly. I am recommending global bond investors with G7 portfolios to instead own Asian government bonds and that is the context.

But I have the biggest weighting in China because China is the most responsible global central bank right now. So in response to this health crisis, China has done much less stimulus than almost everybody else and yet the epicentre of the crisis was China. Indian fiscal accounts much more out of control than China but I agree with you, you do get compensated for the yield but this is a bond portfolio and first and foremost conservative.

The key point to understand right now is not whether you own India or China bonds. The key point to understand is that the bull market in US treasury bonds began in 1981; while in the short term, bonds will continue to do okay because the economy is collapsing and the US with the economic lockdown. But this policy response marks the beginning of the end of the long-term bull market in western government bonds and the asset class which will benefit most from these policies long run is gold.

Would you say that one should ideally have 10-15% exposure to gold because equities have a problem in terms of growth and if yields cannot come down any longer because of almost negative interest rates in Europe and zero interest rates in US, do you think one should have a disproportionately high allocation towards gold?
Yes, and I think if you are in the West, you should. I think if you are in India or emerging markets, as you rightly say, you have got higher yields in Indian bonds but I definitely think people to have a weight into gold even in India. In my view, let us say the virus ceases to be a crisis in three months time but many of these stimulus policies will still be in place. It will be hard for the authorities to remove all the stimulus, especially before presidential election and then the markets will start to focus on the potential for a V-shape rebound and then you can see selling pressure hitting the bonds.

At that point if not before, I expect the Federal Reserve to announce what the Bank of Japan has been doing in recent years called yield-curve control, where the Fed will fix bond yields to up the yield curve. They will just do price fixing in government bond yields that will lock bond investors into very low nominal yields and that is another reason why you do not want to invest in government bonds. So such a policy will make bonds in Asia or emerging markets more attractive because I am not expecting the RBI to fix the five-year government bond yields in India, for example, and that will also make us bullish on gold.

As a theme, if I look at your stock portfolio, you have the highest weightage towards Indian insurance companies, both life and general. If I combine that, total weightage is about 15% of your total model portfolio. Why is that?
Basically I have just shifted more from the lenders to the insurance in the last year to 18 months but in the short term, those two sectors have been hit by the crisis. But I do think there is more credit risk on the consumer lending side.

Do you think in India we could see a large uptick in retail delinquencies?
Definitely that risk is there. Absolutely the longer the lockdown goes on. the bigger the risk.

You do not have a large exposure to pharma or IT? Where do you think those two defensive sectors are headed because the Indian pharma and Indian IT companies do not have leverage on their portfolio? Do you think one should now buy stocks and companies both in India and outside which do not have a balance sheet risk?
Right now those sort of stocks will definitely do better. You got these globally companies with high debt, which are vulnerable the moment this selloff kicked in. So to me, all these defensive sectors benefit. Telecom would be another example. But in the long run, I think this whole crisis will be another positive for ecommerce and another positive for the whole 5G story. So any companies who get into that will be beneficiaries. Also, this whole crisis lockdown activity has further reinforced concerns about supply chains but in the short term, while markets are correcting, pharma and software are obviously going to appear more defensive.

With each crisis, there is a change in the equilibrium of the world; opportunity and threat both get created. So to your mind because of the coronavirus crisis, what could be the new normal for financial investors, for companies and for investors?
The biggest issue out of the current issue is what I said earlier; does it mark the beginning of the end of the bull market in bonds which has been in place for so many years and has created this long term disinflationary trend because the Fed has now embarked on direct financing of the US government? Now if the crisis ends, maybe all these policies are removed in which case not making too big an issue of this. But we know from the experience of the introduction of quantitative easing in 2008 in response to the global financial crisis, it was meant to be temporary but the policies were not removed.

So the question is, will there be much greater government involvement in economies or central bank involvement in economies will remain or will it reduce? Again in Europe, banks have been ordered not to pay dividends. HSBC was ordered by the British regulator not to pay dividends. Do these sort of policies remain in place or are they removed? Forbearance policies ordered by governments for banks that have been implemented, will they remain in place or are they removed? This is the big issue.

If for the next three to five years if you have to choose just one asset class for the Indian investors, which way do you think Indian investors should move? Should they buy index funds, gold funds or should they buy government bonds?
I would never buy an index fund because I do not believe in indexation but what I would do is I would hedge it. I would own an Indian equity fund, I would have two-thirds in an Indian equity fund and one-third in gold but I would not have an index fund.

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