Investors should choose large-cap stocks: JP Morgan's Geoff Lewis

Geoff Lewis, Executive Director, Global Market Strategist, JP Morgan Asset Management

Geoff Lewis, Executive Director, Global Market Strategist, JP Morgan Asset Management, talks to Tanvi Varma about the investment market in India.

Q. What does your latest survey on investments show?

A. If we look at global investments by region, apart from the US, markets are showing preference for cash and deposits over other asset classes. US households are holding 27% in cash and deposits, 25% in fixed income and 42% in equities, while European households are holding 53% in cash and deposits and only 29% in equities. Developed Asian households, which are in Hong Kong, Singapore, Taiwan and Korea, are holding 55% in cash and deposits. In comparison, emerging Asia households are holding 77% in cash, 13% in fixed income and only 10% in equities.

Q. How has this affected returns?

A. Investment in cash and deposits in Asia could be a result of the Asian crisis in 1997-8. Further, people are also responding to the global crisis of 2008, when markets fell about 60%. Investors have not even reacted to the change in interest rates. For instance, average real interest rates were positive between 2000 and 2007, 3% real return in India. However, since 2008, investors in India and other markets such as Hong Kong, Singapore and Thailand have been earning negative real returns from cash. We are not likely to see capital gains from US treasuries as well. What was once a safe asset is no longer safe.

Clearly, there is a need to diversify across asset classes and not confine investments to domestic markets. Equities, being high-risk, tend to give better returns. Relative to history, unless there is another subprime crisis, equities are cheap. Investors should invest in large-cap stocks offering high dividend yield. If interest rates remain low for the next two or three years, there will be a significant shortfall in retirement income.

Q. What is your view on emerging markets?

A. Equities in emerging markets look cheap and economic momentum has improved. We are overweight on China, India and Russia. In Latin America, Brazil is attractive, while Mexico is expensive. Emerging markets have been preferred to developed markets in the past few years. These markets are better managed with better economic polices and inflation targets set by central banks. Since the 1990s till just ahead of the global crisis, emerging markets showed signs of improvement in fundamentals.

Q. What is your view of the Indian market?

A. India has scale, domestic growth sources and does not depend upon exports for long-term growth. Further, it has a rule of law with strong institutions and corporate governance. Morgan Stanley was overweight on India last year and it proved to be a good decision, although it hasn't paid off year-to-date. The reason for the underperformance is cyclical. In India, there was a sharp cyclical slowdown and a big collapse in earnings.

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However, the worst seems to be behind India. India's economy should rebound in 2013-14, assisted by lower inflation, interest rate cuts, competitive rupee and economic reforms. The potential growth is much higher than fourth quarter's 4.5%.

Even when problems were getting worse, foreign institutional investors, or FIIs, flow was not negative. Take, for instance, 2011. The amount of money that flowed out after the Lehman collapse was small. FIIs are looking towards India as a long-term option. Till the middle of April, India has attracted FII flows of $10 billion compared with $25 billion last year. Compared with this, the rest of Asia has got nothing, which has never happened before. This will help fund current account and trade deficits.

Q. Which sectors are you bullish on in India?

A. We like financial services, as we are positive on private sector banks, but not public sector banks, and NBFCs such as mortgage providers and those specialising in infrastructure finance. We like consumer discretionary and cement companies as well, but are underweight in IT considering some companies are not doing particularly well. Earnings growth is not likely to return to levels prior to 2007 any time soon. It has come down to realistic levels with the impact of cyclical slowdown discounted. India is at a reasonable discount compared with its historical average over the past ten years. Its ten-year P/E average is about 16 and it is currently trading at 13x earnings, while its ten-year price to book is at 3.6 compared with 2.6 at present. Hence, valuations are cheap.

Q. What is your view on commodities, especially gold?

A. Gold is a complex investment as, apart from being a market-driven asset, it has consumer demand. Prices are affected by retail demand and as gold's 'store of value' status in India and China. It is seen as a hedge against inflation and deflation and saw demand from ETFs as well. In the past ten years, gold has returned 17% a year. However, it has gone as far as it can. Prices have begun to correct Gold is unlikely to give double-digit returns, but won't collapse. There is a floor between $800 an $1,100 an ounce (Rs 15,500-21,000 per ten grams). It deserves a place in portfolios in uncertain times.