2011 was a year of erosion of wealth. As Indian market crashed 24% in a year, many foreign investors have fled carrying a sore thumb. However, some experts feel 2012 may bring back some cheer.
Adrian Mowat, chief asian and emerging equity strategist, JPMorgan is bullish on emerging markets (EMs) in 2012. In an interview to CNBC-TV18, he said that bearish outlook on EMs is likely to change and investors are likely to get interested in these markets in the second half of 2012.
India too has some good news. Mowat believes that valuations are looking better after India’s stark underperformance. He is expecting RBI to ease policy in response to weak economy environment. Maintaining his positive outlook, he pointed out that cooling off inflation and easing of RBI will trigger off Indian market.
Below is an edited transcript of his interview. Watch the accompanying videos for more.
Q: What is the prognosis for 2012? Do you see more pain for emerging markets like India?
A: We are quite bullish on emerging market equities in 2012 after spending most of 2011 being bearish. The reason we were bearish was that inflation was above central banks’ targets in many of the key emerging markets. There were increasingly interest rates or slowing down loan growth in a place like China. The results were that you had higher discount rates and less growth which tends to cause a rapid PE multiple de-rating. In a normal course of events it is particularly bad thing in a world where peoples risk appetite fell because of issues with the US economy, the Japanese earthquake and don’t forget the Euro crisis which continues.
But as we look into 2012, we have seen a loss of economic momentum in the emerging economies, we are seeing inflation coming off and the response from central banks is now to cut interest rates or at least to move to more of a neutral bias. We have interest rates being cut in places like Turkey, Indonesia, Brazil and Chile at this point in time.
We do expect the Chinese authorities to cut the reserve ratio by 50 basis points on three occasions in the first half of this year and may be a bit more in the second half. With regards to India, we have the RBI now on hold and we think they will move to an easing bias as they have more flexibility with their inflation. One also needs to respond to a weaker economic environment.
When you move into this policy environment where they are trying to encourage growth, it tends to end the de-rating in emerging market equities and turns out to be a good condition. It is a particularly good condition when you have had such a poor performance in emerging markets in the last 12 months. Unfortunately, India ranked in the bottom three of performers in the last 12 months Turkey and Egypt along with India doing particularly poorly.
Q: What is the bullish call premised on those for 2012? Is it a call that markets has been looking severely oversold all of last year and hence are due for a bounce or do you think this could be the fundamental turnaround that the snap of the bear market phase we have been through and the beginnings at least of a bull market phase?
A: This is a story of fundamentals. You are moving from an environment where policy makers are trying to slowdown growth to fight inflation. To one end in which inflation is coming off and none of the base effect is going to look pretty good. We have the Arab spring or the Jasmine revolution or the Middle East and North Africa (MENA) crisis whatever you would like to call it in the first quarter of last year which pushed the oil price up to its highs late March early April.
The year-on-year effect of that is going to look very favourable. So the story that caused emerging markets to do so badly last year which was inflation is reversing and I even think that’s going to be the story in India where there still remains a huge amount of pessimism about bringing down Indian inflation. This is absolutely a story of fundamentals. It is not calling for a short-term bounce in oversold markets.
The fact that the market fell so much does give you this advantage of a valuation cushion and we would say that equities globally have to higher a risk premium built into them and emerging market equities have an even higher risk premium than developed market equities after their relative underperformance of 13% in the last 12 months.
Q: Are you saying we may already have seen some kind of a bottom in emerging markets like India or do you think we will get a better entry opportunity somewhere in the next few months?
A: We saw the low in equity markets on October 4 last year but for me as an international investor looking at the Indian market, I need to think about the currency as well. I am not sure if we have seen the low in the rupee. I do think the rupee has an incredibly important signal for investors to look at.
What the rupee is telling you at the moment is that it’s a difficult environment to fund current account deficits, it’s a difficult environment to refinance external commercial borrowing and that environment is compounded with the case of India. Those that control money offshore in India are discouraged to bring it onshore at this point in time because of the corruption scandals but also what projects can that money be put to work when there has been such a political impasse.
Q: From an Indian context, would you worry about that given what is going on in Iran right now? Can that lead to relative underperformance from India versus the EM basket?
A: If the crude oil prices was to move higher than yes you would get a relative underperformance of a market like India which is a big crude oil importer as well as running a current account deficit. But if you look at the year over year change in oil prices as we move into the first quarter, it looks very favourable. The noise coming out of Iran appears to be noise, its inconsistent statements and if Iran chooses to block the main shipping route for oil, it is effectively cutting off its nose to spite its face. In that, the oil it sails through into Asia, all goes through that particular shipping channel.
Q: What is your own sense of what this recoveries blueprint may look like? For instance, do you think it will be a sharp V-shaped recovery, will market pre-empt some recovery in the economic news or do you think it’s going to be a slow grind this year albeit with the market tilting towards strength rather than weakness?
A: It’s the latter. We did get a degree of a V-shaped recovery after the sharp selloff that we saw in September in emerging markets but what we see is a gradual reduction in excessive risk premium. It’s a story of the world looking less bad rather than perhaps the world looking very good.
So let’s gradually improve valuations in market, reduce risk premiums as people appreciate that the global economy continues to grow, as people appreciate that in the emerging world there is policy flexibility, there is the ability to cut interest rates, there is also a fiscal flexibility in many emerging economies although I wouldn’t necessarily include India in that statement.
Q: Part of your strategy for this year is to approach sectors rather than countries and within that in the Indian context you like some of the banks. Will the rate sensitives be the best vehicle to approach this recovery?
A: If you think about how policy is changing over the next couple of quarters, we are moving from increasing interest rates, from a tight monetary environment to one in which policy become neutral than accommodative. That tends to be good news for financials, it should be good news for consumer discretionary stocks and on a longer-term play the sort of late cyclical stocks that you might wish to look at would be some of the infrastructure names or the construction engineering companies.
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