 Adrian Mowat, chief Asian equity strategist, JP Morgan, said it is time to stop chasing growth in earnings.
What is your own understanding of the road ahead with respect to policies now that we have a new President in the United States?
Mowat: The road ahead is rather bumpy but we suspect we have seen the worst in the equities markets... we have trying to break down what's been going on in the last one year since the equity market peaks... about a year ago, you began to see inflation becoming an issue in the emerging economies - China, India, Brazil or Mexico, and the governments started to raise interest rates and tightening policies to slow economy down... equity markets began to degrade, and on the back of that, events started throwing up a whole series of external shocks... we then began to see the financial crisis becoming a real-world crisis as the global financial system plumbing got very disturbed... we have an on-going issue which ultimately saw Lehman failing... when Lehman Brothers failed, there was a complete collapse in the confidence to own assets, in confidence to lend to other institutions.... that process continues, and the markets remain very weak.... you got an on-going de-leveraging process but the global event is hitting the emerging markets - equities and bonds - but the impact on the emerging markets equities and bonds goes into fast forward...investor confidence was extraordinarily low, and that was the major assumption that you will get a rolling current account crisis throughout emerging economies that wasn’t fundamentally based.... and this was based, on say, the fear driven by the experience in the banking industry....
At one point in October, we were down 44% in the emerging markets... as that occured, IMF and Federal Reserve acted very fast to prevent any liquidity crisis... IMF has put excellent facilities in dealing the issue in Pakistan, Argentina, Turkey and Hungary.. we have also seen the Fed putting in place swap lines to ensure that there is sufficient dollar liquidity in the emerging economies.... as they did that, we began to see credit defaults swaps prices beginning to decline, and the confidence has gradually been re-built in sovereign risk... equities markets began rallying hard from very low levels... I think that process will continue over the next couple of weeks perhaps a month as you begin to get successive riskier versions moderating... however, do not forget that we are going to see the worst US consumer recession since the second world war... I think it is pretty obvious when you start looking at the data coming out of the United States... we are beginning to see emerging markets dealing with the financial shock... you have seen car sales in India relatively weak, industrial production is basically flat year-on-year.
I'm seeing similar data points in other emerging economies but I think it is important to understand what exactly is going on in emerging economies rather than developed economies....we have a phrase the “Big Ugly Experiment”: think about the initial part of the stories, which is tightening of monetary policy to deal with inflation... that tight monetary policy was in place up till a couple of weeks ago and it’s a fact that it is coming through in demand.... now, emerging economies is being hit by very weak export sector plus the shock of higher financing cost... I think what we do is concentrate on the weakness into this quarter and the next quarter.... as we are go into the second quarter of 2009, you may start to see some good news, and the good news would be government stimulating growth, cutting interest rates, providing fiscal policies to maintain growth....
So, I think the process here is we are going through a couple of ugly quarters in terms of growth, some real shocking disappointment in terms of earnings but as we go in to the second half of the next year, we begin to see the emerging markets economies gradually recovering against the backdrop of relatively lacklustre developed economies which may no longer be contracting but they will be weak... so that’s the roadmap... it is the big ugly experiment because we don’t have a decent knowledge and history... it's a time when investors should be doing a lot of homework, keeping their eyes and ears open and also keeping minds open, be willing to change views...
What we expect to see from companies is they recognise how difficult the backdrop is and start to manage for the difficult backdrop... that’s why we are saying IT companies in India are performing well... people trust the management there... that is very credible to be doing things at this point of time.
Do you think central banks across the world have done enough with respect to interest rates and liquidity injection? Or is there little more loosening in the offing?
Mowat: I think the key thing here is the mindset... they understand that there is a very severe problem here, and they need to act to ensure that the real economy can get sufficient money at the right price... they are reacting to crisis, and in a crisis we all make mistakes... the key thing is to have the right intentions and to be willing to constantly modify your actions in order that the desired outcome is achieved... I think we definitely got that mindset... so I would expect more policy response, more fine-tuning...
There is a very interesting story here in India... during the last couple of years, Dr Reddy, the previous Governor of RBI, was very cautious... he was limiting the amount of external commercial borrowings both in terms of quantity and spreads above the sovereign risk... he built up very large foreign investment to reserves within the domestic banking industry... now, the new Governor of RBI is providing a lot of flexibility to manage the external risk in what is very difficult global financial crisis environment... India does not have flexibility on the fiscal side but perhaps they got little bit more monetary flexibility.
Are corporate earnings in India a concern right now?
Mowat: I think, corporate earnings are going to be flat year-on-year... going into fiscal year 2010, if you look at the global backdrop, we have all economies operating below potential... there would be significant moderation of capex plans in the private sector with regards to infrastructure spending in India... you have a financing shock there if you want to use PPP-based infrastructure projects... I think the other issue you got for infrastructure pushing growth here is that only around $60 billion of the projects that has been approved by central or local governments... we need to speed up the approval of projects to help the economy...
India will probably see declining earnings in many companies but I suspect the decline in earnings will be less than the global average, which will be the general trend in the emerging markets... so, if companies maintain earnings, it’s probably the company you should be buying... stop chasing growth in earnings... that’s not the backdrop we got going into 2009.
We have seen an FII outflow of $12-13 billion. Do you see it abating at any point of time? Is liquidity going to be at premium for a market like India?
Mowat: I suspect we have seen the peak in FII selling... the reason I say that is we got around the market when people were fearing the sovereign risk... when the US treasury yields were practically zero, risk appetite also went to zero.... now, you got fire sale going across India... I think you are going to see a gradual rebuilding of equities... the first stage of that is the slowing of net selling... then may be stabilisation. I don’t think that you are going to get significant net inflows into the equity market this quarter and the next quarter because there is going to be lot of noise out there... the mindset changed since Lehman (fiasco)... it's no longer about return on capital. it’s about Whether you return my capital or not...risk appetite is very low, and that means less inflows into the emerging market if any.....
What is your call on the US dollar and crude oil?
Mowat: The European Central Bank was raising interest rates in July, and now it is cutting... that's why you have seen a sharp reversal in the euro and the sterling. The NZ$ the US$ have seen rapid reversals in monetary policies...In Australia, the dollar decline has been compounded by weak commodity prices... so, it is all about other currencies weakening rather than dollar being strong. The Japanese yen is an example of the reversal of the risk appetite.... money is being repatriated to Japan, particularly by fixed income investors. In an emerging economy, what has been seen is that current account deficit countries have very weak currency... so the Indian rupee has been weak, so has been the Turkish lira , the Korean won, the South African rand... and countries with current account surplus with good external position like the Thai baht, the Philippine peso have performed reasonably well...
So, it is a complex position when it comes to the currencies... the rupee is very weak on the back of sovereign fears. I suspect the rupee will be weak in the foreseeable future....
With regard to oil, I have to say that I am a big bear for the energy and the commodity market going into 2009.... demand is very weak, and we might also see weakness in the prices as we go into 2009... then you might see a prisoner's dilemma for countries like Iran, Venezuela and Russia because they need high oil prices to meet their import bill but they can’t get higher prices of oil, they increase production and that brings down the price of oil.
What about the macro economic health of India? People are talking about the rising fiscal deficit being a concern...
Mowat: Manufacturing data would indicate that there is more weakness than is visible in the forecast at this point.... as you go into the next year, I assume that the impact of the low energy and commodity prices and the easing of the monetary policy will be helping the economy. However, the fiscal deficit runs the risk of crowding out of the private sector in terms of the price of money... it becomes important to see that how the Reserve Bank of India deals with this... I suspect they need to keep on cutting the cash reserve ratio in order to ensure that the interest rates don’t increase as the fiscal deficit increases... so there are challenges there... I think the economy can match those challenges but we need to moderate our expectations
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