Geoff Lewis of JPMorgan AMC believes emerging markets haven't done very well because of margin pressures. However, he is positive that the external environment is stabilising and the emerging economies will see some improvement in their growth this year. Thus, JPMorgan AMC is overweight on emerging markets and US equities.
It has recently gone overweight India. According to Lewis India was one of the first Asian countries to see earnings downgrade and now those numbers have stabilised over the last few months. "We have even seen a light upward revision to the earnings per share (EPS) forecast for calendar 2014. Growth has probably toughed in the Q4", he said.
He believes growth will pick up slowly during this year and the current account deficit (CAD) will start to improve.
Below is the verbatim transcript of his interview to CNBC-TV18
Q: What is your expectation in terms of any sort of contagion that we could see once the Cypriot banks open this afternoon? Do you think that the Euro has already factored the worst in?
A: It is very unusual situation because as the Cypriot banks will be opening. This is the first time we have had capital controls on an economy where the currency is the same inside that economy and outside in its major trading regions. So, this is a very unusual situation where case of Cypriot’s wanting to get their money out. Particularly non-Cypriot holders of Euro within the banking system and those Russian companies and there is quite a bit of UK money there too. I believe amongst the 30 billion of Euros non-resident in Cyprus will want to exit as well.
The restrictions will have to draconian and probably in place for quite a long time. So, it is a very strange situation there in Cyprus, but for the rest of the region I don't think there will be big contagion impact in terms bank runs etc. in the other periphery. We would have seen that come in if it was going to happen.
So, people, depositors are treating Cyprus as a one-off. There are a lot of long-term issues that need to be worked out. There is a lot of help that will have to be given to the Cyprus economy, if it is to avoid depression rather than recession. It is very early days and it is a difficult situation. However, I don't think it is systemic and will prove to be systemic, but it is a wake up call to the core euro zone to get on with the principles of building a single regulatory banking system.
Q: How do you see the Italian problem panning out? While Cyprus may still be regarded as one-off and perhaps limited to just that country the Italian yield yesterday jumped because of the political uncertainty. Do you think that can get off the handle?
A: Italians have been used to fairly weak frequently changing coalitions. In that sense whilst this might cause some volatility for the markets. The markets have accepted the fact now that it will take some time until a new coalition can be agreed in Italy. The chances of that arising are still mixed. In that case will have to have new elections, but I don't think this is the major factor. The major thing is that the European Central Banks (ECB) with its outright monetary transaction (OMT) promise has managed to stabilise the fund in markets.
It has brought and end to the outright panic. If Italy is slow to put together a government, I think that’s going to be a drag in terms of pressing on with much needed economic reforms and policies in Italy. I don’t think alone that is a fact that which is really going to upset the apple cart in terms of contagion risks in other European countries. People will just wait for Italy to get their political act together even if that takes some time.
Q: One more word on Cyprus. There was the Dutch Finance Minister saying that the way the Cyprus problem was handled is a template to handle banking problems in other countries as well. Is this going to permanently damage the valuations that will be accorded to banks and financial institutions in Europe?
A: The person who has said that was not empowered to make that statement and soon retracted it. So, this is not a template and the ECB will – and the troika have emphasise that Cyprus has been treated as an exception. What made it so difficult was that large involvement of foreign deposits and the huge size of the Cypriot banking system relative to their small economy. However, nevertheless, the Cypriot banking system relative to the euro zone is very small. It is no bigger than the 44th largest euro zone bank. For example, the entire Cypriot banking system.
So, I don’t think it is a precedent. It raises a lot of question though about can the core agree on a single banking regulator, a single deposit guarantee mechanism and a single resolution mechanism with mutualisation of those potential losses. This is what they need to get on with. Cyprus was badly handled and it points to the need to have a properly functioning unified banking system. If one is going to have a single currency, they can’t have the one without the other.
Q: What are you recommending to investors in order to play the euro zone situation in the best way? Would it be more allocation of funds or do you think that it would be possible for more incremental flows to come into emerging markets such as India?
A: That’s a very good question. We would say both. We would say looking at the markets today certainly the US has the best fundamentals of the developed economies and seems on track to continue its economic recovery. So that is looking quite good and valuations are still reasonable. Emerging markets haven’t done very well and that’s because of margin pressures. It is due to of cyclical factors because they were hurt very badly by the euro zone recession. However, the external environment is stabilising and the emerging economies will see some improvement in their growth this year.
So, we would say to be overweight emerging markets and US equities. Also to have a very diversified portfolio to not forget other assets like hedge funds, Real Estate Investment Trusts (REITs) and commodities. So one needs to spread risks in this environment, but we would judge that the overall global environment for risk assets is gradually going to improve this year. That was not a situation as it appeared to investors in 2012. So from a 12-month view, we are still reasonably optimistic.
Q: How would you advice asset allocators at this juncture? Would US equities be claiming the cream of the money? Where would emerging market equities fall for you in the pegging order, within emerging markets where would India fall?
A: We have recently gone overweight India. We think that India was one of the first Asian countries to see earnings downgrade. Those numbers have stabilised over the last few months and we have even seen a light upward revision to the earnings per share (EPS) forecast for calendar 2014. Growth has probably toughed in the Q4. We believe it will pick up slowly during this year and the current account deficit (CAD) will start to improve. Not dramatically, so there is still a lot of risk - that will still have to be financed.
The Indian Finance Minister came out yesterday and said something about that, but the situation will not worsen in terms of margin and secondary remittance will improve. So, this is a good entry point for Indian equities. We are seeing a continuation of foreign inflows not quite as much in March, as in January-February. However, still India has gained over 80 percent of the foreign inflows into those markets in Asia where we can measure that.
Q: Do you expect it to be as robust Foreign Institutional Investor (FII) inflows in 2013, as they were in 2012 for India?
A: They are certainly on a track to be as robust as they were last year. We have had foreign inflows in total of about 12 billion and last year it was 54 for the year. So, we are on track for quite strong inflows.
However, we would have to say much bigger improvement in global risk appetite for that number to really move up in a dramatic way, when you get a big increase – a sudden surge in funds – that’s not particularly good. So, at the moment it is almost a goldilocks in terms of foreign inflows, not too much, not too little.