The rough patch in global markets continues. In the Citi Investor Conference, Citi top brass are trying to tell investors and companies how to get through this very turbulent phase.
According to Geoffrey Dennis (MD and Global EM Strategist, Citi), lot of investors expect a further significant disruption within the euroarea and that will eventually cause them to turn more cautious again.
Given the bleak global growth environment, Dennis expects more liquidity injections from the central banks. If that happens, global markets are likely to see a big rally. Citi expects the Chinese economy to fare well in the second half of the year, which will be a very important catalyst for markets, he added.
However, he doesn’t see the global economy going back into recession. "We are not going back to where we were in 2009 and if that’s true at some point equities have to find a floor." Dennis sees a reasonable chance of earning upto 20% returns this year in equities in emerging.
Meanwhile, Brent Robinson (MD and Head, Citi Invest Research, APAC) believes that strengthening dollar is a big issue for Asia. "When the dollar is strong, Asia underperforms. So if we continue to see dollar strength then I think you are going to see Asia underperform."
Most investors are gravitating to the dollar because of risks in Europe, if the eurozone crisis resolves then one would see money flowing back into Asia.
Aditya Narain (MD and Strategist, Citi India) feels that most investors are worried about the fall in rupee. "The biggest worry for India really is on the currency front because that is where you don’t have as much control or as much ability to fix it."
Citi is overweight on Hong Kong, Korea and Taiwan and sees biggest value in these countries. On the other hand, Australia and India and Japan are its biggest underweight.
Below is the edited transcript of the interview with CNBC-TV18. Also watch the accompanying videos.
Q: Is the world coming to an end in June or is it not?
Dennis: I don’t think it is coming to an end. There is enormous investor uncertainty about what will happen in the next round of the Greek elections. We are concerned that ultimately Greece may well be forced to leave the euro although we don’t really have any sense of timing. So, to a certain extent it will depend on what those elections results are.
What we are trying to do at the same time is reminding investors actually, the recent growth especially in emerging markets, in equity markets are relatively cheap. So, unfortunately we have to play this as it comes and see what the election results look like and whether we get a government elected in Greece and is fine with pro-austerity, pro-reform in which case markets could well rally after that.
Q: There have been lot of parallels drawn with the Lehman episode but when you talk to investors do you get the sense that they are positioning themselves to buy if there is a big capitulation in the market or will they panic once again if it actually happens?
Robinson: So far we don’t see any panic. There has been some outflow of equity funds globally, but there has not been panic so far. Our view is we would use the summer slowdown or the summer weakness for a buying opportunity probably towards the end of the summer because that’s historically when analyst estimates are cut. August and September tend to be the two worst months of the year. If we can get some kind of resolution with the European situation, the summer time would be the best time to buy.
Q: Is that the only risk because India has been underperforming off late? Or do you think a lot of local issues are compounding the problems for India?
Narain: In terms of market performance, I don’t think there has been such a compounding effect because India has underperformed but very marginally. It is also a function of which timeframe you pick up. But in many senses, memory around that short this time.
In 2009 there was a very bearish view and the markets bounced back very dramatically. 2011 December was similar. So, this time around both globally to some extent and clearly as far as I sense from an India perspective, people are watchful, people are careful but nobody is closing his eyes to either the market or the opportunity.
Q: What’s the flip argument that we will get a bit of a muddle through and markets then heave a sigh of relief and we see the second of the year being much better? What probability would you assign to that scenario?
Dennis: There is a reasonable chance that will happen, but we need to see what sort of resolution you get in terms of this election. The other big uncertainty is when we get a sizable liquidity injection once again from ECB and who knows potentially from the Federal Reserve as well.
That’s where your potentially strong second half rally comes from. Clearly, overriding all of this is that a lot of investors now believe that there is going to be further significant disruption within the euro area and that will eventually cause investors to turn more cautious again. This is why planning for this episode is still relatively good.
But we believe very strongly that the central banks in this environment of somewhat disappointing global growth, very weak growth in the developed world, virtually no inflation in the developed world, concerns about exchange rates within exchange rates, the euro itself within the European continent, we continue to believe there will be more liquidity injections if necessary.
That’s where your big rally comes from assuming that does occur setting us a background by the way where Citi does expect the Chinese economy to be doing better in the second half of the year and I think that’s going to be a very important catalyst as well.
Q: How do you expect Asia to do in this backdrop? Do you expect Asia to go back and break the lows that it made last year because of all this turbulence? Is that your base case or do you think it will not come to that pass?
Robinson: Our houseview is that if you look at valuations right now we are at about 1.5 times price-to-book. If you look at historically that’s below its median range and if you look at Asia it vacillates between 1 and 3 times price-to-book.
So if you look at it historically we are already fairly reasonable. We are not expensive at all. If we do get some kind of resolution in Europe and if we see that full rally, there is pretty good chance of it.
If you look at historically you have had about 70% chance from here of making money over the next 12-24 months if you have been buying at these levels at 1.5 times price-to-book.
Q: So you don’t see a situation where Asia underperforms like it does in periods of global turbulence or has in the past?
Robinson: The big issue is the dollar. When the dollar is strong, Asia underperforms. So if we continue to see dollar strength then I think you are going to see Asia underperform. If we can get some kind of resolution to Europe, because I think most investors are gravitating to the dollar because of the risk, if that normalizes then you would see money flowing back into Asia and that’s our base case.
Q: Stock markets haven’t fallen that much in India as you pointed out, but the currency has. Do you think the currency is leading or pre-empting the stock market fall and can it take a bigger whack if the turbulence globally continues?
Narain: You have had a lead lag cycles that have tended to change what’s leading what. If you see the last leg the equity market was holding until a fair amount of time even if the currency had kind of fallen and the market tended to follow the currency.
You will get a lead lag and I don’t know which one will lead the other, but my sense is the moment one of those two move positively you should start eyeing the other asset class. It’s hard to make a call on which one will effectively move, but I don’t think there’s going to be too large a gap this time around between one of them moving.
Q: The other worry that a lot of investors have is that whichever way 17th of June and this turbulence pans out will at some point start getting into a growth scare across the world Asia included, because we are already seeing some fairly nasty forecast even for India. Do you think it will come to that a general derating of global equities?
Dennis: There is a distinct possibility that global growth could slowdown again for the time. We made a big deal in our research over the fact that in the last three or four years in particular it looks like emerging market equities have followed very closely where our global growth forecasts have been going. Since January our global growth forecast have ticked up and supported stronger markets earlier in the year, supported to a certain extent or maybe was anticipated by the rally that you had in October.
If we were to see global growth slowdown sharply again and lot of downgrades, I think that would be a concern. I somewhat doubt you are going to see much in the way of a pullback in global growth. As I said we feel that Chinese numbers will be vindicated second half of the year. US is probably growing about 2%. We have already got a negative number for Europe.
So I suspect some of these weak export numbers that everyone focuses on so heavily in Asia are partly reflective of frankly a very, very weak European economy. It may not be long before you see some turnaround there. So there is certainly a risk. The fundamental view we have is that global economy is not going back into recession. We are not going back to where we were in 2009 and if that’s true at some point equities have to find a floor.
Q: What about India in that context? Do you think we are really going to sub-6.5% kind of growth even for India? If yes, is it in the price and what ramifications does it have for earnings next year?
Narain: In many senses the market is trading off a 6-7% growth rate level. In some senses expectations have effectively tended to move down. It’s a little hard to really forecast very aggressively how things will change, but my own sense is that the economy is in some senses bottoming out and holding at a particular level.
Unless you have massively negative developments either globally or domestically in some senses you have kind of troughed out. When it’s going to be move back up is going to be a function of how things change both domestically and potentially a little internationally.
But in many senses, at the operating level, the growth option has been taken out of valuations and in terms of earnings forecasts and the base level of growth is what you are effectively getting at this point in time. So that’s one bit. In terms of valuations getting moving down as growth levels have moved down, the market is factoring in about a 6-7% growth level.
What is key to keep in mind is the fact that earnings don’t necessarily follow growth. So if you see developed market and Geoffrey has done some very good work on it, the relative growth premium that Asia has had or emerging markets have had vis-à-vis the developed markets has been very significant compared to the EPS growth premium that these markets have had vis-à-vis the developed markets. In many senses even if your GDP growth is a little lower, it should not necessarily reflect in earnings.
Q: What is investor positioning like? Is it still ultra-defensive wherever people are invested? Whether they want to hide in the safety of cash or are we looking at plays which are benefiting from currency, depreciation? What kind of orientation do you see from investors in Asia?
Robinson: The flows have been negative but nothing to panic order. From our work we see that investors are fairly balanced, probably not defensive enough, so one of the reports that we put out recently is focusing on dividends. If you look at Asia ex in the context of dividends, dividends have outperformed growth. Most global investors buy Asia for dividends.
If you look at dividends, they are still, very little dedicated dividend money for Asia whereas in the Europe and the US there is a lot of money dedicated to more defensive portfolios. In Asia it’s a far less popular way to invest but it actually outperforms growth. So we have put together recently a basket of dividend stocks that investors should be buying. Even now throughout the summer weakness just put that away for a couple of years.
Q: You guys are still running a significant underweight on India relative to other Asian markets, right?
Robinson: Correct. Our biggest overweight are Hong Kong, Korea and Taiwan. That’s where we see biggest value. Our biggest underweight are Australia and India and to a certain extent Japan.
Q: Why such a negative stance on India relatively speaking? Is it to do with policy issues or our macros?
Dennis: I always like to say that I can’t be overweight everything. Everyone sometimes would like me to be overweight on everything. We broadly try to stay consistent as well with the work across the region. We have been concerned about the domestic fundamentals frankly.
The slowdown in growth, the deterioration has been in the mix of inflation with growth. The current account which in a world where emerging market fundamentals have really got a lot better in the last several years compared to what they were like say 10 years ago even at sometimes seven-eight years ago, India doesn’t look so good on current account front.
I am not so worried about the rupee because what we all got to remember is that dollar has been very strong. You see the number of major emerging market currencies coming under pressures. But it just looks just kind of bad and it is difficult to know how India would stop the rupee going down except by maybe aggressively tightening monetary policy which I am sure it already want to do.
Foreign investors are also concerned about the lack of strong prospects or structural reforms. But this is always under scrutiny. Things could change including the markets cheapened up although to be fair, most markets have cheapened up as well.
Q: Given the combination of circumstances around India today, do you think it is likely we will get to those bear market trough valuations which is typically 10 kind of PE in the past or do you think it won’t come to that?
Narain: Unless there is a huge external or a huge internal event, I don’t think so. I think in many senses this provides you a very decent base.
Q: At the conference you would have met several investors. What worries them most about India?
Narain: I think the biggest worry I suspect is the currency because that is something you don’t have the ability to push it out three months or six months if there is a problem. That is some place very simply where you simply don’t have the reserve. You can run with lower interest rates even with higher inflation if your call is that you need lower interest rates.
With the currency, your flexibility tends to be a little reduced. So, the biggest worry really is on the currency front because that is where you don’t have as much control or as much ability to fix it.
If there is a problem and you decide to do all the things required to fix it, there is not enough to suggest that will get fixed quickly enough. Unlike the fiscal deficit, inflation to some extent and some of the policy issues that have been an overhang on the market.
Q: What is the Asian take on another liquidity event if things really become bad and LTRO kind of thing, ECB injecting liquidity or even liquidity from the Fed? Do you think that kind of outcome might lead to spark of a rally anytime this year?
Robinson: The liquidity injections, you get a risk on type environment and so yes we would see flows back into emerging markets. As long as the dollar is strong and that’s where it tends to affect Asia pretty dramatically when it comes to flows.
If we were to get a massive liquidity injection, you would see the dollar start to sell off and other currencies rise temporarily if not for a while. You would see money coming back into emerging markets in India and Asia.
Q: But you are saying unless the dollar index itself trades below 80 sustainably, you find it hard to conceive a major emerging market outperformance?
Robinson: It is difficult to pin point an actual point in the dollar basket but the dollar basket has been in an uptrend since last May so a whole year. That tends to dampen the flows and you tend to see outflows from Asia in that context.
Q: Is it going to be easy to make money from equities this year? So far we have not made too much this year but do you think there could be a laid surge which actually is rewarding.
Dennis: There is more like to be a late surge then another big sell off to be honest. We made a lot of money in the first nine weeks of the year then gave it all back subsequently. The point which we are trying to emphasize to investors against the back round of clear genuine uncertainty of what happens in Europe is that the global economy we thinks its growing, valuations have clearly dropped to extremely attractive levels, not to the bargain basement levels of October 2008, but have come back considerably.
Brent has already mentioned the price to book story within Asia itself. Therefore, we are pricing ourselves now for some negative events and if those negative events don’t occur, again the euro situation settles down for a while, the seasons improve later in the year, the earnings growth is decent, its not super but its decent. Those are the conditions under which you could get strong rally and of course if we got some liquidity injection from the ECB as well the major central banks generally that would facilitate that as well. We think we still got a reasonable chance to get returns of upto 20% this year in equities in emerging.
Q: What about earnings? FY12 was not great, very anemic kind of earnings growth. Are we staring another anemic year in FY13?
Narain: The numbers that we are starting out with are about 12-13%. We have historically over the last two years started out with stronger numbers that have effectively come through. My sense is at this point in time if GDP does slow earnings can effectively hold.
Secondly, in terms of the downgrade cycle, in many senses that has effectively tended to bottom out. At points in time a couple of months back when the market was relatively strong a lot of people were talking about an upward moving earnings cycle, update cycle, which hasn’t effectively transpired with these results.
It is a little U-shaped so some of the gains are going to be a little back ended, but I would tend to believe a 12-13% number for earnings growth for the current year is a reasonable number to start out with. In the context that at the end of the day the earnings that the market looks at are the earnings of the top couple of companies. If anything tend to often benefit in a slightly slower economy and in an environment where they have cut out some of the excessive that they may done historically in the past from a cost perspective and from a profitability perspective.
Q: When you look out the next 12-18 months does it appear to you that we are in markets which are at best ranging and you will get middling kind of returns at best but not like bull market returns from Asia or is your base case that at some point things will turn and you will get back to getting those bull market kind of trends?
Robinson: It’s very difficult to say. There has been a lot of negative news with European situation and the Western global financial crisis a few years ago. We are pricing in a lot of that as we started saying at 1.5 times price the book for Asia you are below the natural average over a 35-40 year period.
Our sense is we are going to go higher in the year end and whether we go into a bull market is difficult to say right now, but the global economy is taken an awful big hit over the last couple of years. So, there should be a natural recovery if we can just get the politics out of the way.
Q: Assigning probabilities to outcomes. As you said your base case is 20% rally from around these levels, probability to a 20% fall from this kind of levels for equities which would be a capitulation?
Dennis: I would give it a small possibility but what if I say would be a possibility and that would happen if the elections result was in the wrong way in Greece with the government being formed by the extremes. You got a very rapid move towards Greece leaving the euro that could involve a hard default.
That would obviously create more tenacity for investors to take risk off the table. For us as equity people you would have to extrapolate and say you sell these markets if you think that rolls the global economy back towards recession which it could do. So, that’s your negative scenario.
If that’s not going to happen, should have there been some other hit to the global economy out there and we frankly can't see right now. China picks up a little bit, US economy does have to deal with the fiscal cliff at the end of the year, but you get some tiny, but some of that is removed, so it is kind of hard to see whether 20% downside is coming. Should have been further significant disruption in Europe and that would be the scenario under which you would get that sort of performance.
Q: Would it be fair to say that you would have higher conviction in this call by the end of June one way or the other?
Dennis: It is unfortunately going to be a very much event driven. The danger to be honest is that we all really do believe that there is a very strong chance that Greece will ultimately leave the euro at some point. The Citi view is 50-75% chance of leaving the euro by the end of next year. Even with a good election result and some sort of rally the people worry does it solve the situation over the long term.
So if that’s going to continue to be to create volatility, but the outright big decline from here has to come from further major disruption in Europe that the central banks are unable to offset in terms of liquidity and confidence in the markets.