The market is currently driven by global liquidity and it would be too early for investors to take money off the table, Apabhai of Citigroup has said. Yes, valuations do look extreme but investors should not worry about that too much and enjoy the liquidity party for a month of two.
Riding high on the liquidity bandwagon, the Nifty, which has already rallied over 12 percent so far in 2017, looks poised to hit 9,500-9600 mark in the next 4-6 weeks, says Mohammed Apabhai, Head of Asia trading strategy at Citigroup Global Markets in an exclusive interview with CNBC-TV18.
The market is currently driven by global liquidity and it would be too early for investors to take money off the table, he said. Yes, valuations do look extreme but investors should not worry about that too much and enjoy the liquidity party for a month of two, he added.
Commenting on the level of euphoria which the market is experiencing, Apabhai is of the view that the market is nowhere close to 2008 bubble and see another 4-5 percent gain in US indices before it starts to cool off.
However, there is a surge in bond yields, it could become a problem of emerging markets which are experiencing consistent flows from across the world. “We have seen consistent flows coming into Taiwan, China, Korea, India and then Brazil,” said Apabhai.
But, if US 10-year bond yields rise over 2.75 percent, it will be problematic for emerging markets. India has been off the radar for foreign investors but the flows have now started to pick up recently.
The recent state election results and markets speeding over 9,000 augments well for India, said Apabhai. There is more upside in India markets, hence investors should not worry too much about occasional profit-taking dips.
He further added the even though we have witnessed an outperformance in emerging markets, but there are a number of risks which could pan out probably in the next 5-6 months which investors should be wary about.
The hope-based rally seen in US markets is largely on account of talks of re-inflation, tax cuts and if the current scenario doesn’t pan out according to market expectations, the flows could well reverse.
Apabhai highlighted that foreign investors are already underweight in Hong Kong & China and if China continues to devalue RMB, it would create further pressure on markets across the globe.
Below is the verbatim transcript of Mohammed Apabhai's interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.
Latha: Where are we now? We have seen a big rally in Indian markets from Budget in 2017 but in 2016 as well. Would you worry about valuations now? Are you still buying India?
A: Markets are still very much being driven by global liquidity and that liquidity is appearing in all across the region. We have got an indication that we look quite closely at the Central Bank balance sheet indicator which looks at the aggregate level of global Central Bank balance sheet across the world and what is happening is that indicator has hit a record high today.
What that is doing is it is pumping this money right across the region. What we are seeing is the money going not only into equities and emerging market equities but also into credit, commodity and bond markets as well. So for the time being we think that this is a liquidity party. Investors should continue to enjoy it.
It is a bit too early to take money off the table. We do see some problems in the next three-four months but at least for the next month or two maybe until late April, early May is probably worth just sticking the course and when we get such a strong liquidity inflow coming into the region then we are going to get into a region where you get the valuations at pretty extreme places. So, there are investors who are concerned out there but it does seem like the liquidity is just forcing them out of the market every time they try to fight against it.
Anuj: You have seen a lot of market cycles. Tell us the kind of fund flow situation that we have right now, are we more closer to the 2000 to 2003 phase or more closer to the 2008 phase from emerging market point of view for the larger picture?
A: From an emerging markets point of view, we are nowhere near the 2008 phase where equities go in to a bubble and we sort of see the parabolic behaviour as the valuations are just far too cheap for that to be happening maybe not in certain markets maybe not in India for example but even in India we are not at extreme levels of valuation.
What we thought going to happen was a few weeks ago, early February, we sent out a note to our investors saying that we thought the markets were at this crucial inflection point that either markets were going to turn down or there was going to be a very quick move up and what we saw was the fastest 100 points move up ever in the S&P after that call for an inflection point high.
We think what is going to happen is that within another 4-5 percent to where we are right now, so in the US equity market maybe another 4 percent is where we are right now, there is another point at which the market is going to have to decide whether it wants to go into a bubble or not. So from that perspective where we are at the moment is probably not completely dissimilar to what we saw in 2013 where we had a lot of liquidity that was coming in as a result of various quantitative easing (QE) programmes from the different central banks.
At that time, it was bond yields that punctured the euphoria in May 2013. This time around if we get to bond yields around 2.75 percent on the US 10-year, it will probably be a little bit more problematic for emerging markets, we would be looking quite closely at that as well. But at the moment at least in the immediate short-term, we are not seeing any of that at all.
Sonia: I wanted your view particularly on India. What is the sentiment amongst large FII investors and traders that you have spoken to with respect to India now? Are big funds putting in chunks of money to work in the Indian markets?
A: It is interesting because I was in Europe about two-three weeks ago and we probably spoke to about 60-70 investors over that time and we had discussions from Japan to China to Korea and Taiwan and various other places across the region and India never came up even once. So it does seem that India was a bit off the radar for foreign investors now.
I think the investors were waiting for the outcome of the election and what we have seen is even in the last week we have been drawing the parallels between markets like Korea where we have had the impeachment of the president, the new president is now going to come probably on May 9 and the breakout that we saw in the equity market there figured a chase for a couple of days and it seems like there is still some more upside to go.
If you compare that to India as well where what we have seen is you have seen the positive result from the market perspective of the state elections, a breakout above 9,000 and then people are sitting there wondering whether they should be chasing or not. So at the moment what we are seeing is this wave of money that is coming in across the region. The one that is catching most people off guard is not in India. They still have exposure to India. The one market that they are very underweight in is probably Hong Kong and China and that is very much driven by credit markets.
The other thing that your investors might be interested in looking at is this correlation that is built up since the US election in November 2016 between the Indian equity market and China credit. China credit has been driving most of north Asia but what has been very interesting is that India now seems to have joined that camp and so that correlation seems to have increased whereas in the developed markets, the correlation is very much to US 10-year bond yield. So what we have seen in the last few weeks is that US 10-year bond yields have been going up and they seem to have stalled and those equity markets in the developed markets have stalled as well but China's credit-default swap (CDS) continues to tighten. We are thinking that credit is now looking very expensive relative to equity but again the liquidity continues to flow in and until that liquidity stops, it is going to be too early to fight this market.
Latha: Can you give your pecking order in emerging markets?
A: It is quite difficult in terms of trying to decide where the market is going to allocate the capital. The way we have been watching it is that basically there is fair ground game of whack a mole where you basically have the mole appearing on one of the holes and then you whack it down and basically it appears somewhere else. So what we have seen is liquidity coming into Taiwan from Taiwan it went into China, from there the leadership we picked up in Korea, last few days we have seen it going into India, we have seen it going into Brazil. So it is going to be quite a high correlation.
What is happening is that people are looking for the underperforming markets and rotating back into those as well. Going forward picture is not one of unconstrained bullishness, one of the things that we are looking at is that the whole of this rally from the US election has been driven very much by hopes of reflation emanating from the US and from President Trump but also coming from China. So you have seen the recent producer price index (PPI) data that has been coming out from China and people are hoping that what that means is that the Chinese credit problems will heal.
If you believe that, there is going to be very significant upside in the Chinese equity markets and some of the numbers that we have done indicate that if the financials can eliminate this credit problem that they have, you could be looking at 60-70 percent return fairly quickly in China and we saw that for example in 2015.
Unfortunately, we are not believers of that scenario and one of the things that concerns us is that some of the things that we are looking at in terms of forward indicators are indicating that China PPI and therefore US consumer price index (CPI) as well could turn lower by the end of the year. If that happens then that is going to be very much a realisation like what happened in 2011-2012-2013 where the market got ahead of itself in terms of the reflation argument and finds that they get disappointed but that is going to be a story for the late Q2 or maybe early Q3 as we find out exactly whether this reflation hypothesis plays itself out or not.
Latha: You began by telling us that there is a huge liquidity rally that investors should enjoy but in your last answer, you have raised one red flag in the second half in terms of Chinese PPI and the Chinese financial sector, what and when are the red flags you would watch out for in this liquidity rally?
A: There is a number of red flags that are probably going to come up and I want to emphasize that these are not things that are going to happen in the immediate short-term, these are more for the post May-June timeframe.
Over that timeframe, what we are going to see are things like the hypothesis that we have had is one of reflation, now the other thing that the equity markets are looking at, especially in the US, is tax cuts. One very simple way of looking at this and it is obviously very simplistic way of looking at it is if you look at US equities where they bottomed on November 9 somewhere around 2013 and then if you assume that one percent tax cut is effectively one percent on the S&P then if Mr Trump is going to cut taxes by 20 percent that gives you a target of somewhere around 2460-2470 on the S&P as to where to go.
Now, if you get to the middle of June and you find that the tax cuts are either delayed or they are not going to happen in the way that the market thinks or they are not as large as what the market expects then of course that is going to be coming back.
Another thing that you need to look at is what happens with earnings. So for example in the US, the earnings are already being scaled back for the second quarter. If that continues then that would be giving markets another room to pose. Yet another factor we are expecting the Chinese renminbi to continue tis devaluation to resume its devaluation, it has been pretty stable since the beginning of this year despite market expectations that the renminbi would continue to devalue. That has not happened but we think that is going to start again probably at the end of the last week or March and then continue feeding through.
If that also coincides with the time when the People’s Bank of China (PBOC) and the Chinese authorities crack down on commodities speculation that will be very negative. I was looking at just before I came here the forward curves on the commodity prices on things like iron ore and basically December contract is about 20 percent below where we are in terms of the spot futures contracts. So again that would be a disinflationary force.
Again we have not seen any action from Mr Trump on tariffs or anything that would cause the rally, so there are a lot of things that potentially could be negative but above it all if there is something in terms of the market considering that the liquidity that maybe coming from the Fed, the European Central Bank (ECB), the Bank of Japan (BoJ) or if there is a big outflow from PBOC reserves then those would be very negative. I can give you a lot of reasons why you want to be bearish right now but I do not think it is the time to be positioning for it right now.
Anuj: These could be outliers and will deal with them when they play out. You said that India has been off the radar of foreign investors and we saw that in numbers all through the last quarter of last year in particular. Now that we have started to see some inflows into our market, do you get a sense that we could go through a foreign investor capitulation if the momentum picks up in our market and we could see a lot of exchange trade fund (ETF) inflows into Indian markets?
A: Yes, I think it is possible. What we are seeing at the moment is the first stage of that is the allocation of capital through emerging market ETFs and even in the last couple of days, we have seen the emerging market inflows coming in. Today it might be a little bit of an aberration that is a big Footsie rebalance that is happening right across the region, that will see net outflows coming out of markets like China, Japan, Taiwan as well but I think the flow is definitely coming in. We have seen an outperformance of emerging markets so far this year. It is about 7 percent, put that into context over the last five years, emerging markets have underperformed developed markets by something like 70 percent. We do not think that is going to reverse but at least this is the time when the market becomes a little bit more hopeful and we still think that there is some upside in the Indian markets maybe 9,575-9,600 and it may happen within the next four-six weeks even.
Sonia: The last time you spoke with us, you said that the quality of this rally was low and you were not too happy with that. This time around are things different, has the quality improved or the purely a liquidity driven rally and not something based on economics and growth?
A: It is very much based on the hope of economic growth and a hope of reflation and of course equities rally on the basis of hope. It is one of the reasons why people like me appear on television to talk about these sort of things.
However, I think the thing is that if this reflation does happen then we have not even started to see the moves yet in the bond market to replace that and of course that will mean very significant sector and country allocations.
Of course, if the reflation does not happen then everything that we have seen happening over the last three-four months will go into reverse. One of the things that is very interesting is that emerging markets -- you can paint a scenario where if we stay in this trading range, it will be the ideal environment with the dollar relatively weak. What is very interesting at the moment is that if we are looking at markets like Korea and Taiwan, what is happening is that the leadership is with very few stocks. So things like Samsung Electronics etc -- these names are leading the market. Even in India if you look at what has been moving the market higher, it has been things like Reliance Industries as far as I can tell and some of these under-owned names.
Now from that perspective what is happening is that the headline index level is going up. What we need to look at from hereon for the next leg of the rally is stocks that are going to deliver some quality earnings. Whether you should be in cyclicals or in defensives, depends on your view of reflation. If you do believe that reflation is happening then you do want to be in those cyclical sectors, which is still quite underowned despite the repositioning that we have had.
However, unfortunately if the reflation does not happen, potentially you could get the next leg of the bond market move down could see US 10-year bond yields down as low as one percent if that reflation does not occur. So that is the big call that investors need to make, when they are having a look through their portfolios -- that is the question that you need to answer whether they are on the reflation camp or whether they think that the disinflation that has been haunting markets for the last 10 years will return.Disclosure: Reliance Industries, which owns Reliance Jio, also owns Network18, which publishes Moneycontrol.