Since early last year they have preferred the developed markets over emerging markets and with the recent events in terms of time table for Fed tapering has reinforced that view, says Clive McDonnell.
Clive McDonnell, Head of Emerging-markets Equity Strategy, Standard Chartered Bank says developed markets were preferred over emerging markets for over a year; and with the recent events in terms of time table for Fed tapering, the view on developed market has only been reinforced.
Commenting on the corporate survey done by them across markets, he says they have seen deterioration in corporate sentiment across India in general. McDonnell remains skeptical of the cement sector since its growth is tied to that of infrastructure. He likes auto space because of its robust order outlook.
He also expects 25-50 basis rate cut from RBI in the July policy.
Below is the verbatim transcript of his interview on CNBC-TV18
Q: Because of the events of the last couple of weeks, that is what the Fed had to say and the kind of jobs data we got from the US have you changed your calls significantly on emerging markets (EM) like India?
A: No, we have not made any radical change in terms of our overweight recommendation for the Indian equity market. Certainly we have been surprised at the overwhelming nature of the selling during June, but the main change that our teams have made is that they have brought forth their expectations for tapering by the Fed to September.
They have also nudged up their interest rate forecasts, their 10-year bond yield numbers by about 50 bps across the board. Those higher 10-year notes will not have a direct effect on India. India specifically, we do look for another 25-50 bps cut from the Reserve Bank of India (RBI).
Q: You have done a corporate survey across markets as well. Did India standout in good light in terms of growth prospects at the end of that survey?
A: India did standout, regrettably though for negative reasons. Our diffusion index fell to about 46 indicating that India is seeing quite a sharp deterioration in corporate sentiment. The number of areas where we saw weakness centered on new orders, also the outlook for business growth. Although on a positive note we did see that the corporates were not as anxious about the outlook for costs, but in general we have seen a bit of a deterioration in corporate sentiment across our survey in India.
Q: While some of these trends have been visible for industrials as a segment what did you observe for some of these consumption driven sectors, things like Fast Moving Consumer Goods (FMCG), autos, cement. What happened when you touched base with those kind of companies?
A: For the cement companies they are tied up with the outlook for infrastructure and they are continuing to see a challenging growth we would say. On the consumer space though, the outlook is a bit more constructive, particularly in auto space. I think from an analyst's point of view we are bottom-up, quite constructive towards autos and for those auto corporates that responded to our survey they are fairly upbeat in terms of the outlook for orders. Again they are seeing slight easing in terms of the cost pressures and they are upbeat in terms of their future business prospects.
Q: What is the broader call on EMs? It is coming down to that for a large number of global investors on whether this asset class will continue its underperformance and therefore is not the right place to be for sometime to come. What is your view on that basic question which people are grappling with?
A: I agree, it is the big call - the outlook for the emerging universe versus the developed markets (DM). We continue to prefer the developed world versus emerging. That has been the case since early last year and certainly recent events in terms of the time table for Fed tapering reinforced that view.
When we look at portfolio flows across the EM universe, obviously we have seen significant redemptions over the past 8 weeks or so, but it is interesting that the selling of EM equity funds is dominated by Exchange-Traded Funds (ETF). That is a reversal of what we saw in 2012.
In 2012 approximately 70 percent of the inflows to the emerging universe were ETF-related and we are basically seeing the reversal of this year that - a very high proportion of the net selling is coming from ETFs. Interestingly active managers are still at the margin contributing a bit of money to the emerging universe But given that ETFs where the overwhelming inflow that we have seen over the past couple of years, if that reverses, it more than overwhelms the intensity of active fund buying. So we will continue to favour the developed world over EMs as we head towards a tapering by the Fed.
Q: Could you just flesh out that point a bit more about what you are seeing with ETF outflows both in the context of whether this is happening generally with EM ETFs and there is not that much country specific activity so people are treating EMs as a whole? Secondly, how much of a role the currency is playing? Is it this rout in the EM currencies that is causing accelerated redemptions?
A: I do not think investors in the US or Europe are taking a call on the EM currencies. I think rather they are trying to lock in some of the gains that they may have seen. But it is indiscriminate. Most of the outflows are proportionate with the size of the individual markets and the benchmark, so hence that is reflected in ETF outflows.
In terms of Fx specifically though, I do think that the outflows from the equity universe in combination with the fixed income outflows are certainly putting pressure on currencies where relevant. So we are seeing currencies such as the Indian rupee in particular come under a significant pressure.
In terms of the Chinese yuan the currency is not free-floating and we are not seeing as much depreciation. We are certainly seeing downward pressure on the yuan at the moment and the period of yuan appreciation would seem to be over for now we would say.
Q: This ETF selling is a fairly recent phenomenon. It has lasted the last couple of months. Do you have any numbers to just buttress the point that you were making that maybe ETF outflows are so large given the context of how much came in that in the near-term that is on the margin going to set prices in EMs rather than any buying that might happen from long only or active fund managers?
A: In terms of the number specifics year-to-date (YTD) we have seen about USD 15 billion of net flow into EM. Importantly, that is way down from the highs of about USD 28-30 billion that we saw around about March time, but in terms of the USD 20 billion where we are today we would say that from the highs that we were the outflows we have seen, we have seen probably YTD, ETF selling has been in the order of about probably around USD 25 billion and that is offset by USD 10 billion of the active inflows giving us the net number of about USD 15 billion in inflows. Therefore, quite clearly the ETF selling is overwhelming what active buying is there.
If we contrast that with last year, last year we saw about USD 55 billion flow into EM universe. About 80 percent of that was ETF related. So, we are seeing that we were big beneficiaries of the ETF inflows last year and now that process is completely reversing and overwhelming the marginal buying that is taking place amongst active fund managers.