Concerned about liquidity condition in India: MS

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Malcolm Wood , Asia Pacific Equity Strategist at Morgan Stanley has a view that the run-up in EM s may continue though lot of good news has already been priced in. He feels that there is strong liquidity within Asia coupled with bullish investor sentiment as there is a high degree of confidence in the investor community.

Woods is concerned about liquidity conditions in India and feels that RBI may tighten further. He is currently adopting a wait and watch approach towards India. Conditions are fairly ripe for correction though this is not end of bull market, he says.

Excerpts from CNBC-TV18's exclusive interview with Malcom Wood:

Q: It has been an unprecedented and a fantastic run for global emerging markets , can this continue throughout this summer?

A: It is possible, but not our best-case scenario. We think there is a lot of good news priced into Asian markets. For a further move higher, we will have to see euphoria among the investor community, both from the international and domestic side.

Q: Over the last few weeks, emerging markets could have sold off from these levels, but it has not happened, like bond yields going up. But the markets go down for a day or two and then just recover to new highs. What would you put this resilience down to?

A: Yes, I think it can be attributed to the very strong liquidity conditions within Asia and also growing investor confidence. The bullish sentiments we get back from our customers would suggest that there is a high degree of confidence in the outlook from the investor community.

Q: Where do you think that confidence stems from, particularly for emerging markets?

A: I guess, there is some sense that we're bulletproof at the moment. There have been, as you would see in cricket, a few googlies delivered, but the market has played them all with a very straight bat. Oil prices went through USD 70 on Brent, gasoline prices at record levels, bond yields going higher again, China doing a little bit of tightening, all those things have happened, but markets have shrugged that off.

Q: What to your mind is the biggest concern? The markets should be cognizant. Is that what is happening in global commodities, the bond market, or a turn in the liquidity picture?

A: I think it is a combination of all three. Just step back a moment, look at where valuations are for Asia. For Asia-Pacific, valuations are now at a modest premium to global markets. That's the first time that has ever happened in the 20-year history of the Index.

So a high degree of optimism is already discounted in prices. It won't take too much deviation in the macro-outlook or the risk appetite of markets to disturb that positive set of affairs, whether that'd be a further back up in bond yields, some sort of credit event, some further concerns about the subprime market in the US or whether it'd be more aggressive tightening from the likes of China. All those are possibilities, it's difficult to identify just one.

Q: When you talk to hedge funds or absolute return kind of guys who might be setting the price on the margin, what are they doing? Are they putting more risk on the table, going even more long on emerging markets or have they started getting a bit cautious?

A: From the data that I have been privy to, it looks like absolute return investors are as extended or as fully invested at this point of time, as they have been in any point in the last twelve months. So there is a high degree of optimism among that group of investors. Indicators in Asia suggest that domestic investors are well and truly participating in the markets now. So it is a combination of optimism from institutional professional investors, as well as retail investors. 

Q: How would you sum up the mood on India now? The last couple of days have been good. What is your take from here?

A: I think the view on India is still very much in two camps. There's the camp, which says that it's an expensive market, liquidity conditions have tightened, the economy is too slow, that should slow earnings momentum, we'd like to buy it a little cheaper.

And then there is the school of thought that India outlook is improving as inflation has moderated, growth still looking pretty healthy, India looks okay.

Q7: Which camp are you in? To be fair, it has been a lot less volatile in terms of earnings than other emerging markets?

A: Absolutely right, we are in the former camp at the moment. So we are concerned about the liquidity conditions in India. There is a risk that the Reserve Bank of India will have to tighten rates further. It has certainly been a great run of inflation numbers that we do not know, but the underlying economy still looks robust to us. So we would be surprised if we did not see further action from the RBI, liquidity conditions are tight, earnings momentum is decelerating; we would like to buy the market at lower levels.

Q: We've had some fairly large domestic issuances in the primary market. Anything that you liked as a story over there, because there is real estate and banking?

A: There is a huge amount of equity issuance coming out of India. It's hard to see that matched anywhere in the region, outside the A-share market in China, at the moment. We've seen some of the issues doing fairly well, in spite of the size of them. Without naming names, it's fair to say that we'd be more focused on defensive sectors in India. Healthcare, perhaps select tech and some of the consumer staple names are the ones that you would want to be invested in.

Q: How do you see the next quarter for global markets, including India?

A: In our outlook for global markets, we have basically reached our year-end targets for many markets. We are ahead in Europe, we are a within a few percent in the US. In emerging markets, Jonathan Garner, our strategist, is only a couple of percent off his year-end target.

In Asia, we are right on my year-end target. So a lot of good news is baked in the market. Without being able to identify a catalyst for tomorrow, it seems possible to us that the conditions are fairly right for a correction. But we don't think this is the end of the bull market, by any means. We'll be buyers at the correction, looking for positive returns into the year-end and out into 2008.