Current rally to go on, eco growth seen lower: JP Morgan

Here is a verbatim transcript of the exclusive interview with Adrian Mowat on CNBC-TV18. Also watch the accompanying video.

Q: Is this pullback rally durable, does it have more legs or is it done for the moment?

A: This rally does have more legs to it, what we had since we started the Hungarian Current Account crisis at the beginning of last month was very rapid rolling fear of current account and liquidity issues around all emerging markets. The result of that was that credit default swaps for the sovereigns in our market spiked up and international and local investors decided they weren't going to buy any assets. There's a meltdown in the market but we will see a rebound from that meltdown and we are going recover into a global recession trade.

Some of the economic data coming out of the developed world is pretty disturbing. Car manufacturers sale were down 25% in the US. We see very weak economic data out of Japan and Europe. We are in the middle of what we call the worst consumer recession since the Second World War in the United States and that is synchronized with the developed economy. The outlook here is for significantly lower commodity and energy prices. Governments need to start easing the monetary policy and stop fighting inflation which is what they are doing in emerging markets for 2008. We are going to see fiscal measures. We must brace ourselves from really awful economic data this quarter. There will hopefully be a recovery into the second half of next year. There is an ongoing shockwave that's come out of this credit crunch, which is the price and availability of money globally has deteriorated and that has real implications on countries that have been spending beyond their means which is the current account deficit countries and unfortunately that does include India. The capital expenditure plans in India that are already being stated will need to be reduced and India's growth rate will need to pay back while the global credit conditions are as adverse as they are.

However, India will have the benefit of lower commodity or lower energy prices which will help the current account situation although it unfortunately doesn't help the consumer.

Q: Do you think we have seen the worst in terms of price damage at the end of October for equity markets or do you think that is as well up to text over the next few months?

A:  I believe we have seen the lows for indices. What we had and do have is capitulation selling. So we are going to see a recovery from the excessive level of risk fear that excessive concern about the credit quality of everything. However, we are moving into a period of significantly lower economic growth and that includes emerging markets as well as developed markets. Expectations for economic growth in India at this point in time are too high.

The buy side is discounting a fair amount of downgrades. We need to be a little careful about stock specific levels that the downgrade isn't too excessive. There will be a definite desire to buy more defensive names going forward which has got very cheap as well as the cyclical names. The government linked companies will also be preferred by investors because they will probably have the priority when it comes to lending from the banks. We are probably going to have a more robust growth from the private sector as we go into the early part of 2009.

Q: We just wrapped up an earnings quarter that didn't exactly cover itself in glory particularly on its margin performance. How bad do you think its going to get for the Indian earnings picture by the time we step into FY10?

A: The whole global margin story is a pretty ugly one at the moment. All economies are operating below potential so that's low operating rates and its also suggesting the pricing power will be poor. So we expect ongoing margin pressure, reduction in operating leverage and pushing down earnings. There are some positive offsets; input prices are now falling and so those manufacturers that are seeing margin pressure due to energy and steel prices are going to get some relief as we go into the second half.

Unfortunately, the story on interest cost is still rather poor. Central Banks are cutting interest rates but market prices continue to rise. Commercial paper rates in India  are 5% higher than what they were averaging in the past 24 months.

Corporate bond rates have also been rising and that is absolutely in sync with what we see globally. All this will put pressure on corporate net profit margins, and it will also pressurise their capital expenditure plans.         

Q: The intense pressure that we saw in September and October in India was a factor of the forced liquidation that we have been hearing about from many hedge funds. Do you think we have seen the worst of that or in the next few months we should be resigned to see more supply of stock on the margin rather than demand from global investors?

A: The long-only funds were seeing significant redemption pressure. If you think about the emerging market space or Bric space, Brazil and Russia fell sharply as commodity prices declined and that poor performance stimulated significant redemptions in emerging market funds and obviously the very troubled global financial system has added the general mutual fund redemptions. I am not a buyer of the story that this is all about hedge fund selling. Most hedge funds I speak to are using a very limited part of their balance sheet and they have been running either neutral or net short position because we have been in a bear market for about twelve months. This is not an environment where hedge funds are running large net-long positions. So this is traditional long-only money that is seeing redemption from its mutual fund holder and us being forced to sell in the market even at these distressed levels.

Will that continue? If we get a rebound in markets and see a bit of stability, you will see the redemption pressure easing off. What we need to see is expectations being brought down and earnings being revised down. Companies are starting to talk a little bit more cautiously and once that's priced in efficiently, we can start thinking about discounting a recovery into the second half of 2009.

Q: The consensus view seems to be by the end of 2009 calendar, we would have started the process of recovery globally and locally and the doomsayers say that this is not going to an easy road up - it will be a multi-year bear market. How are the odds stacked between those two views in your eyes?

A: I think you might get a multi-year bear market in some of the developed markets where economic growth remains significantly below potential as the consumer deleverage abd their savings rate rises. We seem to be getting shock treatment for that in the United States with a very dramatic change in consumer behaviour this quarter.

In the emerging economies, however, I would disagree with that view. Much of the slowdown that you have seen in emerging economies such as India is a function of tight monetary policy and high inflation that we are experiencing in the first half of this year. Remember the monetary policy has a lag to it so you are feeling the most of the pain in our economies in the emerging world at the moment. That pain is compounded by this extraordinary financial crisis that we are living through plus [there is] significant weakness in the developed economies.

As we go into second half of next year, the easing of monetary policy, the pro-growth policies that have been put in place will be stimulating domestic demand in emerging markets including India. Equities will also respond positively to that particularly as valuations have been pushed to levels that we have never seen before.

Q: Do you sense that a lot of Bric funds will either wind up or scale back in their size or not continue to see as much as interest as they did when we had stepped into this year in January?

A: For the near term, it is going to be very difficult to sell a Bric fund because of the outlook for global commodity and energy prices in this significant developed world recession. We are going to see much more modest flows occurring from foreign institutional investors into India. Assuming that they might even turn back into the positive, the benefit you do have in India is that you have growing life-insurance companies, you have recently-stabilised mutual-fund rates, and so that will help un-defend the markets and the markets will become a lot more logical going forward.

What we have experienced around the world is the sell-down of an asset class rather than any differentiation between the relative fundamentals of stocks that will change over the next 12 months. You will see a real dispersion return and the active money market managers and mutual fund managers are going to be out in this market.