HSBC expects 10-15% returns from EM; crude to head higher

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Arjuna Mahendran, managing director and head of investment strategy (Asia) at HSBC Private Bank (Suisse) says that he is not too worried about the Greek situation at the moment. Speaking to CNBC-TV18 in an exclusive interview, he says that liquidity into emerging markets will continue driving equities. "In fact, the LTRO by European Commercial Bank and further quantitative easing in US may push equities much higher," he says. However, crude may inch higher due to the liquidity situation and also aided by geopolitical issues.

Mahendran expects returns from EMs, including India, to the tune of another 10-15%.

Below is the edited transcript of the interview. Also watch the accompanying video.

Q: Do you expect this kind of liquidity last through February or are you getting worried about the lack of resolution in Greece?

A: I am getting less worried right now because if you look at the liquidity situation, particularly foreign flows into emerging market funds, it's been quite positive since about mid-January. A broader picture when you look at the world, obviously they are the short term worries about Greece etc and perhaps some of these markets are overbought at the moment technically, but apart from that the growth in the US seems so real; the employment numbers cast aside any doubts that the US recovery is finding its feet and Europe is still not impacting it adversely. Over in the emerging markets, we have positive news that China and India are now starting to relax their tight monetary policy. So from that perspective, unless there is some big accident in the energy markets which is what we are looking at closely, the risks are subsiding.

Q: Returns have been quite sizable as well for a market like India. In dollar terms, we have already done about 20-22%. Would you say there is still the potential of big upside on equity market prices with risk on and the money you are seeing?

A: In general, I expect another 10-15% in most of the large emerging markets, India included. But of course, we could overshoot rather than undershoot; the risk is more for an overshoot if liquidity really starts flowing this way in earnest. It seems that with some signs that the dollar could be shedding some of its strength early this year and if that trend continues, which I expect it will, because risk is receding and therefore the demand for safe haven asset such as US treasuries are probably not as strong as they were. There is a fair chance that we could do quite well all around in the emerging markets.

Q: Do you think in February when we have another round of Long Term Refinancing Operation (LTRO), we could have even a bubble like situation building up in asset classes globally with so much money sloshing around, do you think they could spike to levels which we can't think even today after the rally?

A: Considering the numbers that the banks in Europe are talking about of one trillion euro in the February round of LTRO which is double what they issued in December, that certainly is a lot of money, and it has to find home somewhere. I am certain that we'll see a repeat of the QE2 episode in the US, when you remember, money started sloshing around the emerging markets. So all that money is headed in our direction and yes, I would agree that there is more risk of overshooting rather then undershooting in our equity markets going forward. But there are risks as well, so it's going to be a fairly rocky ride along the way.

Q: On the energy prices, is it a function of the tightening of sanctions by the US towards Iran or do you think there is some kind of bubble building already and that could impact a market like India specifically?

A: We had a fairly warm winter so far in the US and Europe. That was one of the reasons why US GDP did so well in the fourth quarter of last year; more and more people were employed. Now this cold snap has hit Europe and the demand for heating oil will certainly start shooting up. Given that supply constraints are still fairly tight in the short term and this threat of Iran doing something nasty in the Strait of Hormuz ever present, the trade is a bit jittery and that really is where the risk comes from. If there was some geopolitical issue that crops up.

Q: What about the currency then, this pull back trade from 54 to 48.50? With the kind of money that's coming in would you extrapolate this recent strength in the rupee?

A: Absolutely. Like I said, the more LTRO money that's printed in Europe, that's going to be converted into emerging market currencies and head in our direction. So I am expecting most currencies - the Indian rupee, the rupiah, the Singapore dollar etc to see some fairly strong up moves in the next six months. Of course, the central banks will always try and intervene at some point to stop the currencies from affecting export as adversely. That really is something that has to be factored in, but nevertheless, the trend is definitely going to be up with for emerging market currencies from now on.