Excerpts from CNBC-TV18’s exclusive interview with Christopher Wood:

Q: We have had relative stability in global equity markets this week. There has been a bit of a bounceback. Do you think the worst is over then or there is more to come?

A: Well, my own view is that the next few months should see a material slowdown in the US economy, caused by continued downturn in US housing and growing evidence of weakening US consumption, primarily because of the housing impact and higher interest rates. So, my own view is that Asian and world markets will have to navigate a few more headwinds into the year-end. But the silver lining is, it looks increasingly likely that the Federal Reserve is going to be easing its monetary policy.

Q: So, you are expecting a rate cut on the September 18 from the US Fed?

A: I think if stock markets keep going straight up till the September 18, I am not sure the Fed will cut rates. But I do expect the Fed to be cutting rates at some point in the next 2-3 months in response to evidence of slowing economic activity, of the deteriorating labour market, of deteriorating income growth, and I am expecting more of a correction in the oil-led commodity complex. So, for all those reasons, I expect the Fed to start cutting rates.

But given the fact that the Fed has already injected a lot of liquidity, cut the discount rates, and effectively bailed out one or two financial players by its action last Friday, if the stock market goes limit up between now and the FOMC meeting anticipating the Fed easing, it may choose not to cut.

Q: What do you think is the equity market pricing in or suggesting with its action this week? Do you think it is pricing in a benign scenario that subprime woes might be overdone and maybe it is time to get back on track or do you think it is just a rebound from oversold ground?

A: No. I think the equity market is just reflecting relief that the Fed has acted, staving off at least for the moment what was going to be one or two prominent financial institutions going under and the equity market in my view is just reflecting pure relief and reflecting the fact that the asset backed commercial paper have not yet migrated into a major problem into the US money market funds. But I think it is very important to understand that what people call a subprime crisis is not a subprime crisis. The subprime issue is simply the catalyst that has exposed the real crisis in the whole asset of structured credit. In my view, all aspects of structured finance are now viewed with caution. Investors are very circumspect about them. In the last 7-8 years, world financial markets and institutions, particularly US and European financial institutions have created a new asset classes called Structured Credit, and in my view this asset class has now been discredited as in, in the process of self-destructing.

Q: A lot of commentators and analysts have called this subprime issue a financial problem essentially and a localised financial problem at that. But you are suggesting that this could become a real economic problem not just an isolated financial problem that is easy to resolve?

A: In the US this will have economic consequence, because in many respects, the financial world is more important than the real economy in the US. Off the top of my head, about 30% of profits on the S&P relate to the financial services sector. So, this has serious collateral damage for the US economy. I am expecting house prices to be falling at high single digit rates by the end of this year in the US.

But from India’s perspective I think it is just collateral damage. India is the Asian economy most driven by domestic demand; the Asian economy is the least dependent on US exports. Therefore from an Indian perspective I think it is collateral damage but nothing fundamental. But from a US perspective, I think there is real damage to the economy. So, it depends on which economy you are talking about.

Q: To the extent that the US could be going into a recession, is that your prognosis?

A: I think the US is clearly at risk of going into a recession. I am not an economist; I am looking at it from a market standpoint. From the market standpoint, the conclusions are clear, all the risks to the economy are on the downside, even though the US might not go ultimately into recession, all the risks are on the downside, consumption is going to slow, the Fed is likely to be easing sooner or later. All the risks are on the downside. I don’t want to own exporters in Asia with high operational leverage, I don’t want to own commodity plays, I feel much more favourably disposed towards interest rate sensitives in Asia because in my view the Fed is going to be cutting rates sooner rather than later.

Q: Commodities have corrected a bit, but they have not quite collapsed this time around. Do you expect much more damage to be seen in the commodity space, in the metals space too?

A: No, I expect oil and metals to correct more in the next 2 or 3 months on evidence of accelerating economic slowdown in the US. In my view, the silver lining of that commodity correction is that it will provide more evidence to the Fed Chairman to ease. I think the Fed Chairman is looking for evidence in the real economy of more of a slowdown to ease, hence he only moved on the discount rate not on the Federal funds rate.

Q: What happens to the whole liquidity spectrum in the emerging market universe now? We have seen some deleveraging happening, but because of the problems that are now manifesting themselves, do you expect some more deleveraging to happen in the next few months even from the emerging market basket?

A: No, we are definitely at risk of more for selling. This is the biggest issue for the Indian market; there is a lot of foreign money in the Indian stock market to the extent that Indian stocks are being bought by a multi-strategy hedge fund, to the extent that the black box quant fund, multi-strategy hedge fund was down 30% last month or maybe more or maybe less, but down a lot. These sort of multi-strategy funds will be looking to sell where they have got profits, where they most likely have decent profits before the correction in Asian emerging market equities.

So, the risk of collateral damage for emerging market equities and Indian markets will continue for the next two to three months. But to me, that is a short-term risk. The bull story remains intact, the long-term bull story on India and emerging markets.

In my view, the next bubble to form out of the coming world central bank easings, which will be the consequence of the accelerating US slowdown that we are now going to see, the next bubble beneficiary to form in the next few years won’t be in America, it will be an asset bubble in Asian emerging markets, be those asset prices, stocks or property.

So, my big picture message is very simple. This correction that I personally think that we are going to see more of in the next two or three months, is essentially a long term buying opportunity for Asian emerging markets. I think India remains as good an equity story as exists in the global emerging markets.

Q: I know it is difficult to predict, but from the top off your head, how much more of a correction do you expect to see in Asian emerging markets including India in the next quarter?

A: My worst case for Asia ex-Japan markets, including India, the worst case if the US goes into a real recession, is one third down from the recent peak.

Q: We are about 10-12% down already, so you are saying we could slip another 20%, as much as that from here?

A: Sure, if we go into a real recession. If I am completely wrong and the US consumer does not slow at all in response to these financial crises of recent weeks, and there is no further slowdown, my guess would be that Asia bottomed last Friday, a week ago. My own view is the likely downside lies somewhere between last Friday and that one-third.

Q: What about the famous decoupling theory which has been going around that emerging markets will stand out this time and outperform the US in a big fashion, you don’t see that playing out just yet then?

A: Asian emerging markets have been incrementally decoupling to a fantastic extent, their outperformance over the US has been absolutely enormous since 2003. So there is plenty of evidence of incremental decoupling.

In terms of outright, absolute decoupling, Asia going down, US going up, that is only going to happen after the US has a recession because if you have a US recession then you have the stress test. If Asia does not collapse when that US recession happens then conviction will grow on the resilience of Asian emerging markets, then you will get a definite decoupling. What we have had in recent year is an incremental decoupling. But the relative outperformance of Asian emerging markets has been enormous. So, I would argue incremental decoupling has already occurred.

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