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Jun 18, 2013, 10.39 AM IST | Source: CNBC-TV18

Valuations of EMs attractive; underweight on India: Citi

Citi's Markus Rosgen finds valuations of emerging market equities quite attractive now, despite remaining underweight on India.

Markus Rosgen of Citi finds valuations of emerging market equities quite attractive now. However, he remains underweight on India. In an interview to CNBC-TV18 he explained, given the twin deficit issue, India is unlikely to outperform its peers. Also, the Indian rupee is likely to remain volatile for some more time. From, a valuation and earnings growth perspective, it is not well placed than other EMs.

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"Foreign institutional investors overseas have liked India already. So, our concern is that if those people are already overweight how much more can they basically buy," he added.

Global investors are eyeing the outcome of Fed's two day policy meeting which begins today. Rosgen expects the Federal Reserve to continue with its bond buying programme and not tighten unless there are firm signs of the US economy recovering.

Though the appreciation seen in US bond yields is making global markets nervous, but Rosgen feels a steeper yield curve is likely to benefit the emerging market basket. "For last three years EMs have underperformed DMs because when there is a flat yield curve people go to the safety of DMs and avoid more risky markets of EMs," he added.

Below is the verbatim transcript of Markus Rosgen's interview on CNBC-TV18

Q: There has been quite a bit of pressure on emerging market (EM) equities and currencies. At this point, what probability are you attaching to the Federal Reserve not moving in terms of liquidity easing? What kind of impact will it have on EMs?

A: There would be no tightening announced by the Fed at all. They are going to continue very much on the rhetoric that we have been getting in the course of the last couple of months that if the economy continues to recover at some stage the quantitative easing (QE) will end.

In terms of the outlook for the EM asset class, from a valuation point of view these assets are quite attractively valued. You have quite a few markets around the world where the implied earnings growth rates to perpetuity are in very low single digits, in some cases they are even negative to perpetuity which is a negative outlook. Also if you look at it from a global perspective, global EMs are consensus underweight amongst global funds. So overall, the expectations are quite low.

Q: The US bond yield continues to appreciate further like it has for the last few weeks and EM equities and EM currencies continued their underperformance as they have for the last few months. How high is the probability of this phenomenon lingering?

A: Normally, a steeper yield curve is indicative of a better growth environment and when you look around the world, the areas of the world that are most sensitive to growth tend to be EMs rather than developed markets (DM). For last three years, EMs have underperformed DMs.

When you have a flat yield curve people go to the safety of DMs and avoid the more risky markets of the EM universe. So from our perspective, a steeper yield curve is indicative of better growth environment or to be beneficial to the EM universe, but for the time being there were some positions that people had and were very much of one way. EM currencies is one of them. EM bonds were the other and so significantly larger sums of money have got into EM bonds and EM equities, but sadly equities do suffer when there is uncertainty even in the bond market.

Q: You like EMs, but India is not one of your favourite markets. Can you just take us through why you are underweight on India in this basket?

A: I am very consensus overweight on India and so you are almost back at all-time highs in terms of foreign ownership levels and so, institutional investors overseas have liked this market already. So our concern is that if those people are already overweight how much more can they basically buy.

Secondly, twin deficits in an environment of uncertainties, we are having for the moment is normally not a good recipe for outperformance since the currency has already weakened on the back of it and our concern is that we are going to see little bit more volatility before we start to see things pan out. Thirdly, when we look at it from a valuation earnings growth perspective relative to all the other EMs, it just does not stack up that well and its overall attractiveness puts it into the underweight category rather than either a neutral or an overweight category.

Q: At this point, the equity markets' narrow focus is on what the Fed has to say about liquidity markets, but what if they have a more dire outlook on growth, something which the second half was presumed to be better in terms of macro data? Do you think that might have a bigger negative reaction on markets if there are some concerns about growth faltering?

A: There is a concern about China and everyone is worried whether the growth rate will be 7.5-7.8 percent or will it be lower. On China, people do spend a lot of time worrying about growth which is quite ironic given that over the course of last 20 odd years you have had splendid gross domestic product (GDP) growth, but pretty poor equity returns in China. So, I am not sure that we also focus much on the GDP growth. What people seemed to be less worried about these days is the US growth.

There are worries in the first half of the year that US growth was going to be slightly weaker in light of the Budget cuts, but from that perspective people have turned the corner little bit on the growth scenario. The economic surprise indices that Citigroup publishes and what they are showing is that we are very much at the bottom of the range.

These indices go from low to high, so it does seem to be the case that in terms of economic surprises we are more likely to get positive surprises in the second half rather than negative surprises. So from a GDP growth perspective, we are not that negative. Where you will get further downward revisions though is in terms of earnings growth. So, you are going to get some downward revisions to earnings, but given where valuations are a lot of that is in the price already.

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