Volatility likely to rise further: Citigroup

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Markus Rosgen , Regional Strategist, Citigroup said that global volatility is likely to rise further and that rising yields will also contribute to higher volatility for equities. The current volatility is based on sub prime concerns and high stock valuations he said adding that it will take time for risk premiums to go down.

 

According to Rosgen, large caps will be preferred in Asia over midcaps. He also said that fears that Europe also has big exposure to sub prime is playing on the markets. "We will continue to see healthy inflows into EMs as they have to live with a lower risk appetite," said Rosgen.

 

He added that investors need to live with reduction in risk appetite.

 

Excerpts from CNBC-TV18's exclusive interview with Markus Rosgen:

 

Q: What do you make of the rumblings from Europe now? It seems that the subprime problem is also hurting a lot of the big banks there. Would you be worried about another bout of global volatility now?

 

A: In terms of the global volatility, our view has been for a while that volatility is

actually going to rise and part of it has to do with clearly what has been going on in the credit markets but also given where we are in the valuation cycle.

 

Now what has happened obviously in Europe is, some of the banks have come out, and with their funds they obviously have some issues with CDO s as has one of the smaller investment banks. But clearly, that has not helped.

 

Also, at the other end, if treasury yields rise, obviously rising yields tend not to bode well for equity markets and hence also higher volatility.

 

Q: How do you think this will all pan out in the medium-term though? Will this be an intense bout of volatility and churn that we will have to deal with or do you think there are going to be some long-term repercussions that equity markets might have to face?

 

A: I think one of the repercussions clearly is that the risk premium, which was exceedingly low is beginning to normalise and I think it will take a while for risk premiums to sort of go back down to the lows that we saw before the summer period.

 

But much more important is, what it tends to bode very well for, is much more of a large cap size amongst the portfolios and what you tend to find in Asia is that large caps have better fundamentals, when you look at RoE, margins or free cash flow yields, they all tend to be better with large caps than mid or small caps.

 

The other point to make is that it tends to frame very much a value style of investing rather than chasing pure price momentum, which has done exceedingly well in Asia this year and is now coming to a halt very quickly.

 

Q: It looked like in the last couple of days in light of what the US Fed said that things were beginning to stabilise and cool off a little bit. Do you think those hopes are overdone and we still remain very volatile and are likely to be over the next few days?

 

A: One thing about volatility is it tends to have a very high echo effect. So, once volatility rises, it tends to stay high or longer than people would like it to be. And so clearly, that is one thing to live with.

 

In terms of the Fed statement, they didn't say anything new. They clearly emphasised where the risks are in terms of inflation but still felt that growth was going to be fine, which is also really our house view. So, what has shaken investors today is more the news out of Europe, that clearly some European financials also have some exposure to the subprime and CDO market, but more importantly that some of the funds have issues with the CDOs and subprime.

 

Now, in terms of funds having exposure, that is really something to do with the fund holders and not the shareholders or the banks and I think people need to differentiate between those two and clearly there has not been a lot of differentiation, which has taken place right now.

 

Q: The big concern is that risk aversion will mean emerging markets might get hit. Do you believe that that might be the case and that emerging markets might get sliced off quite a bit by way of liquidity inflow?

 

A: In terms of the inflows into Asian funds, those continue to be quite healthy. So, at least over the course of the last week, one has seen a big reversal within that.

 

What has begun to happen though is that Asia has begun to underperform relative to the global indices, which is what you would expect as you mentioned, in an environment of a reduction in risk appetite. I think we need to live with that reduction in risk appetite. One way to avoid that part of it as I said, is the large cap value has done very well in this sort of environment, and the mid and small caps, and in particular the more marginal midcaps, that is one area that certainly should be avoided.