Bearish investor position led to global rally: Deutsche Bk

Over the past few days global markets have seen a rally and John-Paul Smith, Global EM Equity Strategist at Deutsche Bank feels the rally is mainly due to bearish investor positioning. He believes, the European rally has been triggered by short covering whereby investors who were holding cash have put the money back into the market. However, the weak growth prospects within the European Union still remain a cause for concern.

 "For the time being, the fact that the ECB have made it absolutely clear that they're prepared to do what is necessary if markets riot and put pressure to alleviate some of the pressure is a very positive sign. We have certainly seen that reflected in yields. However, the fundamental problem is there is really no growth and no prospect of growth in most of these countries," opined Smith.
Further, Smith added that the US housing market is showing signs of bottoming out and the slowdown in China is a significant area of concern, despite the fact that the macro indicators do not fully reflect the Chinese slowdown.
Talking about the Indian markets, Smith told CNBC-TV18, valuations in India are fine but, there is some anxiety over crude. Moreover, growth drivers in India have also slowed down considerably. Here is the edited transcript of the interview on CNBC-TV18. Q: The global markets have looked a bit tired over the last few days. Do you still think there is juice in the global rally?
A: I think one of the major reasons for the rally so far has been that a lot of investors were positioned very bearishly going into this. I think a lot of what we have seen and in Europe there has been a dramatic rally due to short covering. Investors who had large cash balances put some of the money back to work in the market.
So I think we may be two thirds of the way through that process. It's possible it will continue a little bit longer, but I expect it to peter out before the end of August.
_PAGEBREAK_ Q: One of the starting point of this risk-on phase was that the ECB said it would be buying bonds. So far we have not seen any concrete evidence of that yet. When do you see that process getting flagged off?
A: For the time being, the fact that the ECB have made it absolutely clear that they're prepared to do what is necessary if markets riot and put pressure to alleviate some of the pressure is a very positive sign. We have certainly seen that reflected in yields. However, the fundamental problem is there is really no growth and no prospect of growth in most of these countries.
That's not just the peripheral countries. If you look at a country like UK, where we have a huge advantage of a devaluation, we can independently manage our currency. Arguably, two and half rounds of quantitative easing have been done and yet the economy here is very weak as a result of fiscal austerity.
In places like Spain, Greece and even Italy, we still have the bulk of that austerity to come. The fundamental problem here is that there is no growth and until there is a prospect of reinjecting growth back into these economies, I think you will see periods of very, very intense pressure on bond yields followed by ECB action. I think this cycle of action and reaction is set to continue for some considerable time to come. Q: Where does that leave currencies? The euro has got its head back somewhat in the last few days. Do you think risk currencies might have some kind of a near-term bottom?
A: We have certainly seen some sort of bottoming out in the risk currencies. You can see that within the emerging market universe where currencies like the real and INR have moved a little bit although, not a great deal higher.
Unfortunately, I suspect this phase will not last and I expect the risk currencies to come under pressure as we move into autumn, as the economic news continues to deteriorate and specifically as people become more concerned about the Chinese economy and the prospects in China. Q: So where does it leave emerging markets? Last few weeks have been good, because we are all fueled by the same liquidity. But for the rest of the year how are you calling EMs now?
A: We have been relatively bearish on EMs now for almost 2 years. Over that time, they have underperformed the US markets in common currency by about 35%. Unfortunately, I see this trend to persist over the medium-term.
Most emerging market economies and stock markets tend to be a geared play on global growth. Given the fact that we are certainly looking towards the end of this year, we are relatively cautious on global growth. I would expect emerging market equities to continue to underperform and underpinning all of it is the very pessimistic view we have on the economy in China, which we think is now heading for something approaching a hard landing.
_PAGEBREAK_ Q: Tell us a bit more about China? How concerned are you at the kind of data that's coming in from there?
A: We are very concerned. The macro indicators in China don't give a full picture of what's happening. If you look at the corporate results and you look at some of the anecdotal evidence that is coming out of the corporate sector in China, the situation is much more worse than the macro economics statistics would suggest.
We also think that there is very limited scope for easing on the part of authorities, because any easing will result in increase in bank lending and a lot of that, because of the structure of the banking sector in China which effectively acts as a quasi fiscal or government spending mechanism. It is likely to result in more NPLs further down the road. Q: Where does that leave India? You were beginning to turn a bit optimistic. Does that view still hold?
A: Well India, unfortunately, is a market which have become a little more optimistic about a few weeks ago. But, I think now the outlook is becoming slightly more pessimistic again partly because the oil prices failed to respond to the poor economic news coming out of China.
I must say I fully expected oil prices to continue their decline on the back of weaker demand from emerging market economies. Instead we have seen close to a 20% rally on the oil prices over the past 6 weeks or so. I think for the Indian equity market to make much more progress depends on commodity prices coming back and on the rupee stabilizing against the European and US currencies.
Valuations actually look ok. By historical standards they are very cheap at the moment. Although it’s still difficult to find stocks that combine cheap valuations with what appears to be positive growth prospects, that really is the problem in India. As you know better than I do, the internal growth drivers in India have slowed considerably due to the hiatus in the reform program.
We are still waiting for some clear indication of what the government in India is likely to do over the next few weeks and months because without the government taking action we find it difficult to believe the Reserve Bank of India is going to be able to reduce interest rates by any significant amount at all.