Inflation environment may become worse in India: Nomura

In an interview with CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee, Ian Scott, global head of equity strategy at Nomura, said the valuation gap between India and other emerging market needs to narrow down. "The relative valuations are still high in India," he said.

He remains underweight on India for now. "Inflation environment may become worse in India." Below is a verbatim transcript of the interview. Also watch the video. Q: Where do you stand on the emerging market (EM) versus developed market (DM) debate?
A: We made a reduction in our EM exposure in the first week of December. We have moved from overweight to underweight and we now prefer developed markets. The key reasons really are the inflationary backdrop in EMs upward pressure on interest rates. Also valuations have been a little stretched in EMs and with such a bid inflow in capital in the last year or two, we felt that probably there will be a pause in those fund flows and that could lead to some underperformance in EMs Q: How do you map the valuations for emerging markets space now after its recent underperformance?
A: One thing we like to look at on the valuations side is comparing the PE multiples for the Indian market with other emerging markets and actually particularly with the Chinese markets. India now trades on about 30% premium to the Chinese market.
That is quite high that is a big differential in terms of multiples. I would like to see that close and that could happen with other EMs doing better than the Indian market. Q: Given that would you say that it is still early to get into India from your perspective even after its recent underperformance?
A: Yes. We still think it is too early to come back to the Indian markets when we compare it either with global equities or with other EMs. Valuations are still a bit high. There is still some adjustment to take place in terms of monetary policy and we may see some near term pressure on margins as a result of higher cost so although the medium term outlook we think remains good probably a little too soon to come back to the Indian market, so we remain underweight. Q: The main concern around market like India seem to be macro in nature whether it is inflation or what is happening with rates has most of that been priced in you think at these levels.
A: There are still some macro concerns out there. The inflation environment is probably going to get worse before it gets better and the interest rate cycle still needs further adjustment so the near term outlook is a little tricky. I think we see valuation premiums associated with the market that could still lead to some underperformance in the short term. Here's another FII view: 'Wonderful' India the place to be in next 2-5 yrs: BGC
_PAGEBREAK_ Q: Your reports indicate that you are looking or at least advising to clients to go underweight on EM positions are you still going with that call post this correction as well?
A: Yes. We are still advising an underweight in Ems. We think it is too soon to come back to an overweight, the valuation is not yet attractive enough in our minds relative to developed markets and inflation is still a concern. The fund flows that have been so positive over the last 18 months, have already started to turn against EMs but our work suggests that there is a longer period of workout for those fund flows. So jumping back in now we think will be a little too soon. Q: So you think you should be expecting some more outflows from the emerging market space over the next few months?
A: On the fund flows side I think is the global EMs funds which have been the main drivers. There the funds that have the best statistical relationship with future return. We still think there is more adjustment to come there in terms of outflows. On the developed market side, we are seeing institutions and retail investors switching out of fixed income into equities.
There is a positive fund flow dynamic in the developed market and we think still some workout to come in EMs. Q: How are you reading the crude oil situation at this point and how are you correlating that with emerging market equity returns this year?
A: The geo-political concerns in the Middle East and North Africa have had an impact on equity markets particularly some of the big oil importers like India. The interesting aspect of this particular rise in oil prices is that the stock market has taken a negative slant much earlier than it did in 2008. Back then oil prices had to get up to over USD 130 per barrel before the stock market worried. This time concerns occurred over a much lower level around USD 90 per barrel and that reflects the geo political aspect to the rise in oil prices this time.
The sense I get is that the investors are more concerned about the geo-politics than they are about specifically high oil prices. I actually think stock markets can live with oil above USD 100 a barrel if we could get rid of some of the concerns on the geo political side. Q: The big bull run has been in the US market and for many people here the targets are now being upped. What is your call on how the US markets may end up the year and how they may perform through it?
A: We are relatively optimistic. Our year end target for the S&P 500 is 1475. It was established back in December. We think the earnings environment remains good and crucially we are seeing revenues now taking up more of the running in terms of driving profit and some of the concerns last year and the year before that it was all due to cost cutting have now passed.
We were seeing really good revenue growth in the US particularly encouraged by the tech sector, that