US mkts lure EM funds; global bourses price in QE end: Citi

"Nations with aggressive reflation policy to outperform and continued rally in the US equities to impact emerging-market equities negatively," John Woods, MD and chief investment strategist- APAC, Citi Private Bank told CNBC-TV18. Woods adds that the markets will correct once central banks start phasing out quantitative easing and there is significant investor-interest in blue-chip companies of developed markets.

Below is the edited transcript of the analysis on CNBC-TV18

Q: The US markets have posted a fantastic run. Do you expect that the global markets to start picking up with that cheer?

A: The trend is differentiated and divergent. Economies with aggressive reflationary policies are doing particularly well in terms of risk assets and by that I mean Japan, Switzerland, the UK and the US. All these markets are either posting fresh highs in many instances or at least five-year highs. Those with slightly more restrictive or tighter monetary policies and I also include those economies impacted by a stronger dollar, are the ones that are struggling a bit.

Two-to-three weeks ago, there were concerns that the subsequent correction would probably impact markets a little more. For that reason, I was somewhat cautious on Asian risk. I suspect now that the correction that has essentially played through the consolidation seen over the period is probably coming to an end. As the US ticks higher, the differential between the two is probably going to become a little too apparent and I think I will become more positive towards Asian risk in the next two-to-three weeks.

Q: So, do you foresee a situation where money continues to gravitate towards the US which remains an outperforming market in relation to other emerging markets?

A: I am concerned about that. I think that at the current juncture, the correction has been sufficient to address some of those concerns and the relative divergence or the differential between the two is sufficiently attractive to encourage some sort of reversion.

But the key risk, I think perhaps in the second half rather than Q1 of Q2 of this year, is the fact that some of the markets may become a bit optimistic about fiscal consolidation, the housing market and the unemployment rate in the United States to result in the ten-year yield or term yield to start ticking up and attracting a little more capital into the country.

That is exactly the driver that will push up both US equities and the US dollar. As history indicates, that combination tends to have a slightly difficult implication for emerging-market risk in general, and Asia in particular.

Q: Is there a risk of a bit of a bubble building up with markets rewarding central banks who have not been so disciplined and penalising the ones who have been?

A: I think that is an important risk to highlight. Obviously, if you speak to the likes of Janet Yellen, William Dudley and Ben Bernanke, they would put you straight to the extent of suggesting that quantitative easing (QE) continues to be open-ended.

At the current juncture, there is no evidence or no signs that they would start removing or restricting it, to Japan, and to an extent, the ECB. So, for as long as those three providers remain active then I think that the liquidity driven rally has legs.

But certainly, as we all know, QE cannot be an infinite exercise, there has to be a certain juncture where the market starts realising that it is going to be constrained. The fact that ten-year yields have moved from 1.5 percent and changed to slightly above 2 percent, is evidence that the market is gradually pricing in that eventuality.

Q: On the subject of liquidity, the Emerging Portfolio Fund Research (EPFR) data, indicates that for the first week of March, US equity funds saw inflows of USD 5 billion. Has investor interest started to shift to the developed markets as compared to emerging markets as was the case in last year?

A: Absolutely. From a client-perspective, there is a consistent and substantial interest in developed-market equities, particularly of the US largely on the back of a stronger earnings profile and a stronger price performance. There is migration from cash into risk largely towards credit but in recent months, there has been a lot of interest in developed market blue-chips and dividend-paying equities, but it is yet to see that aggressively filter through to emerging market or Asian risk in general. So, though there is a bit of caution the key trend is the shift to risk.

Q: What is your tactical call on emerging markets including markets like India where performance was fantastic last year but it has started to dither this year?

A: To be fair, that is pretty much the scenario across Asia, particularly North Asia. Southeast Asia continues to perform well but certainly in the north, the very attractive and aggressive rally in the early part of January-February essentially has now been given back. The market is pretty much focusing on when the catch-up will play through.

Two-to-three weeks ago, investors were cautious on the markets and there was widespread opinion that the correction would have further to run. We are looking at accumulating risk at current levels with the expectation that the markets will move higher over the near-term.