Don't see major recovery in global mkts in H2: Deutsche Bk

The global markets are keenly watching the Greece election results on June 17. In an interview to CNBC-TV18, John-Paul Smith, global EM equity strategist of Deutsche Bank says, Greece will attempt to remain in Euro, even if Leftists win. “I think whatever the outcome is, even if the Leftist parties or Leftist coalitions effectively win the election then there will be an attempt to remain in the Euro. That will probably result in a protracted period of negotiation,” he adds.

He doesn’t expect to see a dramatic recovery in global equities in H2. According to him, valuations are very cheap. “They are cheap, when you look at developed markets. They are cheap, when you look at emerging markets. They are certainly very cheap relative to history, when you look at India. But obviously the dynamics are relatively poor. I think we will probably and obviously there is a very wide range of possibilities, but I would expect that we would finish the trading around these levels,” he adds.

Below is the edited transcript of his interview with CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.

Q: What are your expectations? How do you think the Greek election will pan out?

A: That's a very difficult question to answer. At the moment, none of us can say with any degree of certainty at all what the outcome of the election will be on Sunday. But I think whatever the outcome is, even if the Leftist parties or Leftist coalitions effectively win the election then there will be an attempt to remain in the Euro. That will probably result in a protracted period of negotiation.

My own personal expectation is that the more main stream parties will probably win. As to whether it is a good outcome or a bad outcome for Greece to remain in the Euro, that's very difficult to say. There is a school of thought that thinks that remaining in the Euro only really puts off the inevitability of the day when Greece has to exit.

Q: The problem the market seems to be grappling with as well is what happens post-Greece. How worried are you about what’s been happening in other key markets like Spain and Italy and whether that will continue to weigh on sentiment?

A: I think it's possible. If we do get an outcome to the Greece election that the market receives positively, we will get a hiatus for a while and that things perhaps will be a little bit less volatile than they have been. But the underlying problem remains. The underlying problem is that there is very little growth within a lot of the peripheral countries in the Euro zone. Italy itself has relatively okay debt dynamics, but the problem is ofcourse that the underlying lack of growth in the country means that the level of debt that they built-up in the past becomes a problem. That then the market starts to extrapolate forward. So, I think whatever happen, it's likely to remain a difficult situation for sometime to come.

There is, however, one piece of potentially good news on the horizon, namely the fall in commodity and oil prices, which is taking place at the moment. This is being really driven by two factors. One is obviously the situation in Europe and the lower growth that we are seeing in Europe. But the other one, which is partly related, but also partly happening for reasons of its own, is the fall in GDP growth and the weak economy that we are starting to see in China.

My expectation as you know for months has been that the Chinese economy will get weaker and that that will have a pronounced impact on the commodity prices. Certainly, for the US going forward this is extremely good news and also for Europe as well. Question is to whether it can offset the other problems in Europe. At the moment, it doesn't look like though it can, but there may be a tipping point at some stage where low oil prices in particular start to inject more of a growth dynamic into some of the developed market economies.

Q: Whichever way Greece goes over the next few days, the focus clearly is on what the ECB does next to arrest the Euro problems. Are you expecting another round of easing from them or any measures which might come out next week?

A: Certainly, if we were to see a situation where it looked as though Greece were to come out of the Euro zone then I think we would see quite dramatic ECB action as well to safeguard the position of some of the other countries. You have mentioned Spain, Italy obviously, Portugal as well in that sort of scenario.

But the question really is, ‘whether the markets would take some sort of Greek exit as drawing a full stop over the whole episode or whether on the contrary they will look at it as a precedent for the fact that once a country leaves the Euro then other countries can follow suit?’ But you would certainly expect the ECB to be very supportive indeed of the other sovereigns within the Euro zone.

_PAGEBREAK_

Q: What’s your call for equities for the second half of this year? Do you think valuations might restrict major downside from hereon?

A: This is the big question. Valuations are certainly very cheap. They are cheap, when you look at developed markets. They are cheap, when you look at emerging markets. They are certainly very cheap relative to history, when you look at India. But obviously the dynamics are relatively poor. I think we will probably and obviously there is a very wide range of possibilities, but I would expect that we would finish the trading around these levels. That's my central expectation.

We can't rule out a repeat of a situation 2009 where equities recovered very dramatically. But on balance, I think that’s relatively unlikely. I suspect on the other side of things that interventions from the central banks will probably be enough to avert a sort of worst case scenario as we saw in late 2007 going into 2008.

Q: The other big expectation is from the Fed. What is it that you expect to see come their next policy and whether or not there will be that concrete QE3 announcement?

A: Yes, I think if the situation in the Euro zone would deteriorate further then you probably would see some sort of action from the Fed. But I think at the moment the inflation fundamentals, within the US, are quite nicely balanced, because on the one hand you have got the declining commodity prices, which obviously is good, on the other hand you have got some pick up in housing related inflation, particularly on the rental side.

Also, what the Fed has been consistently stressing, especially Bernanke, is that at this point in time the most urgent action that's required in actually from the government, it's from Congress and it's from the administration in doing something about this so called fiscal cliff. Without that, I suspect and form of further easing from the Fed is unlikely to have any pronounced effect at all. So, really it's up to the politicians in the US at this stage.

Q: Where does this leave the emerging market space and tactically how would you approach the whole pack in the second half of the year?

A: We have seen pronounced underperformance over the past three-four months from the emerging markets, a lot of which has been currency based. So, you have seen currencies like the South African rand and the Indian rupee come off an awful lot. If and it's a big if the situation in Europe were to stabilise a little bit then you would start to see a marked differentiation between the performance of different emerging markets. So, those emerging markets that weren't so dependent on Chinese growth and on commodity prices such as for example India and Central Europe would perform relatively well.

Assuming that the slowdown in China continues then those emerging markets, which are more dependent on high commodity prices, such as Brazil and Russia and to a lesser extent China itself would do relatively badly. So, going forward, that's what I would really like to see, an increased differentiation between the performances of these big emerging markets.

Q: India’s own macro has not done very well over the last few months culminating in a recent threat from the S&P to downgrade it to junk status. How are global investors approaching India at this point?

A: This has been building up for sometime. The problem in India, the deterioration in economic growth that we are seeing, is partly the product of external events, particularly in Europe, but much more the result of a lack of desire really to undertake fundamental economic reforms within India itself. This is not confined to India, it's the same thing in Brazil, Russia, it's to a lesser extent perhaps the same thing in China.

What happened is that during the financial crisis and the aftermath of the financial crisis these big BRIC economies were sort of consumed by a sort of hubris and complacency at policymaking level. They simply didn't undertake the sort of reforms which are necessary to ensure continuing high rates of growth. The problem ofcourse is that once you go into a weaker economic environment then it becomes much harder to undertake these reforms. That's the issue that all these countries have. Ofcourse you could argue in a way that China has a small advantage in that China isn't a democracy whereas India and Brazil in particular are fairly vibrant democracies. In India's case, in particular, it makes much more difficult to get these reform through as you know better than I do.