EMs at risk until dollar shows sign of stability: Citi

John Woods of Citi Investment Management believes the Fed tapering will take effect from September unless there is a major shock on either direction — up or down.

However, Woods told CNBC-TV18 that emerging markets (EMs) have already priced in the impact and the US markets, the S&P in particular, are looking fairly valued or even rich at this point. Post the tapering, he expects a bit of money rotation back into the substantially cheaper EMs. He feels EMs are likely to remain volatile and there is no way of getting around that until there are some further signs of stability in the dollar. Below is the verbatim transcript of his interview to CNBC-TV18 Q: Looking at all the data points, do you get a sense that the Fed is on course for September tapering and in that case, what would be your outlook on the emerging markets? A: They are on course. It would take a pretty substantial shock in either direction, an upside shock or a downside shock to change the market’s view that tapering will take effect from September. The data that we have been seeing has been reasonably constructive, there have been a couple of weak prints. However, in general the momentum behind the data seems to be positive. So, on that basis, it will take place. What impact does it have on emerging markets, I think it is being priced in. Obviously we had the shock of the initial taper back in May-June time and the markets have corrected substantially since then. The only real market move over the illiquid summer months and this is a seasonal factor as well is whether or not US investors come to the view that the US markets, the S&P in particular, are looking fairly valued or even rich. We started the year with the S&P at around a P/E of 12-13 times, which subsequently increased now to around 15 times. So, on that basis, I would not be at all surprised if we see some sort of summer correction. We may see a bit of modest rotation back into the substantially cheaper EMs. Q: Therefore you wouldn’t factor in any risk aversion in EMs, will you, in the next couple of months? Nothing on the agenda that might unleash one of those selling bouts? A: No, I am not saying that. I believe that once the tapering does take effect and this is in play then obviously the market is going to look particularly to the US dollar. Expectations of its strengthening and that tends to have a bit of a sucking effect from EM as liquidity has drawn out to the higher interest rate differentials. So, on that basis I still think that EM is absolutely at risk of volatility. There is no way of getting around that until we see some further signs of stability in the dollar.