Neutral on India; expect earnings to improve: JP Morgan

Geoff Lewis of JP Morgan AMC, in an analysis of global markets and economies on CNBC-TV18, explains that there is little hope of a solution to the fiscal cliff before January 1. Lewis believes growth will pick up in the US in the secnd half of 2013. He highlights that the tail-risks have been removed in the eurozone and China while maintaining a 'neutral' rating on India.

Lewis expects some improvement in India's corporate earnings and indicates that  gold could be a good hedge against political and economic uncertainty. He expects oil to remain in a tight range in 2013. Below is an edited transcript of Geoff's analysis on CNBC-TV18 Q: Do you still think any resolution of the fiscal cliff is possible today?
A: Certainly, the US is going over the cliff. I do not think there is much hope of a last-minute agreement today. It Rather than a minimal agreement such as the Senate Bill, I think it would be better for the Democrats or Republicans to get down to a fuller agreement in the first couple of weeks of January.
But of course the longer this goes on, the more the uncertainty and the more the markets are likely to weaken. That could provide an interesting opportunity to increase exposure because at the end of the day there will be a compromise agreement which prevents the full 4 percent of fiscal tightening.
However there are expectations of a 1-1.5 percent of fiscal tightening- there will be no extension of the payroll cuts nor the unemployment benefits and that will cause a temporary weakness in the US economy in the first quarter. But growth will pick up in the US economy later in the year. Q: Has this slowdown in the economy been factored-in by the equity markets or do you think equities will be a little downbeat in the first few months of 2013 as they absorb in this fiscal contraction?
A: I think that there will be some volatility in the early part of the year. There is uncertainty after all, over the value of the fiscal multiplier. The International Monetary Fund (IMF) has just come out with a research paper which has said that when there is a negative output gap, as there is now in the US of about 5 percent of GDP, that is when actual output is below potential or trend, then fiscal tightening can have a larger negative impact.
So to that extent, it would be much more preferable if fiscal consolidation in the US was to take a gradual path which is what it has done over the last three years, getting the deficit ratio down from well over-10 percent to 7.4 percent in the last fiscal year. This steady progress is much more desirable in a fiscal cliff. Q: What I actually wanted to dwell further into is, in such a scenario will you actually be a buyer of equities, especially US equities and maybe even economies which are connected with it?
A: Yes, we believe that a lot of tail risk has actually been removed, particularly in the eurozone and also with regard to China. China is on a relatively strong recovery path and this is something that we have always believed in.
So once the US fiscal negotiations are over and there is some kind of agreement, then the macro-economic scenario is not terribly optimistic in terms of rebound in growth, but it is more optimistic in a lot of the tail-risks that bothered investors so much last year, having been curtailed.
So investors, in our view, should be increasing their exposure to equities and be willing to ride out the short-term volatility and take a longer term view and look forward to a better global economy, say in the second half of 2013. Q: What gains would you see in the S&P-500 in 2013?
A: Though I don't provide a forecast on the index, investors were rewarded perhaps by larger gains than expected at the start of 2012, something like 16-17 percent for the S&P.
Now it may well be that 2013 is a year with less tail-risk, lesser macro economic uncertainty but somewhat lower returns, but nevertheless returns that are relatively decent and will be better than the kind of returns you would get, say from the G7 developed-government bond markets. Q: India has been the third best market in Asia after Thailand and Philippines, in 2012. How do you see this market doing in 2013?
A: Currently within our Pacific regional equity portfolios, we are 'neutral' or ‘fully weighted’ in India. We have seen strong gains which many people did not expect earlier in 2012. Most of the bad macro-economic news is past and we are at the trough there, so we are looking forward to maybe some improvement on the earnings front.
So I think foreign investors continue to see India as a very attractive secular growth region and institutional investors are beginning to move more money into emerging Asian markets, including India. So from that point of view I would not be pessimistic. I would be including India as ‘fully weighted’ in my portfolio. Q: Will gold put another subdued performance in 2013 considering expectations on economic recovery in the West and the East?
A: I think gold has certainly corrected and it certainly looks expensive on a longer-term trend, particularly if we deflate it by the Consumer Price Index (CPI) and then look at the real value of gold.
However in terms of an ongoing global economy which is going to have quite a considerable political and market uncertainty, gold has been quite a good hedge. I do not see investors abandoning it all together and I think there is room for gold to recover somewhat in 2013. Q: What about oil and base metals? How exactly do you think these two asset classes could possibly perform in 2013?
A: For oil, I would basically look at a relatively stable period. I think the physical market is quite well-supplied. We are not expecting a strong V-shaped recovery in the developed market. So there are no real major changes in the supply-demand balance.
If you abstract from those geopolitical concerns then, I would say oil is likely to remain within a relatively tight trading range, at least in the first half of 2013.
For other commodities it is likely that they will pick up somewhat, but only moderately. There are no big growth drivers across the globe- Europe is flat, the US might grow by 2 percent, China is moving upside from 7.5-8.5 percent. So there are no conditions for a commodity boom in the near-term, but there might be some cyclical recovery.