Earnings momentum to be concern for mkts ahead: HSBC Bank

The emerging markets in Asia and particularly India have seen a steady inflow of foreign funds over the last few days. Arjuna Mahendran of HSBC Private Bank feels investors are preferring this region because it is showing definite signs of growth. However, he believes earnings momentum could be a cause of concern going forward.

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Mahendran also added that the US political situation may result in some volatility in markets. Going ahead, he expects the Asian central banks to be more dovish in the near future. Here is the edited transcript of the interview on CNBC-TV18. Q: We have been seeing tonnes of cash coming into this region. What have you made of it? Is it choosing a country or are people just preferring Asia over other regions right now?
A: I think it is definitely people preferring Asia over other regions, because this is probably the only region where you see some definitive signs of growth. India growing at 5.5-6 percent is still better than some of the East European or Latin American countries which are growing far below that.
That is one point, but the other point is that this quantitative easing that we are seeing simultaneously out of Europe, Japan and United States, which started in September is starting to assert itself in terms of those liquidity overhang flows coming over into our region. Whether this money is going to prop these markets up definitely is the big question going forward.
I think in China today we have seen some signs that the government is starting to change policy to enable insurance companies to invest in bank stocks etc. All that could create a short-term flurry, but I am still concerned about the momentum of earnings and this I think is going to be the challenge going forward. Q: We got USD 20 billion plus this year in India quite unexpectedly by many quarters. Do you see this trend accelerating as we get into 2013?
A: Absolutely. It is all a function of global liquidity creation, isn’t it? The Fed's QE3 or QE infinity as several commentators have dubbed it is an open-ended program. There is no real stop to the amount of liquidity they can create. They are printing about USD 85 billion every month to buy everything from mortgage-backed assets to other types of the Twist related government securities.
All that starts to move out of the United States chasing investment opportunities overseas and is headed in our direction. That is not going to stop, not by any means. The question is where will it go? How will institutional funds who basically commandeer these sort of flows allocate their resources between different countries within the Asian region?  I think that is the big question and particularly between sectors because we have seen some of the consumer related sectors running ahead for most of last year.
Now it is a question of whether infrastructure and commodity related plays can catch up with that spectacular run we have had in sectors like healthcare and consumer related plays. That I think is the big question mark and if the governments are able to get their act together we could actually see that eventuate. But that is a big if.
Let us wait another couple of months before we really see some clarity in terms of the Indian government's policies as well as China's new leadership setting its new course in action.
_PAGEBREAK_ Q: In the near-term, what would you think is a higher probability outcome, a phase of risk off because of the fiscal cliff uncertainty or is it actually acting as a positive trigger for the market because of some resolution being cobbled out?
A: I think definitely we are looking at some form of risk off in the next month or two for the simple reason that American politics has become as fraught as Indian politics. It is like the two sides are taking extreme positions. The Democrats under President Obama want USD 1.6 trillion worth of new taxes to be imposed. The Republicans on the other hand want about USD 1.4 trillion worth of cuts in expenditure.
It is between a rock in a hard place in terms of the political discourse and I cannot see any via media in the short-term. This is going to definitely result in some form of volatility in the markets in the short-term and a lot of the smart money I think is just taking profits whenever there is any strength in the market such as now.
I think the savvy investors are taking some money off the table waiting for January to see whether there is a dip which they can then buyback into. Q: How will this global environment sit on the shoulders of RBI or domestic banks? What do you think the RBI will do come the December policy?
A: I think the fiscal cliff has global ramifications. There is a binary outcome that is going to eventuate from whatever happens in the political scene in the United States. On the one hand you could have early resolution which would mean strong growth, big confidence boost. American growth rockets up to 2-2.5 annualized in the first or second quarters, but the more likely outcome is that they drag their feet and American output then grows only at about 1-1.5 percent and that is a big difference.
About 1 percentage point in American growth to the downside could mean the difference between 5.5 and 6.5 percent growth in India, because of the implications for outsourcing activity and general demand globally. All that will mean that the Reserve Bank of India and other central banks in Asia will have to anticipate some form of global weakening and thereby ease monetary policy.
The Reserve Bank of Australia which is a bellwether in this region, tend to move first amongst all central banks to cut their rates now to the lowest level in about five years. That I think has set the tone for central banks going forward. We are going to see more dovish signals from our central banks in Asia rather than hawkish ones. Q: You spoke about sector rotation. Typically, in this kind of liquidity environment would it be prudent to start going up the risk curve taking on slightly higher beta exposures which tend to do well in such benign liquidity kind of environments?
A: I think so. One definite trend we have seen in the last two or three months has been a move towards midcap stocks. In India I think this is very evident. We have also seen it in Singapore, Hong Kong etc. The midcap stocks which are undervalued have been running and the large cap stocks which have already been spoken for are largely being ignored.
 
That trend I think is the first evidence we have that these benign liquidity conditions are giving fund managers the additional risk appetite to take a slightly deeper plunge in terms of the liquidity spectrum i.e. midcap stocks being slightly less liquid than their largecap counterparts. But, in terms of sectorial rotation we have not seen much going on.
It is the same old sectors, the consumer related plays etc. that are attracting the money. I am really looking to see whether the sectorial rotation starts in earnest in a month or two which would then mean that we are seriously looking at higher risk appetite in our markets.