Slow EU growth, fiscal cliff make EMs attractive: JP Morgan

US President Barack Obama was elected for a second term in office and Geoff Lewis of JP Morgan AMC believes the equity market would have benefitted if Republican candidate Mitt Romney had won. In that case, the key issue of the US fiscal cliff could have been solved more effectively, feels Lewis. According to him, US markets could see a correction going into the year end if an agreement on the fiscal cliff is not reached by December.

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Lewis further added that slow European Union growth and the US fiscal cliff issue is making emerging markets attractive at the moment. Moreover, markets like India could see strong foreign flows owing to positive policy action from the government. Here is the edited transcript of the interview on CNBC-TV18. Q: What did you make of the market’s reaction to President Obama getting re-elected this time around? Do you think that is just a kneejerk negative sentiment and would you advice a buy into the dip that you have seen?
A: I think what we have seen is obviously hope of a Romney victory which is now priced out from the markets. In the short-term that was expected to have been more friendly to the equity market because on a key fiscal cliff issue, Romney was more inclined to go with a status quo and an extension on both taxes and spending.
Now of course we are back to a divided government in the US and President Obama has to negotiate with Congress. In order to get things done he will have to find some common ground. Investors are now working up to the fiscal cliff which is looming. We could either see an early compromise and if that could be reached in mid-December, it would be very positive for the markets.
This just would be a kneejerk reaction or if it is difficult for the Democrats and Republicans to reach a compromise it could be taken right up to the last minute. That I think would cause some correction in the markets going into the year end. Of course there is always the possibility of not reaching an agreement in time and there might be a late compromise. The agreement has to be reached sometime in Q1 of 2013.
It is all now very much about what we can expect in terms of an agreement on an orderly US fiscal consolidation. We have seen the budget deficit come down from 10 percent of GDP to 7 percent in fiscal 2012, but under the fiscal cliff it is headed for 4 percent in fiscal 2013. That is too rapid an adjustment and that is likely to push the US economy into recession.
I do not think there is much doubt about that. It is this problem now that basically the US administration and Congress have to sort out between themselves. That is really going to dominate the market’s attention now more than the eurozone issues. Q: How worried would you be about the eurozone issues at this point? We did have those comments come in from Mario Draghi yesterday with regards to Germany possibly now being weighed down on economic uncertainty etc. and then we had the industrial production data which was not very significant in terms of a gain for Germany. How exactly are you reading the situation there and how dominant a concern would it be as opposed to the fiscal cliff situation?
A: I think the EU’s economic forecasts are just catching up with some of the more high frequency numbers. It has been apparent for some time now that the German economy is suffering because of the recessions in smaller economies and also in larger economies like Spain and Italy which are contracting in terms of GDP growth.
Also, Germany is leveraged to the global business cycle because it is very heavily dependent on exports of capital goods and machinery. These areas have been slowing as well. So it is not surprising that the German economy is now starting to suffer. It is no longer growing at 2-3 percent in YoY terms. The last number was 0.5 percent and the EU is now looking at slight negative growth for the eurozone area in 2013 as well.
I do not think this is new news. I think it is difficult to see the eurozone returning to strong growth anytime soon and this makes it more imperative than ever that we do start to see some agreement which will enable Mario Draghi's outright monetary transaction program which is the eurozone's equivalent of quantitative easing will start kicking in and providing some monetary support.
_PAGEBREAK_ Q: What is your view on how the equity markets will move from now until the end of the year? Ultimately if the taxes on both dividend and capital gains go up, because President Obama is pro-higher taxes, stocks deserve to be at a value less than where they are currently, right? Do you expect to see a selloff towards the end of the year in the US markets?
A: I think it is going to depend more on what kind of agreement or lack of agreement there is between the Republicans and the Democrats with regards to all the issues. All the tax and spending cuts have come within the fiscal cliff. If there is an agreement, taxes probably increase on dividends, capital gains and for higher income tax payers.
But, at the same time, one of the biggest barriers to the equity market I think has been macro uncertainty.  Once we get this agreement, low taxes are going up. Much of the uncertainty is itself centered around the fiscal cliff and as this dissipates and vanishes, I think markets should benefit and are more likely to move higher despite some increase in taxes for the upper income brackets in the US. Q: Wanted to touch upon the Indian markets in specific. What exactly are FIIs thinking towards the Indian market, i.e. can we see more incremental flows considering that it has been a good year for Indian markets as compared to other EMs? What is the perspective that FIIs are working with, especially with the uncertainty or the trepidation that is currently dominating the eurozone as well as the US markets?
A: I think the more we see the eurozone mired in slow growth and more the uncertainties over the fiscal situation, the emerging markets are going to look more attractive. Though, India’s growth has come down, a lot of international fund managers would still be very happy with 5.5 percent growth and of course we have seen an end to policy paralysis.
The government seems to have woken up and it has already announced a number of reforms. It seems to have been reenergized. So under this environment I would think the outlook for emerging markets like India over the next 6-12 months is actually improving.