Remain short on EMs; Europe to stabalise soon: UBS

The global equity markets which had fallen sharply last week on Federal Open Market Committee's comments on quantitative easing are likely to recover and rally in the medium term, however emerging markets would continue to disappoint, said Stephane Deo of UBS.

"We will remain short on EM compared to other countries. We don't really like EM stock markets. It is a story about growth not accelerating, weak commodity price, and weak currency," Deo said.
He expects advance economies to grow at better pace than emerging economies. Deo also pointed that Europe was on its way to stabilisation and may come up with a positive surprise on growth front. Also read: India can fall 5% more from here; upside capped: Blackridge
On global equity markets he commented, "If you look at the selloff last week it was essentially the defensives that sold off, the cyclical part of the stock market has been over-performing in the downside. That tells you that the market is increasingly betting on a recovery," Deo added. He considers correction in the last week as a good entry point for investors. Below is the verbatim transcript of the interview Q: There is some semblance of sanity that has returned to the global markets after the havoc that we saw last week post the Federal Open Market Committee (FOMC) meeting. How would you approach it now? Would you nibble into the developed markets (DM) at these levels? Would you just wait for the dust to settle a little bit?
A: I think the reaction of the market was overdone to a large extent both in the fixed income and in the equity market. In terms of the equity market from my point of view it is very much of an entry point now. We will see what happens today, but we have already seen some rebound. What is interesting is if you look at the sell off last week it was essentially the defensives that sold off, the cyclical part of the stock market has been over-performing in the downside. That tells you that the market is increasingly betting on a recovery. I think the stock market will continue to rally in the medium-term and the correction last week is an entry point from my point of view. Q: Nevertheless the market clung onto the downward revision of the US Gross Domestic Product (GDP), but that is really lagged data. What we are going to get on nonfarm payrolls next Friday will be much more recent data. Do you think that can swing the market more and can break this nascent rally if it turns out to be a good number?
A: As you said the GDP data are very backward looking. The downward revision is a bad news, but it is bad news about something that happened three months ago. I think the non-farm payrolls are much important because they are forward-looking. They are telling you something about the health of the economy. What we think will happen is the data will continue to be good. We actually think that non-farm payroll will be around 200K on average during second half of the year. In this kind of context the Fed is indeed likely to reduce QE at the end of the year which is negative for the market, but a continuation of positive economic data is the element that will dominate and from that point of view that should continue to support the rally. Q: The other point of concern perhaps is that the 10 year yield did not really fall much inspite of the lower revision of the Q1 data. We saw risk assets firing up, but 10 year continues to remain at 2.53-2.54 percent. Do you think the connection between this yield and risk assets is kind of diluting or do you think this one-off and if the yields continue to rise we should worry?
A: Again, our research show that when the yields are very high say 6 percent or 7 percent, an increase in the yield is usually very bad for the market. But when the yields are very low the relationship is actually inverted. So, imagine you have a yield at one percent and you move to two percent. The stock market actually have rally in this kind of a situation. We are still in this situation where the long yields going up tells you that we are normalising, we have a recovery, our economists are forecasting three percent next year and in that case the stock market should continue to rally. So, I don’t think it is inconsistent to say that 10 percent yield will go up and the equity market will go up. If you look at May for instance, we had a big sell off in treasury, 50 basis point (bps), little bit more actually and the stock market was up to three or four percent depending on which index you are looking at in the US. Q: Since you track the European markets very closely as well. Just give us an update on what you would think will happen there because now after that long meeting that took place in Brussels finally the European Union has come out with some formidable steps to prevents the banks from failing, defaulting rather. Do you think Europe will continue to just be on the sidelines and not dominate mind space or do you see that as well come into the forefront because of issues with respect to Greece etc.?
A: There are a number of things that are improving in Europe. The current account deficit (CAD) has been reduced massively. The Greek bank have been recapitalised this week. The delta is more than one point and if you look at the data for instance the Purchasing Managers’ Index (PMI) was totally disastrous. A few months ago it was at 44, and it is now at 48. So, it is still bad, but it is getting closer to 50. So, I think Europe is very close to stabilise. You will not have a recession forever, at some point you will stabilise. So, I actually think that Europe is an interesting one because it has been on the sidelines for long, could be a provider of positive surprise. Q: Fair point, actually delta is the problem perhaps in emerging markets. Do you track that space at all and do you get a sense that after last week's savage fall there is a recovery in the emerging market equity space as well and if you have any preferences in them?
A: If you look at the delta again, advanced economy will increase the GDP by 0.8 percent on our numbers and the developing economy by 0.3 percent. So, we don't really like EM stock markets. It is a story about growth not accelerating, weak commodity price, and weak currency. The rand for instance has lost one third of its value since the beginning of the year. So, there are a number of headwinds for EM market. I think that we will still be short EM compared to other countries. The problem is valuation.