Cautious on global mkts, see correction: Nicholas Ferres

The US and European equity markets were mostly lower. Investors in the US took profits on the back of many analyst stating that corporate earnings could be weak following recent fiscal impasse in Washington.

Federal Reserve Chairman Ben Bernanke said, " It is very, very important that Congress takes the necessary action to raise the debt ceiling to avoid a situation where our government doesn't pay its bills," in an event sponsored by the University of Michigan. In an interview to CNBC-TV18, Nicholas Ferres, Eastspring Investments says they are still relatively cautious on markets in the near-term after the recent run-up and maintain a relatively neutral equity position. He further adds they expect correction in equities in the run up to US debt debate. Below is the edited transcript of his interview on CNBC_TV18 Q: How are you calling the next few weeks? Do you see the prospect of a correction or a pullback in global markets more likely than a continuation of the upmove? A: Unfortunately my view is fairly similar to the last time I was on your program, we are still relatively cautious. We have been rotating a little bit out of US high-yield bonds, so we have been reducing our risk there, but we have maintained an overall relatively neutral equity position. We may start to take profits on some of the trades that we have had for example, like Japanese equities which have performed extremely well over the last couple of months. There are couple of key thing for investors; markets are obviously trading up near the highs, they are relatively overbought and equity volatility is extremely low. Volatility up until the last couple of weeks has been fairly low and so it has probably never been cheaper to buy protection or Put Options on emerging market equities for example. So in the short-term I am relatively cautious. Q: Do you think markets will pullback because of the sheer fact that it has gone up such a lot without a break or do you see any trigger in the horizon which might push equity prices down? A: On the encouraging side, we have seen an improvement in global growth momentum and I suspect that is why equity markets have performed fairly well over the last month and half. One of the potential catalysts for a correction is the debt ceiling debate in the US. They avoided the fiscal cliff in the short run on January 1, but all they did was push that out to March 1, when it comes to the automatic spending cuts and also clearly the debt ceiling. It is still a material risk in the US that there will be significant fiscal tightening this year in addition to what we have already seen which is around 1.5 percent of Gross Domestic Product (GDP). The impact can still be quite large and even though the underlying economy is improving, this could cause a material slowdown and therefore have an impact on corporate profits and equity prices. Q: EPFR data this morning indicates that for the first part of January global investors actually pushed in the most amount of money they have in many years into global equity mutual funds. Are you sensing a change in terms of investment sentiment going into this year towards equities? A: Yes, I suspect that that is another reason why I am relatively cautious. I would take that as a contrarian signal. Usually, when everyone starts to pile into equities, it is quite a good sell signal from our point of view. So I do not take that as an encouraging sign at all. Q: What do you think the likely trajectory for markets will be through the course of this year? There is one deadline in February, another in March for the US markets. Is that where you see the greatest correction or do you think it could likely happen in the second half of the year? A: I think there is a decent chance of a pullback around that time in the lead up to that. Markets have already priced in a lot of good news and the equity flows have been fairly strong and I actually take that as a contrarian signal. So that plus relatively full valuations, very low equity volatility and the chance of fairly modest risk premiums, suggest chance of a pullback fairly soon is in order. Q: Any chance of disparate movement or decoupling in that process? We saw a bit of it in December, how US markets moved was not necessarily how many key Asian markets moved. A: I guess that is possible in the short run and perhaps it might to outperformance relative to the US. US over the last couple of years has been an outperforming market, so we may see the US become a relative underperformer. We certainly think that US equity valuations are not as attractive as some of the other markets in this region for example. However, if there is a material correction in US equities then Asian equities would probably follow. Q: Is that what you expect to see though, something sharper than a 5-7 percent correction? A: It is entirely possible. It is much larger than that. I would not be surprised if it is 20 percent going into the middle of the first quarter.