US economy recovering; optimism on Europe remain: StanChart

The US market has been correcting of late and there have been huge earnings disappointment. Gerard Lyons of Standard Chartered Bank believes the weak US earnings are a reflection of its underlying economy. Although, the economy is recovering, it is going to be a gradual process, added Lyons.

Besides, the fiscal cliff could lead to 4.5% contraction in the US GDP, feels Lyons. Therefore, the base case now would be to resolve the impending fiscal issue.

Shifting focus to Europe, Lyons said the International Monetary Fund meet at Tokyo indicated optimism in the ailing economy. He believes the issues relating to Europe would eventually come to the fore.

He also hopes to see further easing from the central banks of emerging markets. 

Here is the edited transcript of the interview on CNBC-TV18.

Q: US market has been in a corrective phase led by some recent earnings disappointment. Do you see this trend continuing?

A: I'm surprised with such a big earnings disappointment. Maybe it highlights expectations management, maybe expectations were running ahead of reality. But what we have seeing from the earnings side is a confirmation of what has been happening to the economy over the last year, which is America's sluggish not spectacular recovery.

But, in terms of where we go from here, obviously it is difficult to predict the results of every company. However, in the next few weeks one might expect to see the same thing repeated in the rest of the earnings season. But, the US economy still looks like it is going to have a steady pace of growth in the year ahead.

In fact the economic data is slightly better in some of the earnings projections and again that is relative to expectations. The data is better than what the market expected, the earnings data is worse than the market expectation. But, the key message is to step back, put this in perspective and the underlying message is that the US economy is recovering, but it is a difficult recovery. It is a hard recovery for companies that pass on higher prices and it is a hard recovery for companies to make big profit margins. Nonetheless, it is a recovery.

Q: Next week onwards the market will start fretting about the results of the US elections and what it means for the fiscal cliff situation which is seen as the biggest risk in the US market. How do you see that event panning out between now and the end of the year?

A: Anything seems possible to me given the complex politics involved. The most sensible way to think about it is that the fiscal cliff will not fall off completely. If US was to fall over the cliff, it is as much as 4.5 percent contraction in terms of GDP because of the fiscal effect itself. It is likely that there will be some compromise. There will be some sort of a tightening of fiscal policy, maybe 2-2.5 percent.

But, interesting enough my own perception of recent events is that in the last few months even though we have not had the fiscal cliff, the uncertainty around it and also the fact that some spending plans have not been continued has already had a negative impact on growth. A resolution of the cliff itself would remove some of the uncertainty. Maybe it is best to think of it as having a net contractionary impact. But, indeed the removal of uncertainty might be positive for one or two sectors of the economy as well.

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Q: What about Europe? Over the last three months we have not seen Europe as a key risk for global markets, but of late there have been some negative rumblings about Portugal, Greece. Do you see Europe coming back as a risk on the table in November-December?

A: It is one step forward, two steps back. Never mind two steps forward one step back, Europe does it the other way around. A few weeks ago I was at the International Monetary Fund (IMF) meeting in Tokyo and to put this in perspective, a year ago when these meetings took place in Washington they were full of pessimism because of Europe. This year the meetings in Tokyo were slightly more optimistic because Europe is seen as being back from the brink.

But, the reality is that the underlying fundamental problems in Europe persist. What we tend to see is the actions from the European Central Bank (ECB), sometimes political and policy comments, help the markets. They certainly have a surge in confidence and that slowly ebbs away as economic reality beckons.

What we have currently seen in this phase is economic reality beckoning, that is after the initial euphoria a few weeks ago in response to the ECB actions pronouncing the reality that the periphery economic conditions are tough, yields are creeping up again in some of the preferred economies and therefore, funding once again is a big issue. The European problem still persists.

When it comes to a head at some stage, probably not just now, but the problems will persist and will come ahead at some stage. To be quite frank, it is impossible to say when.

Q: In this kind of environment would you expect emerging markets to continue to outperform? Do you see that happening in 2013?

A: I think the biggest challenge for emerging markets is complacency. There is an idea that policymakers can be relaxed because they think growth will outperform. Also at the same time, there is a need to make sure that reforms are pushed through.

One of the biggest challenges for emerging markets is their financial sectors which are not big enough to absorb potential future inflows from across the developed world. There will be more investment from the west to the east, from the developed to emerging or developing world. Therefore, I expect to see more money flowing into emerging markets.

Without corrective action in advance or immediately after that takes places, it is going to be reflected in asset price inflation, rising stocks and rising property prices. But for the moment the emerging markets rally can continue in the sense that it will be given a helping hand by monetary policy easing.

We have seen easing in Philippines, Thailand and in other countries as well in the last week or so. So policymakers will be focused more on growth slowdown than on any long term inflation risk. That growth slowdown, while it is negative for equities across the emerging world will be counted by policy easing including rate cuts which will be equity and market supportive.

Q: Where does this leave India in the context of an emerging market view?

A: I do not know if they are skeptical. I think the key about reforms is not only to announce them but also to implement them. Execution is the key. The execution of reforms in India is going to be the most important issue, not just for people's perspective, but from international investors' perspective as well.