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Last Updated : Jul 01, 2016 06:06 PM IST | Source: CNBC-TV18

'Investors chasing EM yields in low-rate environment'

The rally in global equities that has taken since the Brexit vote is largely driven by investors who are chasing yields in a low-rate environment, says Geoffrey Dennis, Head of Global Emerging Market Strategy at UBS.


The rally in global equities that has taken since the Brexit vote is largely driven by investors who are chasing yields in a low-rate environment, says Geoffrey Dennis, Head of Global Emerging Market Strategy at UBS.

"Bond yields are low around the world especially in the US and the UK and hopes are that the Fed is on hold for a long period of time. Therefore, investors are chasing yields and going back into emerging market equities," he said.

Terming it as a classical liquidity rally -- one that would be difficult to predict in terms of how long it lasts -- Dennis said Brexit would likely have an economic impact.

"That means a further strong liquidity rally in emerging markets will eventually take us to overvalued levels and that is what the risk is," he said.

Below is the verbatim transcript of Geoffrey Dennis' interview with Reema Tendulkar & Nigel D'Souza on CNBC-TV18.

Nigel: What have you made of the recent risk on rally across the global assets post the big talk about Brexit?

A: It happened because you have seen a tremendous drop in bond yields since the UK referendum vote. You have also seen a decline in rate expectations across the developed markets. So we are in an environment here where the dollar is rallying against sterling and to a certain extent against the euro though it is pretty flat against emerging market currencies.

So bond yields are low around the world especially in the US and the UK and hopes are that the Fed is on hold for a long period of time. Therefore, investors are chasing yields and going back into emerging market equities. So it has been quite a surprising move I think.

Reema: Do you think the surprising move as you call it in emerging markets is likely to continue because now the expectation is that the Fed is not going to hike rates at least till the end of this year?

A: I think it could run on further. It is a classic liquidity rally and liquidity rallies can go on a fair time and get to overvalued levels but what we would be concerned about would be the following things. It is entirely possible with some strong US data that Fed comes back on to the scene over the next few weeks.

The impact of the UK referendum vote -- assuming that UK does leave the European Union -- will be to weaken UK and European growth. So if the markets continue to rally in EM without there being any growth follow-through, eventually we become too rich in terms of valuations.

So I have no idea how much longer it may go on. It may run a while bit it is not going to run for that long because market will become too expensive.

Nigel: As far as the referendum is concerned there are talks maybe eventually Brexit may not happen. What is your view? Are we going to see a Brexit happening or is there a possibility of a change in the referendum?

A: I am not prepared to say. I am not in a position to give a view as to whether it will happen. All I would say is that it is very clear that the negotiations to leave the EU will be very prolonged and the market is beginning to wonder whether because of the political uncertainty in the UK both with the government and the opposition. They are beginning to wonder whether EU exit will occur after all.

We do not have a view on that. We are not experts on politics and we do not want to have a view but the markets are now thinking there is a possibility that there would be an exit after all. Without any question, this is contributed to the rally you are seeing in risky assets. 

But all we would say is however politics plays out in the UK and Europe in the short-term, it is going to have a negative impact on the economy and in European economies. That means a further strong liquidity rally in emerging markets will eventually take us to overvalued levels and that is what the risk is.

Reema: What about the Indian markets. We are already at 2016 high, we have seen the monsoons progress well, the expectation is that earnings will pickup. Do you think the Indian markets could outperform in the near to medium-term and do you see the possibility of the Indian equities hitting all time highs?

A: We certainly believe that the risk is that market could go lower. Our Indian strategists believe that the earnings expectation in the market is still on the high side but in the event that you continue to get some further risk-on move on the upside in the near term within emerging markets, India will probably be part of that.

But the real key here is to argue that Indian market is somewhat expensive and earnings estimates may be a bit on the high and it will still be a low beta market. So, if the market re-rates again, which at some point it will, India probably outperforms. But if the market run on here is driven by risk rally with some of the emerging currencies like Brazil and South Africa doing strongly, I would expect India to underperform in that environment. So I do not think there is a lot of upside in India and we still are concerned about whether the market is overpriced given earnings expectations.

Nigel: If you believe the market is complacent about the Fed move. What sort of returns are you factoring in from emerging markets for the rest of this year and also with regard to India?

A: Right now our target for the emerging markets is about 1 percent above where we are now as of tonight\\'s close. You know what has happened; emerging markets rallied 5 percent into the referendum vote they then sold off by 5 percent in the first two days. They have rallied back now almost to where we were before the vote last week. So we think there is a bit of an upside and of course as ever all our targets are under continuous review. I think what is surprising to me at the moment is the power of this liquidity rally that has developed and that could take the market beyond our yearend target but in a world where growth is weak and where these events in Europe are likely to be negative, we would be concerned that if market rally too much from here, they simply become expensive in therefore vulnerable.



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First Published on Jul 1, 2016 01:28 pm
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