US market may fall 20%, see EMs breaking down: Asianomics

Also Read: See more EM outflows; India still overbought, says Macquarie

Below is the verbatim transcript of Chris Roberts' interview with CNBC-TV18's Udayan Mukherjee.

Q: Is there anything in the technical charts that you study today which is telling you that something bad is going to happen in global equities or such a sign has not cropped up yet?

A: The only sign that something bad is going to happen is a much longer term analysis that we do. Our belief is still that the American stock market, which we all correlate to quite highly particularly in times of trouble, is going through a secular bear market which is long sidewise pattern, which typically last between 15 and 18 years. We do not think that pattern is ended. The risk this year is that we have a cyclical decline in America and if we do have that decline, it will be quite a large decline; I would guess something like 20-30 percent. These are long slow patterns, so we don’t have to rush out and panic yet. I do think that this years experience where we saw a very short lived correction cause a lot of angst in America suggests to me that the markets aren’t ready to fall yet. We are still bullish on America, we are wary this year that the risk is, we have the beginning of a cyclical decline after what has been an extremely good five year run-up from the lows in 2009.

Q: What tells you that 2014 could be the year of such a cyclical decline after so many good years?

A: In the past since we turned to the year 2000 peaks and troughs have been seven years apart. We have had 2000 the top, 2007 a top, 2002 a low, 2009 a low. So, 2014 would also keep that seven year relationship intact. That is not enough reason to go out and sell anything. However that combined with what we are seeing on the secular bear market pattern and also what we see in our very long term analysis in America using monthly data shows that we cannot ignore the risks that we have a cyclical decline in America.

The other thing to remember is that since 2010-11 most other stock markets have either gone sideways or down. So, money has been funneled into the leaders and out of the leaders America has undoubtedly been the best performing.

Q: In the cyclical declines of the past have all markets tended to more or less fall inline with the US markets? You have had a situation where the US has outperformed many other emerging markets dramatically. Could it be possible that other markets do well in face of a decline in US or is that just being wishful?

A: I would love to say yes but history says no. The problem is if the decline is very modest, if the decline was limited to 10 percent fall then I would probably bet that emerging markets would outperform during that – maybe they will fall 5 percent but when the fall becomes more meaningful, it is contagious. So, the problem is that if you have a decline of 20 percent or 25 percent then you can expect all these emerging markets to match that decline or exceed it by little bit. The only good bit of news in that situation based in the last few years is that there is no obvious sign of general over enthusiasm for markets in Asia, it has been stock specific, for example in India there has been a lot of enthusiasm for pharmaceutical and technology stocks.

Q: Where do you pick that 20-25 percent number for? Is it just the average decline of the last few major cyclical declines in the US?

A: The last significant decline was 50 percent. I do not think it is going to be as serious as that. It is based on what we have observed in this secular bear market that lasted long time, what we are expecting now at this stage of the cycle is to see a partial retracement of the gains from 2009. So, the S&P has gone from roughly 700 to 1,900 – that’s 1,200 points, so half of that 600 – that will be a sort of rule of thumb of the expectation, so something like that.

Q: You would say the odds of it happening over the next 6-12 months is significantly high?

A: I would say that they are getting higher but one thing we have done is to keep objective, we have designed these indicators to tell us when it is happening. We have researched the back history of these markets and we have come up with something that when this event happens we think we will have a handle on it. I can't say for sure it will happen this year. I have written to clients saying I think it will but we need to see it happen first.

For example we are still telling people that we are bullish, we are still recommending to buy things but at the longer term time frame we are wary that this is the sort of overhang that at some stage this will become an issue and people will have to be wary of that decline. However we don’t think it is going to happen next several weeks. It is a long term slow signal. However we are becoming increasingly aware that that is going to be a problem.

Q: What are the telltale signs of such a decline? What would you be watching out for to convince you that that process has started?

A: First thing that you see is that it loses momentum. So, it is still going up, but it is not as strong as it was. To complete that signal, you need to see momentum rollover and that is what we are waiting for now but these signals are slow. The last signal we had was six years ago, so we have been waiting for this, not for six years but for the last two years we have been waiting – that was a window we thought would open that potential for the signal to start but we have not been nervous because we know what we are waiting for.

The signal has not yet occurred. In the shorter term with any sort of work you do on the technical basis, the first sign of a problem is when you break a low which held before. So, the first low that we talk about now is the low in America recently which is 1,738 on the S&P, which was the low in January when we had 6 percent correction. So, that is the first level. If that is broken that will disturb people, make them worry that there is a top forming in America. So, that would the first level to focus on.

Q: Any of the other indicators like the volatility index or how the US dollar is doing or even how the bond yields moving. Do they give you any early signs that trouble is brewing?

A: Sometimes there are some signs, for example there are periods where you do not need to look at the stock market, you can just look at the euro and you know what the stock market is going to do. You have got that situation in Japan now. You do not need to look at the Nikkei; you can look at the Japanese yen and say I know the stock market will be up today. That is very unsatisfactory, that is the reality.

Q: What is the euro telling you now?

A: We recommended clients to short the euro at 1.3650. We think 1.40 is the ceiling and we have a very interesting situation here because what has happened in the last couple of weeks is commodities have moved into a bull market as far as we are concerned. If that means that people are getting speculative confidence again, it maybe that the dollar strength will be postponed, if the dollar falls below 1.40 on daily closing basis against the euro then the next levels to look at is 1.50. If that was to happen, then my feeling is that you would be in the midst of a mini speculative run on most instruments; people would be having confidence that the dollar is not going to be strong, they will be looking at gold again, they will be looking at commodities, they will be looking at emerging markets and that is something that could very easily happen. At the moment we have got a short position, we know where we are getting out but above 1.40 would be a signal to me that people are getting speculative again.

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Q: You would say that as things stand now it is a low probability outcome?

A: You never know. We are close enough that you can’t vote it out but part of the way that we look at markets and we make decisions on market is that we don’t like it here but if it goes above here we have to recognize maybe we are on the wrong track. So, 1.40 is a very important level. At the moment the dollar is being very strong this year) against the Canadian, against the Australian dollar, it has been strong against the Yen. The only currency it has been weak against is British Pound and the Euro. So, they maybe the last holdouts and they could weaken which is why we wanted to short the Euro. However, if it was to get above 1.40 that is again one of the things we are aware of in the background if that happens maybe it changes our short-term dynamics.

Q: Few words on emerging markets per se. If you were long emerging markets today, would you hold that long position or would you wind up in advance of the scenario that you are talking about for 2014?

A: If I was a global investor, I wouldn’t have money in the emerging markets. It has been unrewarding since 2010. If I found myself stuck in emerging markets, I wouldn’t pull plug yet. I would consider doing that later in the year. There are some strong seasonal tendencies in the emerging markets, for example there is a tendency to put a high-end in the spring and sell-off into late summers. So, at this stage of the year, I would be little bit more relaxed. There have actually been some interesting buy signals on markets like Brazil and Turkey in the past few weeks, which suggest they could have some rough side before they fall down again. So, at this stage I would stay with it but if you step back and look at how emerging markets have done, it has been a very poor performance. On a relative basis the emerging market are now below the global financial crisis lows. That is such an indictment to performance; this is relative to the American market.

Q: Is it still a relative call that you speak of now or in absolute terms do you see the emerging markets fall this year?

A: In absolute terms the emerging markets are in a sideways range if you use the Morgan Stanley Capital International (MSCI) EMF as a benchmark; there has been a sideways trend for 2.5 years. We believe that, that sideways trend will be followed by break to the downside. The best the emerging markets have managed during a very strong period in America is going sideways. That is not encouraging because unless America keeps going up and there is a rethink of emerging markets at some stage America will want to correct as we discussed earlier, the advance from 2009 and what will happen is, people will look back at emerging markets and say that was a consolidation and now we are having a correction inline with the America. So, from this sideways movement we expect it to break to the downside but it will probably need the incentive of that American cyclical decline to make it do that.

Q: What about the other scenario which is that America gets stronger from here and that picks up or sort of excites a slightly larger bullish move in the emerging market equity space, how much of a probability would you set on that kind of an outcome.

A: I think in the short-term that can happen because it almost feels that might be underway now because for the first time for a long time commodities out of the work we are doing are suggests that are in a new bull market. A lot of the emerging market weakness in the last couple of years was centered around the commodity producers, Brazil being a classic example. So, if there is a sign of some stability in commodities or actually price increases that may help sentiment towards those markets and in general that would help the MSCI EMF to prove from these lower levels. I don’t see – let us say that America continues to go up for two or three years possibly what that may mean is that we get to the top of the range again or we breakout a little bit but you would be in an underperforming asset class. So, for me that is not attractive. The outperformance is very clear and still intact and you need to see some change to make asset allocators want to change their mind. In the last four months you are probably aware that there was – definitely towards the end of last year, value investors were talking more about emerging markets again for the first time for quite some time. So, that is encouraging but when they look at the price action there is nothing really helping them to make that decision. They are not under pressure because they are still underperforming.

Q: It is interesting that you mentioned commodities because when they do well some markets like Brazil, Russia do well but India does not necessarily do well in such cycles. Do you think that commodities will lead emerging markets higher and therefore India might be an underperformer in that scenario?

A: India has been very interesting market because it has been dominated by a couple of sectors. The Indian market itself, if we look at the Nifty, it has reached a very big level. This 6000-6400 has been a barrier now for six years and the longer that continues the more people are aware of it and the more reluctant they become to buy when it gets above 6000. So, what the people have done in India, they have outsourced the index issue and said okay I am going to go with the sectors and the stocks and that has created probably quite some valuation concerns on the leading sectors because they have just been strong for such a long time. However, in our work we are finding most of the interesting stocks are still from those leading groups. There is a real have and have not relationship in India. In the market a lot of stocks are doing very poorly, commodity based stocks doing badly, the banks are doing badly as a whole. It is really some of the consumer plays, the pharma’s and the tech’s which are getting all the attention.

Q: Does it worry you this narrowness of this market?

A: Narrowness is a concern and the biggest concern we have – we were actually bullish on India, we like the market, but the biggest concern we have is the lack of participation from the small cap universe. Small caps have failed to confirm the new highs in the Nifty for long time. If you look at small caps in US dollar terms they are down about 70 percent in three years when you take the loss of the rupee and the lack of interest in small caps. That is a huge loss.

The good news is that is going to be the next really big opportunity in the market – the small cap index and the small cap market. For now it is a concern that you can't have a continual firm market if you are not getting broad participation, it is doomed, end in failure.

Q: Where would you put India in the rung of BRICS markets now if you had to sort of prioritize?

A: From the work we do it is second to China. China is a little bit better than India, not by much a little bit better. Definitely it is in front Brazil and Russia. The BRICS really I think this is part of the problem, we had this real manic excitement about emerging markets so we came up with BRICS. I think it was Goldman Sachs who came up with it and they have just let people down. This is why you have seen this continual erosion of relative value versus the developed markets for 40 months now.

They were hyped up to some extent, they did not deliver and now people have not yet forgiven them and I think we are going through that capitulation phase in that relationship.

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Q: You spoke about that 1738 level on the S&P. Is there a corresponding level for the Nifty below which you will start to worry?

A: In the short term 5972. It is the low that we saw a few weeks ago when we first came back from the high of 6415 and we held. My feeling is India is trying to convert 6000 from a ceiling into a floor but there is lot of nervousness around this level. Daily close below 5972 we would go back to being neutral, not bearish, but neutral from a bullish standpoint. So, we stop being bullish, we turn to be neutral if we have daily close below 5972.

For us the big story still in India really is the individual stocks. We are still finding a lot of decent stocks here performing well but they have been the ones which have been performing well for a long time. So, that is a little bit of a worry.

Q: Above what level would you say markets get exciting? If I were to put it in different terms, the rally that you were talking about in emerging markets, in the MSCI EM over the next few weeks in the event of such a rally playing out where could the Nifty go to?

A: Let us start with how people would view these problems of a level which can't be conquered. The high level so far which is actually the all time high of January, 6415, if you start to have a couple of closes above that level people  certainly would change the way they are thinking about the market. They would be selling less aggressively, stepping up to buy stocks they like a little bit more aggressively. So, there will be that shift which helps the index make some progress. Just above that level we are looking at 6800-6850 is the next barrier. However if the market wants to get bullish here we can step back and say we know there is a election coming and there is some wariness in front of that. However when we step back and say if it trades at 6500 that is the highest level it is ever traded at and that is going to help sentiment.

If people then look around and see the other markets are moving higher definitely the foreign participants in the market will change their mentality a little bit. So, a daily close above 6415 a couple of close above that will change the sentiment. Very quickly you could go up to 6800 from there.

If we have global rally then it is possible that the market goes quite a bit higher from there. It is constructive here – the bigger market, the large caps but the longer term problem is lack of interest in small caps. If that improves that could help things quite a bit.   

Q: In the event of such a rally would it still be a rally in your book that you would like to sell into?

A: The way we advice our clients when we do things for example we will sell some of our positions if we think things have gone up too much but we will retain a position if the trend is intact. Our whole basis is we are trend followers. So, there are lot of stocks that we are interested in India that we would hold if that trend is intact knowing we are taking the risk that if the rally fails we will be selling at lower levels but then we might get pleasantly surprised. If we break out of this higher levels that is the sort of environment where a good accident can happen. People could get speculative and push the market up.

Q: Would technology still be  top of your list in India, stocks like TCS and Infosys?

A: Out of those stocks at the moment we actually prefer Wipro because it has got a sorted four year base below it. Infosys has had a marvelous run up to a new high but it has got a little bit stretched here. So, I would like to buy that a little bit cheap if I could.

Pharma still looks pretty good to me. Couple have fallen by the way side but pharmaceutical stocks still look good. Then they are some selective consumer plays, we like Tata Motors for example. However it is a story that is quite familiar around the region. Pharma is strong throughout the whole region. The Chinese pharmaceutical stocks are very strong, the auto stocks are strong and some selective consumer stocks are strong. So, regional investors actually have been doing the same thing.

China has an even worse looking big picture market than the Nifty. However it has been certain stocks, the Chinese internet stocks have been very strong, the pharma stocks have been very strong and some of these consumer stocks have been very strong as well. So, India and China do have those similarities actually.

Q: Would you still buy an ITC where there have been a few question marks off late?

A; ITC I think is getting very close to being interesting again. If we see momentum begin to turn up, it has drifted sideways, it has lots its way a little bit. It was a very tight strong uptrend for a while, it is now drifted sideways and we have got back to levels now where we think if momentum picks up again that would be a buy signal. So, that is looking pretty interesting to us.

Q: Would you buy any of the Indian banks or is it in your no-no list?

A: I haven’t seen anything interesting on the banks at all.

Q: What about the large cap Reliance?

A: The problem with Reliance at the moment is that it is below a very difficult level. Rs 900 plus on that stock is very difficult. It looks to me like it might drift down to Rs 760-770. If someone liked Reliance I would say the try to buy it under Rs 800 with a view that you might be selling at Rs 900 if it gets backup there.

The way we look at stocks is that f most of the shareholders are happy because they are making money those stocks tend to perform better. Reliance has a lot of people losing money on it. So, that means in strength people are trying to get out and move into better looking stocks. So, it is a tough one. I would only buy it on weakness and I would be reluctant to that to be honest.

Q: If you had to pick one stock in India what would it be? What is the best looking chart you see here?

A: The most recent recommendation we made was Tata Motors. What we like about some of these Indian stocks is that when you look at things like TCS and HCL Tech, there has really been so little correction. You worry that you are buying something which could easily have a 10-15 percent fall. Tata has just emerged from a 18 month triangle. It recently tested the breakout zone. So, it is not stretched, it is not over extended, it is in a sector that is doing well in the region. So, if I had to pick one today I guess it would be Tata Motors.

The other one I am really interested in because it has got such a unique DNA to itself is Hindustan Unilever which is now down about 23 percent. It has had a habit of dropping 20-29 percent over last couple of years and then recovering. I think that is looking very interesting here.