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Fed may raise rates once more: Morgan Stanley
Moneycontrol.com | June 30, 2006
Malcolm Wood, Asia Pacific Equity Strategist at Morgan Stanley does not see much difference in the Fed's May and June statements. But after this, he expects other Central banks, including Bank of Japan, BoJ to raise rates too. Fed will most probably raise rates once more, he says.
According to Wood, it is too early to say if the liquidity squeeze will be over as more liquidity tightening is likely by global central banks.
Wood also feels it is premature to expect a sustained rally and a choppy period is likely in regional markets. He also believes that the regional markets will be a good buy, if PEs fall below 11.
Valuations in India still look elevated to Woods. Therefore, he is looking below 9000 as Sensex level for investment.
Excerpts from CNBC - TV18's exclusive interview with Malcolm Wood:
Emerging markets seem to have received the news from Fed very well. Does this change your circumspect stance on India and some of these markets now or do you think things might continue to remain tight?
I think last night, the Fed was conveying a picture of stability in its views. If one compares the May statement to the June statement, there are not too many differences. I think that was what encouraged the markets.
Obviously, we saw a bright note in the US and that was followed through, as one would have expected in Asia.
Our take on this is that Fed has at least one more rate hike to do. It is quite concerned about inflation and it is a little premature to think that the liquidity squeeze that we have seen in the past one-two months is over.
Do you expect a string of outperformance from emerging markets including India once again now or do you think it may not be such a good summer after all?
I think it is little premature to expect a sustained rally at this point in time. We think that we are in for a choppy period here in the region, not just in India but in the entire region.
The reasons we say that is because we are not sure on the growth outlook, particularly in the US. Our guess is that will be a soft landing, but that is obviously a forecast not something that we can point too concretely.
Now the US has slowed in the Q2, if that is the picture that continues it will be good news. But it will take a little while to clarify that.
So first is soft landing or a hard landing, while second is the Fed. But other Central banks as well are becoming important here. We are talking about the Bank of Japan and the European Central Bank, each of which we think we will be raising rates again over the next couple of months as well.
Then you got the whole issue about sentiments from investors. Our view is that investors have certainly turned more cautious, more uncertain. But they certainly haven't capitulated at this point of time. So perhaps we want to see more of that in order to set us up for the rally.
So those factors together suggest to us that it will take a little bit of time. The other thing that might act as a cause for a more positive outlook could be if we reach to valuation levels that we think rock the solid support levels.
We have got close to that in Asia a couple of times, so from a regional perspective that is encouraging. But at this point of time, we think it is a little early to be making the rally call.
How choppy do you reckon it is going to be and what are those levels from which you see this market rallying more strongly?
In terms of the choppiness, we think we are in for a period of high volatility. I can give you some regional perspectives on that. The way we look at the volatility, we think it is going to bounce and stay up above that 20 per cent level for a while. It has been a long- term downtrend, but this is going to disturb that for a while.
The reason for that are the issues that are alluded to. There is uncertainty about the growth outlook, there is uncertainty about what the Fed is trying to do and that of course creates volatility in markets. It is not unusual toward the end of Fed tightening cycles.
In terms of valuation across the region, we believe that the markets are a good buy when the forward PE falls below 11 times. We might have reached that couple of times over the past few weeks, but are not quite there. From a regional perspective, we think we are going to get close to those valuations support.
From an Indian perspective, we think that is little bit lower. Obviously, India has been significantly re-rated by investors over the past couple of years. So valuations in India still look more elevated to us than elsewhere in the region.
So what is the fair value for India?
We will be looking at the index level of below 9,000.
What are the chances that this summer we get a rally?
I think we could get a rally, if we saw signs that the US inflation concerns were way over done. So if we got some good inflation numbers tonight, along with good CPI numbers that would be coming in the next couple of weeks and the inflation expectation measures that the Fed is closely watching, if that also comes off, then that would encourage the Fed and the markets to think that they are getting on top of these inflation concerns.
That would be the one key catalyst that would get us going. Obviously if the Fed changes its tone and say we are done, that would be another catalyst that would get markets rallying. Those would be the two reasons that could give us a summer rally. But I think we unfortunately won't get that in the next few weeks.
What do you expect to see for the next six months in a market like India?
I do not think the liquidity squeeze is over. I think there is more to come in terms of liquidity tightening from global Central Banks. So in our view, the Bank of Japan will end its zero interest rate policy.
So now when they start to have a positive interest rate again, we think that there will be something that markets will need to work their way through.
The data flow out of Europe is very strong at the moment. The German IFO index is at the highest levels in 15 years. So we think that the ECB will be rising rates further again and then obviously the Fed will raise the rates as well.
Then if we look at our region, obviously the Reserve Bank of India [Get Quote] raised rates recently. But they were not alone, I can point four-five other Central banks which have raised rates within our region over the past month or so.
So global liquidity conditions are tightening and we expect that to continue. In terms of investor flows, just to give an idea on that aspect of liquidity, we have seen redemptions from the emerging funds survey.
We have seen redemptions representing about 50 per cent of the inflows that we saw from January to April. So we saw massive inflows in that period and half of those have gone out in the subsequent six-seven weeks.
So from that perspective, there has been a pretty good adjustment on the liquidity picture. But we think there is probably a little more to go there as well.
But India seems to have done well in not seeing that kind of reversals from the beginning of the year. How would you read it; positively or there could be more to go from India?
That is always a difficult one to get a hand on. Obviously, if one is a portfolio manager running a global emerging market portfolio and you see this sort of correction that we have seen over the past month or two, there is an issue of liquidity as well as market view.
So if one can sell shares in Taiwan or Korea, but struggles to sell them in Brazil, Russia and India, then you may be encouraged to take profit or to reduce your exposure where you can, particularly if one is concerned about redemptions within your fund.
So suppose I were to say that from a overall perspective, there have been material redemptions and how portfolio managers handle that on a day-to-day basis may depend in part on liquidity conditions within markets, that are just referred to.
If one has been buying Indian midcap stocks, then it may have been quite difficult to liquidate those positions over the past one or two months.
Whatever the Fed said last night, where does it leave risk aversion trade?
The risk aversion trade is an interesting one. When we were back in late April, early May, our view was that markets were pressed for a continuation of strong global growth and a very benign end to the Fed tightening cycle.
Now obviously, we had a bit of a shock to the benign end to the Fed tightening view. We still think that earnings expectations are probably a little bit aggressive in some markets, particularly on the basis of global growth strong and people seem to be extrapolating a continuation of that.
So if we sort of look at those two parts of the puzzle, we would say that the Fed concerns have certainly reasserted themselves. But we do think there could be some earnings risk particularly in the more cyclical sectors that are linked to the US economy, US consumer in particular.
That is not a big issue for India; it is an issue for exporters in some markets like Korea, where expectations have come down sharply. Similar is the case with Taiwan and elsewhere in the region.
So, those will be the two parts of the puzzle that we will be looking at as I said some adjustment, but not total at this point.
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