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In 2019, stage will be set for EM outperformance against US market: Adrian Mowat


The dollar will weaken and EM FX including those which have overshot, have already started recovering, Adrian Mowat, EM – Equity Strategist, tells ET Now at the ET Markets Global Summit last Friday.

Edited excerpts:
Would the dovish comments made by the US Fed, help emerging markets? If yes, how?

It helps the bullish hypothesis. The underperformance in EM year to date has been mainly because the US economy has been growing much more rapidly. That meant global investors would be better off sticking with US equities rather than emerging market equities. Now there are also some other factors that work and this is where I think the Fed comments are important. Dollar has generally been strong and the emerging market currencies have been weak. As an international investor, you are concerned about the currency.

The Feds comments, shift the probability around the dollar from being strong to actually being weak because the expectations of another four moves by the Fed by the time we get into middle of 2020 now looks less likely. Also, the currency markets will begin to discount that. The dollar will weaken and EM FX including the rupee which I had argued have overshot and on the downside, are going start recovering. We are already seeing that. Rupee was at 74 against the dollar. We are now below 70 in a very quick move.

If we were to really bifurcate the entire EM pack into two – one, the commodity manufacturers or producers like Brazil, Russia, etc, and the other commodity consumers like India, Indonesia. What is the outlook 12-15 months down the line?

We are looking specifically at crude oil. Crude oil is very bullish for the Indian market. It means that probably the inflation forecasts for next year are now too high rather than too low and that the pressure on the RBI to raise rates (another 100 bps was the concensus) may not come through. That is very bullish for the Indian markets.

I do not like to look at commodity versus non-commodity markets, The Russian stock market is very small and the Brazilian story has much more to do with the change in government

A more conservative macroeconomic policy will help peoples confidence in the domestic economy. If we want it to be split into two the asset classes, I would spilt it into those that have been very negatively impacted by the trade disputes and China slowdown which is China, Korea and Taiwan and those that are less impacted by that.

We have had significant underperformance by China, Korea and Taiwan this year. Once the Chinese economy begins to stabilise and recover, we will see quite a significant outperformance by China, Korea and Taiwan where valuations are very low, sentiment as well as positioning is quite poor, It could be a rewarding trade for next year and that would be the key driver of a meaningful outperformance of the EM.

How do you see the relationship between China and America progress from here on?

We are really talking about the Trump administration and their positioning here because China to some extent is a bit of a passive player in what is going on. Economists like Peter Navarro who is among Donald Trumps advisors has consistently had a very hawkish view on China and three decades ago was writing about trade deficits and how these were negative things. So, we need to understand that their views are also very entrenched. But US did come to an agreement very quickly with Mexico as they are renegotiating NAFTA and then with Canada. They have had a truce with European Union as well.

Over the last 12 months, emerging markets and India in particular has not received much inflows from FIIs and has mostly seen outflows. Do you see chances of that trade reverse now in favour of emerging markets going forward?

It is growth investors that buy into emerging markets. The first condition they must have is a higher level of earnings per share growth in EM versus the US markets. This year the differential was something like 14% in favour of US EPS growth versus EMs. That is why capital has been going into the US and coming out of emerging markets. As I look at forecast for 2019, the EM EPS premium is going to recover versus the US and that will support an outperformance of EMs. Plus you will get a currency move and capital flow into emerging markets will accelerate and India will get its share of that.

What is the stance of the fund managers towards India in particular now that the broader market valuations have corrected quite reasonably? Is there willingness to take a fresh look and deploy money?

Well no. You need to look at this from the perspective of an EM manager. Year to date, the Nifty index is up in India. In China, the Shenzhen and Shanghai index is down 20%. So, investors have been positioned typically overweight on India as they view this is a more defensive market which is less impacted by trade disputes and China slowdown.

The risk for India over the next 12 months is that the factors that have driven the outperformance of India will change and you probably see the average EM fund manager move from overweight India to may be more of a neutral position. There could also be some risk management going into next year because there is a general election.

As for the general election, the assumption from the international investors is that the BJP-led government remains in place with a reduced majority. But that is the base case, as the political campaign heats up, perhaps people might decide to do a little bit of risk management and at that margin, there could be some outflows.

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