George Hoguet is managing director and chief investment officer at State Street Global Advisors. State Street is the world's largest money manager. Hoguet looks into the future to plot where the global financial markets and India could be headed over the next 12 months.
He feels, "I think that Indian stocks are richly priced relative to their emerging market peers, but nonetheless long-term strategic investors should have some exposure to India."
Excerpts from an interview given to CNBC-TV18
Running as much money as you do in the emerging markets, how do you feel about the whole asset class right now after the turbulence of the last few months?
There is no question that emerging markets are facing a more difficult environment in the months to come, particularly given the uncertainties surrounding the economy and by extension the world economy. But I think the secular forces driving world economy returns are dominating, and will continue to dominate the cyclical factors.
So when you look forward to next 2-3 years, do you expect to see liquidity flows remaining robust into some of these emerging markets?
They are definitely hostage to the global economic cycle. And should we have a recession in the United States, which then adversely impacts the export volumes coming out of Asia and particularly China, which then would back up on the rest of North Asia suppliers like Taiwan, Hong Kong and so forth, that would dampen enthusiasm.
But the secular impetus is quite strong and emerging markets, which have historically been an exotic asset class has become more mainstream.
During the start of this asset class in the late 1989-90, emerging markets actually sold at a P/E premium to developed market. Now they sell at 20 per cent discount. There is scope for that price-earning multiple discount to actually be further reduced.
But we have to say that it is all subject to the evolution of the global economy and in particular what happens to the US and also commodity prices. We don't think that we will have recession in the United States but the U curve is becoming more inverted day by day.
How susceptible are emerging markets' performance to a commodity meltdown?
There is no question that it would have a negative impact on return of equity to emerging markets. Return on equity now is about 19 per cent - actually in excess of developed markets' return on equity. A lot of this has been driven by commodity prices.
So, if you look at Brazil for example, which is a major supplier of iron ore to China. India and China's demand for oil of course is well-known and other commodities like nickel are in short supply. So, the global boom that we have had which has been lead in parts by Asia and India and China has fueled this rise in commodities.
So, the question is that, as the US economy slows down will commodity prices fall sharply? We don't think so. But it is also true that there is a speculative element currently in commodity prices. We have seen the unwind that has just taken place in the past month in the United States' oil market.
If expectations were to change rapidly and there was a rapid liquidation of speculative positions in commodity prices, then it could potentially impact risk appetite with regard to emerging markets and also at a more fundamental level, should these prices remain more strained - it would effect earnings prospects for many of the companies in emerging markets.
Do you see much lower metal prices in the future? Would you be short in those stocks?
I don't think so. I think that what we have determined here is that here there is both a supply element and a demand element and there was under-investment basically in the 1990s and it takes a while to bring on new capacity and both the demand and supply curves are relative elastic, and it takes a while for these effects to pass through.
But I think one also has to be discriminating and look at each commodity in terms of its own fundamental dynamics, its global patterns of use and where demand and supply is likely to manifest itself in the months to come.
Do you find India less susceptible to these kind of commodity swings or will we behave pretty much in line with the other emerging markets?
India is what's known as a low beta market, so it is less volatile in relation to the world market portfolio - for example in relation to Turkey. So, whenever emerging markets go up one Turkey goes up two and when emerging markets fall as they often do in violent sort of moves, then Turkey goes down very rapidly.
What makes you most optimistic about India?
I actually think India is expensive in a global context. I think that the earnings growth that is expected is quite high - over 16 per cent - over the next couple of years and also there is a lot of interest in the technology sector because even though the TMT stocks (tech/media/telecom) got absolutely clobbered in 2000 selloff, this technology wave is continuing throughout the world and IT spends are growing, and is likely to grow for many years to come.
And ofcourse outsourcing is in its infancy and India is not only going through business process outsourcing but also knowledge process outsourcing and moving up the value added chain.
I think that Indian stocks are richly priced relative to their emerging market peers, but nonetheless long-term strategic investors should have some exposure to India.
You wouldn't put any fresh money into India at these prices, would you?
Emerging market equities are 6 per cent of the world's investable capitalisation measured by Morgan Stanley Capital International. Within an emerging market portfolio, I would be structurally underweight on India, by probably about 2-3 per cent simply because one can buy Brazil at seven times forward earnings and Russia is only about 11 times forward earnings, but India looks expensive. All the same, I would have some money in India based on its weighting in the emerging markets indices as a whole.
Over the next 3-4 months, do you expect to see the kind of heightened volatility that we saw in the middle of the year?
I think volatility is going to go up because there is a great deal of disagreement with regard to the Federal funds rate. Two of the most prominent securities houses on Wall Street, one of them has Fed Fund Rates at 4.25 by the end of September '07 and one of them has it at 6 per cent.
So, when you have that type of disagreement, there is potential for surprise one way or the other. We have also been in a period of extreme low volatility and after the spike we had in May-June, it came back in and the spreads came back in.
But I think, it's likely that unbalanced volatility will rise. It will take some precipitating news - if we have some shock - like some sort of confrontation with Iran or a series of terrorist events. But even in the absence of that, some economic news might raise volatility.
What would you own in India?
I would own a broadly diversified portfolio. We continue to think some of the energy stocks and (raw) material stocks are of interest, but I would be broadly diversified at this particular juncture.
Between India and China you would put more money to work in China right now?Yes. I think the Chinese economy is more resilient to external shocks and to a change in an investor's sentiment. Chinese reserves now are close to a trillion dollars. The Chinese economy is growing more rapidly than India. China is attracting a great deal of FDI and I think the environment that we are facing, it is quite likely that China will be able to withstand strains in the global economy should they materialize, better than India.
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