n an interview with CNBC-TV18, Ian Scott, Chief Global and European Strategist, Nomura says, the recent rally in emerging markets (EMs) globally is primarily a reaction to the sharp underperformance that they saw earlier in the year. “I think it has been more of a short covering rally than a start to a new bullish trend of outperformance,” he adds.
He further says, he wouldn’t switch from developed markets (DMs) to EMs. “I think the fundamentals in EMs remain somewhat uncertain. I think it’s too soon to be upgrading EMs,” he adds.
Commenting on India, he says, he would be cautious about Indian market. "The valuations are high not just relative to DMs, but relative to other EMs," he adds.
Also read: Why is RBS still not bullish on India?
Below is a verbatim transcript of his exclusive interview with CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.
Q: Your take on this big pullback we have seen across the emerging market region generally and what you have made of it?
A: Obviously there has been a strong recovery in emerging markets (EMs) globally. I think it’s primarily a reaction to the sharp underperformance that we saw earlier in the year. I am not sure that the fundamentals have really changed an awful lot. I am not sure that valuations are really compelling at these levels. So, I think it has been more of a short covering rally than a start to a new bullish trend of outperformance.
Q: It’s come with a big burst of liquidity though, how much of that is chasing momentum right now and how much is backing the fundamentals of these markets?
A: I am not sure it has been a fundamentally driven rally. When you look at some of the key drivers of EM performance, in particular oil and commodity prices generally have been rising, which is not usually a good thing for EMs, particularly some of the ones that have been the strongest outperformers.
Secondly, we haven’t seen a big reversal in fund flows. Thirdly, I think the inflationary pressures and the upward pressure on interest rates in EMs remain. So, I think this has been a short covering rally rather than something based on strong fundamentals.
Q: At the start of the year, emerging markets were underperforming developed markets quite considerably and that seems to have turned around a bit over the last 15 days. Would you now start buying or favouring emerging markets over developed markets? Do you think that trade has reversed for good?
A: Now, we wouldn’t switch from developed markets (DMs) to EMs. I think the fundamentals in EMs remain somewhat uncertain. Interest rates do need to go up, inflationary pressures remain. I think with commodity prices particularly food and energy prices rising strongly that could have a damaging impact. If you look at what’s happening to earnings revisions, they are worse in EMs than they are in DMs and the same is true for the revenue revisions at the moment as well. So, I think it’s too soon to be upgrading EMs.
Q: There has been some talk over the last few days that some of the sharp burst of money that we got in emerging markets and in India could have to do with the flows post the Japan crises, the amount of money which was thrown into the system and that found its way into emerging markets and commodities. Did you see any direct correlation?
A: I think obviously the Japanese crisis has led to some meaningful underperformance for the Japanese market. But we don’t see a big reaction in terms of fund flows and the buying that’s taking place in the last week or two in EMs is been pretty small. So, it is quite a big rally in EMs with quite a small amount of buying.
Q: So what would the picking or pecking order be within the Asian region now for you?
A: If we were going to pick any of the markets in the Asian region, I think the Chinese or Asian market is the area that we would favour over others. Chinese market trades on a substantial 30% discount to the Indian market, so that would be where we would be looking. Elsewhere in the DMs, I think the Japanese market has overreacted to the earthquake. I think particularly in the last few days we have seen the yen weakening and the stock market going down, I think that is a gross overreaction to the problems that Japanese society and economy are facing at the moment.
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