In 2017, developed nations to outdo emerging ones: Aaron Low

Interview with Aaron Low, principal, Lumen Advisors

Emerging markets could once again underperform developed markets this year; however, the performance gap won't be as high as last year, says Aaron Low, principal, Lumen Advisors, a global asset management company. Speaking to Samie Modak at CFA Society India's investment conference, Low says that, despite challenges, India offers one of the best opportunities in Asia. Edited excerpts: 

Do you expect developed markets to do better than emerging markets again this year? 

Developed markets should outperform emerging markets (EMs) again this year as well but by a smaller margin. The rally in developed markets at the tail end of 2016 was fuelled by speculation and we still need to wait for earnings to pan out these justifications in higher price multiples. The headwinds for developed and emerging markets are different. I think developed markets are struggling with policy mistakes and derailment while emerging markets will face deleveraging issues. Both are impactful but deleveraging effects tend to drag longer.

What are the key near-term global risks for equities? 

Key global risks are policy implications of the current spate of anti-globalisation forces prevailing over developed markets. This can have significant impact on trade and on emerging markets. Also, rate hikes in the US pose a bigger threat to emerging-market deleveraging. Rate hikes are likely to be consistently timed with the US business cycle, rather than the global business cycle. So, it's a bigger risk for emerging markets than it is for the US.

Which countries offer best opportunities in emerging markets? 

India still poses one of the more attractive opportunities within emerging markets if it can maintain stability in currency and inflation. The reason lies in the quality of its growth as the private sector and the government sector are  more aligned to engage expansion than previously managed. The Philippines and Myanmar are also relatively attractive markets but pose more risks than India.

Having said that, the challenge for India is it requires more infrastructure investments for the next leg of growth.

What’s the foreign flow outlook? 

Outflows from emerging markets should stabilise. Still, investors are cautious about prospects to growth. Emerging markets are a tactical bet on growth, so we could see inflows if global growth surprises on the upside. I would expect some pickup in growth but would not venture to the levels seen in the 2000s. We have seen some inflows back into equities but global allocations are still ‘neutral to underweight’ in equities. Those inflows still have not offset the outflows witnessed in the previous two years.

How will higher inflation in the US impact emerging markets and Asian markets? 

The stronger dollar has mitigated some of the growth headwinds for Asian trade but, at the same time, it poses higher costs of capital for the resource-hungry Asian industrial complex. Places that should benefit more are likely the commodity-based EM countries which have lower domestic inflation. Even though we expect inflation to pick up in the US, we are not expecting significant resurgence in pricing pressures.

Why do overseas investors prefer India over other peers?

The reasons are not hard to fathom. India has a strong, well-educated workforce which is cheaper than China. Plus it offers a lower economic base means that India still has some ways of being one of the shining stars of the EM. There are significant barriers and risks to the sustainability to the current momentum but the country has the necessary political leadership and vision to partner with industry to make a real difference this time.

Are you disappointed with the delay in earnings and economic recovery in India?

Yes, with regards to the delay in earnings. But we know that earnings kick in with a lag and once the shock of the demonetisation program has run its course, there should be more clarity on the earnings and economic momentum.

Do you think demonetisation will hurt the Indian economy?

So far the demonetisation doesn't seem to have had a very significant impact on the economy. As the currency gets placed back into the banking system, we should see more productive use of capital and that may even have an impact on the cost of capital.