Indian markets have tumbled over 10 per cent this calendar year (CY16), with the foreign institutional investors withdrawing over $2 bn. Hong Kong-based Geoff Lewis, senior strategist (Asia), Manulife Asset Management, which has around $301 bn in assets under management globally, tells Puneet Wadhwa that CY16 might be another year of net FII outflows for emerging markets. However, the pace of outflows is likely to subside by mid-year. Edited excerpts:
Are the global equity markets strongly in a bear grip or can there be a silver lining as we move ahead into 2016?
In January, Investors found themselves caught up in a perfect storm that no-one had anticipated or forewarned them against. These fears are understandable. There will inevitably be some spill over effects on the real economy from the January stock market correction. But unless markets fall a lot further in the first half (H12016) and then stay depressed, we do not think the January correction is a big enough shock to undermine our base case scenario of moderate growth and low inflation in 2016.
We simply do not foresee either a US or global economic recession within our forecasting horizon, based on the high-frequency economic data that we track and a wide variety of recession gauges. This view assumes that potentially higher US rates won't tip the US or global economy into a recession.
What is your outlook regarding rate hikes by the US Federal Reserve (US Fed)?
After the first rate hike by the Fed in December, markets have now moved on to the extent/number of rate hikes next year. We expect the US yield curve to flatten given low inflation expectations. We are of the view that having raised rates once, the US Fed will be very cautious in raising them again.
Moreover, the US Fed is well aware of global deflation risks. Given the dreary economic indicators we have seen in the US so far this year, I think it is more likely the Fed will stay on hold in March.
The latest Fed dots suggest the Fed will hike rates four times by 25 basis points over the course of 2016. The markets have priced in zero rate hikes in 2016. For the latter to occur, the Fed would have to materially revise its growth and inflation forecasts downward at the March FOMC meeting. Our view is straight down the middle between the FOMC and the markets-we expect a 25bps hike in June and then one more in the second half of 2016. The greatest risk to the US economy continues to be the Fed tightening monetary policy too far, too fast.
How similar, or different, is this global financial market correction going to be as compared to 2008?
There is absolutely no comparison whatsoever between now and the situation in 2008 immediately pre-Lehman and well into the Global Financial Crisis. To suggest that there is a close similarity, as some in the financial media wish to do, is to fan the flames of ignorance and unwarranted fears. The situation facing the global economy today is not ideal, but we are far from another global crisis. The world economy on the latest forecasts from the World Bank and IMF is expected to show growth of around 3%, not stellar, but far-removed from the slump in activity seen in 2008.
Do you expect the Chinese economic growth to slow down even more than what is being widely expected?
Chinese economic activity has already slowed to around 4%, if you take physical measures of output for the component industries within manufacturing, where physical measures, steel bars, tonnes of cement, etc are mostly negative. We believe it is close to stabilizing, and that Beijing has enough policy room to achieve this. The services sector in Chinas remains buoyant and overall job creation is satisfactory.
Do you see more allocation to emerging markets, especially India, by foreign institutional investors (FIIs) in calendar year 2016?
A general economic recovery for EM has been postponed to 2H 2016 at the earliest.
Whilst the present risk-off episode is about to blow over, there are no early catalysts in sight to bring international investors back to EM equities in a hurry. At the very least, we need to see signs of an inflection point in earnings, and the latest results and analyst revisions, or momentum, do not offer much encouragement.
India has suffered in the latest outflow episode, but has better underlying fundamentals, given its domestic growth sources. So we would expect FIs to return to India ahead of other EMs, though only slowly at first. 2016 will likely be another year of net FII outflows for EM overall, though the pace of outflows should subside by mid-year.
There is a large range of potential outcomes for individual EM in 2016, depending on policy, the USD, China and politics, both geopolitical and domestic. Thus a selective approach within EM is called for, especially as our base case expectations are initially cautious for EM coming into 2016.
What is your strategy regarding Asian markets, especially India?
We continue to be positive on Japan as a rare non-consensus opportunity that could last for a decade or more. Following extended periods of volatility in 2015, we expect to see further stabilisation in Asian equity markets in the year ahead, with the potential for further monetary easing in some countries, including China, India and Indonesia.
For EM overall, it is too soon to be going overweight, as the combination of a strong USD and weak commodity prices is proving difficult to overcome. While inflation seems a distant possibility, the general uncertainty is supportive of a position in gold in the portfolio, especially now that gold seems to have found good support after its 4 ? year decline from the 2011 peak. Investors should take the January correction as an opportunity to conduct a thorough portfolio review.
What are your expectations from the Union Budget 2016?
The Indian budget in 2016 is unlikely to be the major event that the financial media wish it to be. Mr Modi has already set out his reform agenda, and this budget is likely to hold few surprises. Far more important than anything new that this budget is likely to offer would be if Mr Modi found a way to get some of his key measures through the upper house, where the Congress-led opposition have shown little interest in cooperation, even over the GST, a measure that originated with the previous government.
When a government has a coherent medium-term economic strategy mapped out, as the BJP evidently does, economic commentators really should stop looking to the Finance Minister to perform magic by "pulling rabbits out of hats" on budget day. To view the annual budget in such light is simply devoid of rational meaning and only serves to continue the budget day charade.
How will the markets react to any deviation from the fiscal deficit target?
A good budget should, by definition, if fiscal policy is on track, be boring. That said, this is absolutely no time for fiscal austerity. India has many pressing needs, in education, infrastructure, health etc. Mr Modi should take advantage of the margin of spare capacity in the economy and the relatively low demands of the private sector for funds to boost spending in key areas wherever he can. Fiscal austerity in India's case is always wasted opportunity.
What are you advising your clients to do over the next few months? Is investing in fixed income segment a good option?
Although fixed income will provide better downside protection than equity if there is a recession, we retain a cautious stance on fixed income given our base case that a recession is not within sight. In addition, bond yields are very low or even negative in some countries, and offer poor value with little upside. The recent volatility in financial markets has confirmed our view that within asset allocation a broadly defensive stance is sensible at this point.
Volatility in equity markets is a concern, but so also is volatility in the credit markets. Recent market dislocations, however, also provide investors with an opportunity to capture better opportunities, and bottom-up stock pickers should be looking eagerly for oversold stocks.
We believe there are still many challenges facing the energy complex, and our considered view is that we will see lower energy prices for longer. There are many similarities between the current energy environment and the energy environment that prevailed in the mid 1980's. While in the short term, we could see a final spike down in the oil price, the trend in oil demand by emerging economies remains firm. Have oil prices bottomed out?
So a new oil price range of $40 to $60 per barrel could emerge in the second half of 2016 and prevail for some time. Stability rather than the absolute level of the oil price is what the world economy requires for sustained growth.