Michael:We’re entering a period of global synchronized growth (Livemint)

An increasing number of analysts seem to imply that the euphoria that has lifted Indian equities to record highs in the early part of the year will fizzle out later in 2018, says Rainer Michael Preiss, executive director, Taurus Wealth Advisors Pte Ltd.

“The consensus view on Indian equities now increasingly says that a Goldilocks scenario of a sharp earnings recovery, but with continued robust macro stability—benign inflation and currency rates—appears priced in,” Preiss said in an interview.

Edited excerpts:

During an earlier interaction with us, about a year ago, you said India could benefit from the Donald Trump administration’s search for new allies in Asia to counterbalance the rise of China. When do you see Trump really get tough on China over trade and when that happens who will be the beneficiaries?

Geopolitics in the Trump administration has taken on new complexities. The US–Russia relationship and the Chinese One Road, One Belt initiative that now also potentially includes Latin America is a key development that, over time, might reduce the global influence and role of the US dollar.

Recent news (has it) that Germany’s central bank and the fourth largest economy in the world included RMB (Chinese yuan) in its official reserves while previously repatriating its gold reserves held at the Federal Reserve in the United States back to Germany.

Developments like these show that the America First policies could lead to new strategic decision making and potential reordering of the current financial architecture.

Outside of the geopolitical sphere, are trade-related fears the biggest external risks we face, since the whole cycle in Asia is currently still very export-orientated?

After many years of extraordinary monetary stimulus and unconventional QE measures, we are now entering a period of global synchronized growth just at a time when the largest economy in the world, the US, is embarking on tax reform and fiscal stimulus.

The global economy is rebalancing, and this is increasingly led by China and supported by the Trump administration’s America First policies are pushing some countries like Pakistan away from the US dollar and firmly into the Chinese RMB orbit of One Road, One Belt initiative.

Asian economies historically tended to be focused on export-led growth, but, increasingly, domestic consumption-led growth is fuelling the economy that increasingly is built on creative businesses and technology-led growth.

China is trying to lead in this new economy initiative and the stellar stock market performances of Tencent (Holdings Ltd), Alibaba (Holding Ltd) and Baidu (Inc.) to mention but a few is proof that investors are voting with their money.

Trump has recently started to flex his muscle on the trade front by imposing tariffs on solar products and washing machines; clearly, this was aimed at Asia, but markets clearly ignored it. If he continues on this path and affects more products, then there is potential of trade retaliation and a likely trade war scenario evolving.

Most fund managers and analysts share the view that India represents one of the best structural stories in the emerging markets (EMs), but is it really poised to ride these structural advantages?

Indian equities had a great run, and many global investors continue to be overweight Indian equities in emerging market portfolios. India historically has benefited when oil and commodity prices declined, and has faced headwinds when oil was rising.

Current market action seems to reconfirm this as Russia as an oil producer is the among the world’s best-performing markets, but India is considered to be increasingly facing headwinds. An increasing number of analysts and banks’ official house views seem to imply that the euphoria that’s seen Indian equities building on record highs this year will fizzle out later in 2018.

The consensus view on Indian equities now increasingly says that a Goldilocks scenario of a sharp earnings recovery, but with continued robust macro stability—benign inflation and currency rates—appears priced in. However, the equity markets can continue higher as momentum and bullishness is strong. What is important is to keep an eye on the US dollar as it will be a good indicator of when flows reverse.

What are your most attractive emerging markets for 2018?

Investors are bullish on emerging markets on bonds and equities partly because of what is happening in the US and partly because of world growth and higher commodity prices.

Nearly 10 years after the financial crisis brought the global economy to its knees, conditions have finally improved enough to crystallize the view that synchronized global growth is currently underway. In this scenario, EM as an asset class tends to outperform.

EMs outperformed developed equity markets in 2017 and we expect the same trend to continue in 2018. Revenue and earnings growth are up year-over-year, not just in the US, but worldwide. Despite President Donald Trump threatening to raise tariffs and tear up trade deals, global trade is accelerating, while the US dollar is declining, further leading to tailwinds for emerging market equities.

The broad-based improvement in EM external balances should make the asset class much more resilient to rising core market rates, certainly when compared to the taper tantrum in 2013.

EM equities may hold up better in the global reflation environment than bonds and currencies. Worldwide business optimism, as recorded by October’s IHS Markit Global Business Outlook survey, climbed to its highest in three years, with profits growth and hiring plans continuing to hit multi-year highs.

Year-to-date 2018, the best performing equity markets are all markets that have a commodity angle and are considered to be linked to the China One Road, One Belt initiative.

The strong rebound in oil prices led Nigeria to become the second best performing stock market globally, followed China’s HK China Enterprise Index as the third best performing market in the world.

Kazakhstan and Russia are 5th and 7th best performing markets that are driven by higher oil and commodity prices. Russia in particular is an attractive valuation story; current year estimate price-earnings ratio of 6.6 makes it one of the cheapest equity markets.

It is interesting to note that both Italy and Greece are among the best performing markets globally so far this year as the European Union is considering to move to closer integration and potentially focus away from austerity to more growth oriented policies and fiscal stimulus.

South Africa is one emerging market that could surprise to the upside in 2018. Many investors increasingly see a window of opportunity and a feel good factor about South African equities at the moment. Long overdue after the disastrous Jacob Zuma years.

With EM assets still well bid as we enter 2018, investors are looking for ‘the next big EM story’ akin to Brazil in 2016 and Mexico in early 2017. South Africa in 2018 could be at the top of the list of potential candidates, given the market-friendly ANC leadership vote. Improving macro fundamentals already underway and ‘room to catch-up’ could support South African assets in 2018.

South African rates and FX appear inexpensive and South African equities are under-owned in global portfolios, which could lead to a re-balancing and catch up.

Plenty of things could upend the two-year rally in EM equities. Yet no one seems to agree on just what they are. For now, the bulls are firmly in control of the long EM trend. The key risk for EMs are an unexpected sharp spike in inflation within mature markets as this could be “a game-changer” for equity flows. In addition, this could probably spur tighter global financial conditions and become a headwind for risk assets.

But for now, most banks and the Washington-based Institute of International Finance remain constructive on EMs, forecasting non-resident portfolio equity flows rising to more than $150 billion this year from about $70 billion in 2017.

Will the US tax reforms trigger a resurgence in corporate capital flooding back to America, thereby driving up the value of the US dollar. So, how big a risk is a strong US dollar for EMs?

The rally that’s set equities on fire in 2018 raises the risk of a market correction, though a bear market is unlikely for now. So far this year, risk appetite has picked up materially, nearing its all-time high, led by equities. The question about the impact of US dollar strength on emerging markets is often backward looking in my view. The world and the balance of global power is shifting.

Historically, there was a strong correlation between risk off and a rising dollar, but, increasingly, these correlations could become less statistically meaningful.

In the new macro environment of US tax cuts potentially leading to much higher US government deficits, the positives for the dollar of lower taxes might be offset by a larger deficit to be net/net neutral impact.

Also EM domestic fundamentals are now stronger than in the past, and this implies fundamentally stronger local EM currencies against the US dollar.

In terms of asset allocation, we are underweight bonds in 2018 and favours emerging- market assets over developed ones, especially in equities.

Will rising corporate bond yields see Indian firms going back to banks for loans?

Bond markets could finally be signalling investor concern over slowly accelerating inflation. Historically, correlation between stocks and bonds changed when 10-year Treasury yields were +4%.

The current debate among fixed-income investors is whether the bond market could be turning into a bear market. The key driver for an eventual bond bear market is gradual re-pricing of inflation risk linked to a booming European economic recovery, ongoing underlying strength in the US and increasingly positive data from China following that country’s Communist Party Conference late last year. A weaker US dollar could add to rising inflation expectations.

Media reports that the Chinese government might slow or halt US Treasury purchases could further lead to a change in sentiment towards US dollar-denominated debt and might lead to higher yields.

The new narrative increasingly is that the big buyers of the global bond market—the central banks—are pulling back.

The pace is different in different countries, but the direction of travel is still roughly the same. On top of that, a great flood of supply is coming all at once across all major markets—not to mention, according to JPMorgan Chase and Co., a massive $1.3 trillion of new Treasury issuance over the course of 2018.

So, it looks as if the balance between government supply and investor demand is finally shifting and leading to a re-pricing in global fixed income markets.