CLSA's popular contrarian analyst Chris Wood says that Asia and Emerging Markets are in process of incremental decoupling where Asia and EM are in a bull market while Western economies are on a countercyclical phase of a bear market.
Click on image for the interview or go to the transcript below (Hat Tip Prieur Du Plessis)
Q: What have you made of the markets’ move in the past few weeks?
A: I was expecting what I call a counter trend rally, driven by a counter trend rally in the S&P this year. The key point is that the S&P in the fourth quarter last calendar year went further below its 200 DMA, and at any point since 1932, in the midst of the great depression. So, it was almost inevitable that we were going to have a counter trend rally at some point in 2009. Actually, I thought it would start with the arrival of the new administration in January-February, but it didn't start so much. My guess as to how far this rally can go is 1000–1050 on the S&P, but in my view from the Western view, the S&P standpoint, I am viewing this as a counter trend rally in a secular bear market for the US. I have a different view for Asia and India. I believe Asia and India remain in a secular bull market. So I have a fundamentally different view for the Western world and Asia.
Q: How would you describe what happened in 2008 then in India and other Asian markets like China? Deep cyclical correction? Over 10–15 months in an overall secular bull market?
A: I would describe that as a deep cyclical correction in Asia and EM driven by massive collective damage from what was going on in the Western financial system. That is why with my absolute return portfolio, I have been recommending investors from the middle of 2007 only to own my recommended portfolio, by hedging the Western financial risk by being short on western financial stocks. But in my view, the sell-off in Asian stocks last year was exacerbated by dramatic liquidation by foreign money particularly by hedge funds and so called fund of funds. What is being positive there in the rally began in Asia in October-November last year, is that we've seen growing local investor participation in Asian market, so the people who bought earlier in this rally since late last year weren't foreign fund managers but local investors throughout the region. That growing local investor participation is a long term positive.
Q: So are you saying that the secular bull market has commenced again in India and other Asian markets?
A: Yes, I think it has recommenced. It is two technical pieces of evidence that support that view. First, Asian markets and EMs have been leading this rally ever since they bottomed last October-November. Second, when the S&P made a new low in March, the Asian markets and EMs did not make a new low. That is technical evidence to me that Asian markets and EMs have become the asset class of choice in global equities. In the very short term because Asian markets and EMs have outperformed dramatically there is some short-term scope for the S&P to outperform. However, in the long run, in my view, the asset class of choice to remain fundamentally overweight is Asia and EMs. In my view, the biggest beneficiary of the dramatic monetary easing, quantitative easing undertaken by the Western central banks led by the Fed won’t be American/British consumers or American/British stock markets. The biggest beneficiaries will be Asia and EMs. In fact, the dramatic monetary easing could lead to massive asset bubbles in due course in Asia and EMs because the excess liquidity will flow to the best growth story and the best growth stories in the world are Asia and EMs. They have best demographic dynamics and have the healthiest economy because unlike the Western worlds, they do not have the structural leverage problems.
Q: Often, the measure of the restart of a bull market after a bear market is when the previous highs get taken out. How long is it before you think India and other Asian markets can take out their old bull market highs?
A: I don't assume that happens quickly, because I am bearish on the Western world. If I wasn't bearish on the Western world, then I would say very quickly, but I am. So in my view we are in a process here, we have commenced a process of incremental decoupling from Western markets. At the beginning of 2008, many investors in China and Indian equities believed in decoupling but by the end of 2008, after dramatic collapse in Asian stock markets after the Lehman bankruptcy, investors stopped believing in decoupling and started believing in the absolute opposite. The absolute opposite was a export-correlated train wreck with the US consumer. People became extremely negative on the most important EM story which was the not India but China. This year but the India and China economies have shown growth momentum; those very bearish concerns were misplaced. So we now have some empirical evidence that Chinese and Indian economies are able to decouple to a certain extent from the American economy, from the American consumer. The American economy is not growing, so that is building confidence in asset classes. We have begun the process of incremental decoupling. But I think unfortunately when the S&P turns down again when people realise that it is an L-shaped situation in the US, not an U-shaped or V-shaped recovery, you will get renewed correction. But my view is that next time the Western stock markets go down the Asian markets will prove much more resilient. But this process is incremental; it is not going to happen on a 12-month view.
Q: How bearish are you on the US markets?
A: I would expect a retest of 660 level in due course in the US if the equities correct and it coincides with the new dollar rally because the dollar rally is on deleveraging. But if the dollar keeps declining then the lows on the S&P need not be so large because some of the downside will be taken on the dollar.
Q: Even if the S&P were to go for a re-test you think none of the EMs, including India, will go for a test of their 2008 lows?
A: I don’t believe in a world where the S&P re-visits the lows of March. I don’t think the Asian equities markets, India will re-visit the lows because Indian economy has demonstrated its domestic demand driven resilience this year. We are now getting people talking of 5.5–6% growth, a few months back the RBI had come out with statements that growth was going to be much slower than expected and it said that growth was going to be 6%. Reality is at the beginning for this year, investors thought 6% was not attainable, but the data that has been coming out has been a positive surprise. The Indian economy is keeping its growth not by artificial stimulus measures by the government so basically the data has been a positive surprise this year and the government has been another positive surprise, which has been a clear mandate which should allow a more coherent policy which should allow for a renewed vigour in the infrastructure cycle now.
Q: How positive is the election?
A: I don’t want to over-dramatize it because of the Indian government history of disappointing on reform expectations. But I what I do think is positive is that most foreign investors who were on the sidelines before the election as they knew the situation is inherently unpredictable. So because of the clarity and because you don’t have a weak coalition government I think that was a major catalyst for foreigners to re-invest in India and logically the sector that should benefit is the infrastructure sector. The other point is that it has removed the risk that the fiscal deficit in India gets out of control.
Q: What are you overweight on in India, china and what sector in india?
A: I am overweight both on India and China but in the last quarter more India, because I was more overweight china in the first quarter. But in my long only portfolio, I am 33% in India and my biggest weight is in Indian banking though I did add a infra name after the election.
Q: Public sector units or private sector?
A: Both, but if I were making a new allocation it would be to a private sector bank.
Q: This trait to tanking up to defensives, you think that trend is over?
A: Tactically, Asian markets have had a big rally and people were fortunate in to be in the high beta names and they should be thinking of moving to less high beta names now, 70-80 on the oil price, you should reduce the beta names. But I would reduce in the commodity driven stocks, not banks.
Q: Do you find any discomfort with regard to valuations in India?
A: PEs look scary in India especially infra, but India is genuine domestic demand driven growth story. So it deserves a high PE premium, on a price to book basis, India looks undemanding. The whole risk in Asian valuations is in the potential negative correlation to the western world.
