Year 2013: Goldman Sachs bets on emerging markets, India (Money control)

For the global economy, as a whole, we are looking at 3.1 percent growth this year in Purchasing Power Parity (PPP) terms. We think that it will rise to about 3.5-3.6 percent next year. Timothy Moe, Goldman Sachs

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Year 2012 has been a good year for most Asian markets. In an interview to CNBC-TV18, Timothy Moe, chief Asia-Pacific regional equity strategist at Goldman Sachs says things look a little bit better in the emerging world. "We are certainly looking in our official forecasts for the relative performance of the emerging markets to outstrip that of the developed ones," he adds.

He is looking generally at a slight firming of growth for most Asian economies next year. “Against the backdrop of a modest pick up in growth, overall, we think that should bode well for the corporate earnings environment and consequently for equity market performance,” he elaborates.

He further says sentiment for India is turning positive. "In order to become more constructive from here we need to have a bit more confidence that the industrial production cycle would indeed begin to turn up. Our economists are hopeful that it may begin to be more visible sometime in the middle part of calendar 2013, maybe around June or so," he adds

Given the fact that equity markets tend to be forward looking, it will suggest that as we go through the next few months, it might be wise to be opening up one’s hopes a little bit more towards the upside. "But we still think, right now, it may be a bit premature. As opposed to feeling that the risks as previously were lined up more on the downside, we think the risks are balanced and actually shifting towards the more constructive side as we look forward in time," he asserts.

Q: How do you view 2013? Do you see 2013 being an encore?

A: Our early views are on the positive side. We have currently extended our targets to September of next year. We are just in the process of finalising our views for next year-end. But our expectation for the MSCI Asia-Pacific, ex-Japan Index, is 500 on the index level, about 10-12 percent upmove from current levels. If you add-on some dividend yields on top of that, you can get to a mid teens type of total return for the region as a whole. So, our starting premise is one which expects a further building on this year’s constructive returns to propagate into next year.

Q: Would that happen regardless of some headwinds from the developed markets or are you factoring in some kind of tailwind from those shores in 2013?

A: We certainly are endeavouring to include all our global views in our MSCI Asia Pacific views. I would say that the outlook for the developed market is bitter sweet. The bitter side is that the absolute level of growth will no be as stellar as it has been in previous years. But in terms of the delta, the change between 2012 and 2013, we do expect that many of the developed markets will be incrementally better.

For the global economy, as a whole, we are looking at 3.1 percent growth this year in Purchasing Power Parity (PPP) terms. We think that it will rise to about 3.5-3.6 percent next year. If you think about the developed world, the US, we think will grow about 2 percent. For the US, you can basically decompose that into a good private sector. But a headwind from the public sector, the much discussed fiscal retrenchment that is taking place and the fiscal cliff.

For the Euro area, we think there will be a very slim recovery from current recessionary conditions. So, this year, for the Euro area, we are looking at about minus 0.5-0.6 percent GDP growth. For next year we will have about 0.1 percent or thereabouts, just a very, very slim recovery, better in the core, still challenged in the periphery.

For Japan, next year, we are looking at just sub-2 percent growth. We have actually taken numbers down little bit in the last few days. We are still looking at about 1.6-1.9 percent around in there, that sort of level of growth. So, for the top three global economies, the picture is one of a little bit better growth year-on-year generally, but still at a subdued rate overall.

Turning to the emerging world, things look a little bit better. China, which obviously is the largest of the emerging economies, we are looking at a pick up in growth from about 7.6 percent this year to about 8.0 percent next year. That will have some good ripple effects throughout the rest of Asia. We are looking generally at a slight firming of growth for most Asian economies next year. So, against the backdrop of a modest pick up in growth, overall, we think that should bode well for the corporate earnings environment and consequently for equity market performance.

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Q: What about market performance expectations between the developed and the emerging world? Do you expect to see a situation where emerging markets outperform and that sucks in more liquidity compared to developed market equities, a trend which we saw in parts this year?

A: Indeed. We are certainly looking in our official forecasts for the relative performance of the emerging markets to outstrip that of the developed ones. So, in our global asset allocation publications, we have an overweight for the MSCI Asia-Pacific, ex-Japan region, compared to an underweight for United States on a 12-month view. That is something that reflects our expectation that we think that relative performance will begin to shift back in favour of the emerging arena, more broadly one that has been underperforming the developed world since September of 2010 with just an initial signs of an uptick in the last month or so as the China equity market has begun to firm. So, we do think that there maybe some sort of a relative improvement in performance coming in 2013 for the emerging versus developed world.

Q: Would you say that this will be reflected in the currency markets as well where the dollar loses ground and Asia-Pacific (APAC) currencies actually gain in 2013? Do you expect to see that trend?

A: Broadly speaking, yes. Ofcourse there are some nuances between different economies and different currencies. But overall, our view, generally on the part of our FX strategist is one which is generally dollar cautious. The principle reason there is that if monetary policy in United States is going to be on the very-very accommodative side for sometime and the Federal Reserve, on record, is saying that they do not attend to shift into straits until 2015, we are in a very accommodative environment in United States.

If we look at indicators like our broad balance of payments, which is broadest indicator of net flows into or out of the US currency, is suggesting that US weakness should be a general trend that we would be seeing. Against that if we look at the corresponding broad balance of payments for many of the Asian economies, we would expect to see some kind of tailwind behind many of their currencies.

If we take that into fundamental fair value space, we think that many of the Asian currencies still are at levels which are on the moderately undervalued side. The Korean won will be a good example of that. So, we think for many of the Asian currencies, notably some of the ASEAN ones as well as the Korean won, could post some moderate appreciation as we look into 2013.

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Q: In your discussions with key clients, what do you sense in terms of how they are positioned as we end this year? Have they recalibrated to a reasonably overweight kind of stance in Asian markets? Or would you say that they are still underweight and you can see a lot of rebalancing of weightage at the early part of 2013?

A: The demand and supply for stocks is something that is one of the core drivers of the margin of equity market performance. In response to the rally, that we have seen from markets from the lows late-May and early June until now, we have seen some degree of re-risking on the part of many of the institutional investors that we speak with, irrespective of whether they are hedge funds, mutual funds, insurance companies, pension funds or other forms of institutional investors and indeed, in some of the high net worth investors that we speak with.

So, the point here is that there has been some recovery of risk appetite, but to a level which is still on the conservative side. If indeed, the global economic backdrop is stable and the political and policy environment is correspondingly stable, then we think there certainly is room for people to let the reins out to a further significant degree. Then ofcourse, there is another very important theme which our Chief Global Strategist, Peter Oppenheimer has written about. That is the potential for a shift from bonds back into equities, given the fact that many bond markets are stretched in valuation terms, interest rates are at very very low levels and policies suggest that they will remain that way.

So, in terms of relative value, one of the points we have been making as a group is that the relative attraction of equities versus bonds globally, is probably at its most attractive favouring equities for the last two generations. That sounds like a big word, but it is not an exaggeration if you look at the relative valuation of these two asset classes. It seems right now to significantly favour equities.
Q: From the various pools of money that you alluded to, which classes of investors seem like they might actually drive a lot of the flows into Asian markets next year? From an Indian perspective this year, we have seen a lot of money coming in from Exchange-Traded Funds (ETF). We have seen some rebalancing from the emerging market funds who have upped their India allocation in the last few months, but from a broad Asian perspective what do you expect to see in 2013 between these various pools of money?

A: It is a question that is hard to answer in a completely categorical fashion, because the data is not fully clear. It lags for some of the larger portions of the investment pool and there also is very much of this reflective mentality. The reality of the money managing business is that money does tend to chase performance.

When markets are doing well, people tend to get more enthused and sentiment, activity and money flow can change in a very dynamic manner. Our sense is that probably the greatest potential energy as far as shifts of funds, is coming not from the dedicated mutual fund managers whose brief is to invest in Asia-Pacific region, but it is coming from a larger pool of capital with so-called crossover capital which does not have the obligation to invest in regional equities, but has the capability of doing so.

For example, there are many large US funds who have up to 15-20 percent of their investment mandate, they have the ability to invest away from the US. So, that is the sort of potential energy which has been unfulfilled lately. However, if the relative attraction of the different markets shifts clearly in the favour of the Asian region, then that is money that could come in. Equally, there are many global types of funds who maybe more heavily weighed currently in bonds, but who maybe deciding incrementally, to shift towards some of the higher yielding portions of the equity space.

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Q: The kind of money that you are describing, would you say it is particularly susceptible to global sentiment in terms of switching between risk-off and risk-on because that’s what we tend to worry sitting here, that something changes in the global sentiment and suddenly a few billion dollars move out and that affects market performance very significantly. Are we vulnerable to that kind of thing in 2013 or would you say those risks have subsided somewhat?

A: Regrettably, I think that vulnerability remains with us and the fact is that, we live in a much more connected world these days and it is not likely to change any time soon. But we all know the story, information flows much more quickly, the mode of communication has accelerated, facilitated by all the technological innovations that we are all aware of and capital does seem to be skittish at times. If there are developments or shocks that happen to the global system that gets reflected quite quickly in terms of people’s appetite for taking risk in different areas.

So, one of the unfortunate realities of the money management business these days or the investment world these days, is that you do a very significant rotation in terms of the relative performance of different assets. One of our favourite charts shows that if you look on a monthly-basis and just look at the outperforming markets within the region and the underperforming ones, there is really no market that consistently outperforms for two months in a row.

You tend to have this very cyclical ebb and flow in terms of who is the leader and who is not and this makes running money quite difficult because, what it means is that if you have a strong fundamental view. You maybe right, that you can go from point A to point B in terms of your performance, but the path from point A to point B tends to be a much more volatile one than perhaps several years ago. Earlier, you might have a more steady string of outperformance or underperformance. You could just have a view implemented and stick with it and feel that it is being incrementally validated each day when you come in and look at your screens. These days you have to take a lot more performance pressure and so your daily mark-to-market performance stress, which can cause a great deal of kind of psychological stress on portfolio managers-we call getting chopped around in the noise where people might feel susceptible to overtrading, in the volatility that’s just the feature of the environment and that’s something, which I think everyone needs to be psychologically prepared for, because it is just a feature of the investment terrain that we are navigating these days.

Q: You are guiding for a 10-12 percent kind of market performance returns next year, which is not bad, but it is modest by bull markets standards. What are the chances that we don’t actually track just about tepid earnings growth next year in terms of Asia PAC market performance, but the market gets hopeful that we have started on a multi-year journey of incremental improvement in the environment and it starts re-rating so that you get a valuation expansion, at some point next year as well, is it too premature to start talking about those things?

A: Right now, what our methodologies are suggesting to us is that the valuations that we are seeing in Asia are broadly in line with the sort of cyclical environment we are anticipating. There maybe some moderate upside to valuations, but not a significant amount under the sort of environment that we are projecting. The global economy, which we think will be improving next year but, one which will not be as rip-roaringly strong as it had been for example in the mid 2000s or in the immediate aftermath and recovery from the global financial crisis. So again, that’s okay, but not a very fantastic level of global growth. We think the current valuation levels are pretty much fair and maybe they’ll leave a sort of 3-5 percent upside on average next year.

Now, in order to argue more conclusively for greater valuation expansion which is possible, we would like to see either of the overall growth backdrop improve. Somewhat more concretely or more specifically, we would like to see the earnings environment recover to a better degree than we are projecting.

Now, our expectation next year is that if we have a gradual recovery and an economic momentum then, we will see some of that operating leverage begin to work to the positive side. We think that overall profit margins, which for the region as a whole are about 8.6 percent currently, can improve somewhat to a higher eights or maybe even nine percent next year and not along with some okay revenue growth can give us something like 11 maybe 12 percent EPS growth next year. Though those numbers are certainly better than 3 percent this year, but it is not exactly rip snorting level of overall growth. The region is certainly capable of delivering higher rates of profit growth than that.

So, if we became more confident, then there would be a more robust profit growth recovery. History would certainly suggest that investors would become enamored of that and could pay up valuations to a greater degree than we are expecting. So, there could be a virtuous circle of stronger profit growth and also valuation expansion. That really is the bull case as you alluded to.

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Q: In September you upgraded India after a long time and you put a Nifty target of 6,300. What was that predicated on?

A: It was a couple of things. We have been generally cautious on India since June of 2010. We first downgraded the market at that point when things were in a very brilliant mannerism. We were pretty soundly derided for not getting it and being overly doer and cautious. We took some heat on that for about a quarter, but ultimately that proved to be a view which had some merit to it. Obviously we came into a more pronounced cyclical downswing fundamentally in India’s economy and in terms of the corporate profit cycle.

Things obviously had run their course. So, when you roll the clock forward by about two years we had seen a very significant de-rating of Indian markets. One of the primary reasons why we shifted our view in June of 2010 was because we liked the India story, but we thought that India was pricing in a great deal of good news at well over 20 times forward earnings. We began to have some concerns about some overheating fundamentally and Tushar Poddar, our Chief Indian Economist was beginning to get much more concerned about fundaments overheating in many parts of the economy.

So, as the last two years progressed, what we saw was the valuations of the Indian equity market come down to levels that were more acceptable. However, the level of fundamental concern that we had in terms of the cyclical stresses, in terms of some adverse policy developments that seemed to sap some of the animal spirits on investment front and in terms of downgrades to corporate profit growth expectations; all of those kept us on the sidelines or on the more negative side of the investment ledger.

Then just recently, we felt that a lot of those concerns that had begun to be much more realistically priced into the equity market. So, the risk versus reward of the equity market valuation was arguing for a more balanced view. Then, ofcourse when we saw some changes to the policy front, specifically some of the announcements with regards to allowing more Foreign Direct Investment (FDI) to repelling some of the taxation legislation; we viewed those sorts of policy changes as being much more constructive. We felt that they might have some positive fundamental impact and they might have some positive impact in terms of investor sentiment, both equity investors as well as real economy investors. The combination of those factors - pricing, positioning of investors in India, all that suggested that we did not want to overstay our welcome from a risk averse standpoint. We felt that moving back towards a market weight stance was more appropriate.

In order to become more constructive from here, we need to have a bit more confidence that the industrial production cycle would indeed begin to turn up. Our economists here are hopeful that that may begin to be more visible sometime in the middle part of calendar 2013, maybe around June or so. Given the fact that equity markets tend to be forward looking, that will suggest that, as we go through the next few months, it might be wise to be opening up one’s hopes a little bit more towards the upside. However, we still think right now it maybe a bit premature. So we are comfortable with where we stand. But we certainly think the risks are balanced and actually shifting towards the more constructive side of the ledger as we look forward in time.