Jonathan Garner of Morgan Stanley believes that the emerging markets are discounting a recession scenario at the moment. In his opinion, allowing the European stability mechanism and direct recapitalization of banks are seen as positive developments. Garner expects 20-40% returns from the Indian equity market in the next six months.
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Below is an edited transcript of his interview. Watch the accompanying video for more.
Q: What is your observation on the notes that have been coming out from the EU summit and the impact for emerging markets?
A: One of the key starting points is that the emerging markets are exceptionally cheap. In fact in our view, some form of recession is unlikely; obviously the European situation could generate an outcome like that. But the news that we have today does seem to be a significant incremental positive.
There are two separate pieces of news. Firstly, the Spanish bank bailout funds will be supplied on the basis to the existing Spanish sovereign debt i.e. the mistake that was made by the official authorities of putting themselves in to the senior position to existing debt holders in the prior bailout particularly of Greece, that will not be repeated.
Secondly, it does appear that they are heading towards the situation of allowing the European stability mechanism but it seems to be ratified to directly recapitalize banks that get into difficulty. So that is a movement towards banking union and it is an attempt to break the link between sovereigns and banks.
Q: What could be the potential of these two bits of news, do you think they can spark off a big risk on and do you see it as a temporary bit of good news or do you think this puts a backstop on risk for the next two-three months?
A: It does seem that it is a significant positive. But the markets are exceptionally cheap, as I said earlier, to history. For example, India, that we have upgraded today, is trading at the price to book multiples around about trough multiple from 2008 and 2002. So that is already discounting very significant bad news.
Q: Part of your observations on that upgrade suggest that India tends to outperform in the period post sharp oil price declines, given what has happened with the EU summit and a change in risk sentiment, would you say this could become a risk for a market like India that there is a sharp spike back on commodity prices especially crude?
A: No, oil markets are relatively well supplied at the moment. There are several other positive dimensions about the situation in India outperforming other emerging markets. Now that was not the case throughout the 15 months. But the currency has weakened up very significantly and we have a 52 rupee dollar target for the end of the year. Obviously, there is significant disappointment that is taking place around both growth and inflation in India.
Q: Are you expecting emerging markets to do well in the second half of the year, and in that context, India could outperform you feel in the second half of this year?
A: We have not put it on an overweight, we have put it on an equal weight. But we expect between 20% and 40% returns on these valuation levels six months out. My colleague Ridham Desai has a Sensex target of 20,000 so I think that is certainly very achievable, it is not fairly higher.