Mkt will be attractive if corrected: J P Morgan

New Delhi: Asian Regional Strategist at J P Morgan, Adrian Mowat believes that underline fundamentals are still strong in emerging markets.

He adds that India should correct by 4-5 per cent and that markets will look attractive at 11,000 levels.

He also says that all markets will focus on cues from US Fed.

Excerpts from CNBC-TV18's exclusive interview with Adrian Mowat.

Q: India is under pressure like rest of Asia and emerging markets, how much more blood letting do you expect?

A: I think we have moved from a period of abnormally low volatility particularly in developed markets.

There was a situation in the United States when the economic data, and more importantly, corporate profit data, were quite strong.

Bond markets gradually normalised in a consistent steady fashion, with US bond yields moving higher but slowly, without disrupting equity markets.

That was the period we enjoyed up until middle of May, but now the irony is that we are moving towards the end of the Fed tightening cycle. And we had the last rate hike on the May 10.

One is going to see real divergence in commentators' view on where interest rates are going in the US. We are going to have three things that the market is going to focus on to generate volatility.

First; core inflation in the US is right at the top of the Federal Reserve comfort zone. They like to target between 1 per cent or 2 per cent. If one looks at the pattern of this market, we had a sell off late last week based on bad inflation data.

We rallied because PBI was less than expected. And we then fell because core CPI was much weaker than expected. So that was on the inflation front.

Two, the economy in the first quarter was very strong, second quarter will continue to be strong, but we see it weakening in the third quarter. So equity markets have started thinking whether inflation will move higher with economic movement slowing.

And finally, the equity markets are confused by the new Federal Reserve Chairman, since they are not quite sure about the message he is giving out in terms of on whether he needs to continue tightening and at what level he would need to tighten to.

So these levels of uncertainties are generating volatility in the equity market and one must remember that volatility has been very low.

I see this as more of a normalisation trend as opposed to something we should be too concerned about. There is a risk building - that is, if core CPI remains quite high throughout this year, then the Fed may need to be seen to continue to tighten.

This could be a part of the issue. Also, the new Federal Reserve Chairman is still trying to build his credentials. And as the US effectively over tightens its hold, growth in 2007 seems very slow, and that is what the market fears.

But all these conversations are with regard to United States. I do not see this as an emerging market issue, neither as an Asian issue.

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Q: Isn’t that going to effect flows into the country, and isn’t that the reason why we are seeing the markets here so volatile today?

A: When one gets a correction in the US market, one tends to get a bigger intra-day move in emerging markets because they are less liquid.

The underlying fundamentals of emerging markets are very strong and most of these economies have run counter cyclical policies for the last five or six years, which is given them a fair amount of cushion with regard to their fiscal position, their current account, corporate balance sheets and consumer balance sheets.

So when I look at most emerging markets, I am quite comfortable. However there is a class of emerging markets, where there seems to be a risk.

There are two class emerging markets, one is with current account deficit and others are associated with carry trades that is intra-trade differential with US.

So intra-trade differential for the US have a threat of either declining or remaining consistent. This means local interest rates need to hike prices. The current account deficit implies that the confidence needs to remain high in order for those deficits to be funded.

So India has two levels vulnerability here; there is a current account deficit, which has been expanding. The current account deficits are quite unusual in emerging markets these days.

The other current account deficits that are meaningful are in Turkey and South Africa but those countries have very big FDI flows, which seems to be covering them.

So India is relying partly on short-term portfolio flows with current account deficit.

The area of risk is that Indian markets have already moved to a premium to US valuations. Most of the other emerging markets I look at, trade at quite meaningful discounts even though I would argue that they should trade at US valuations if not at a premium.

But the problem for India is that it has already done that. So I think we are vulnerable in the Indian market for this type of volatility.

Q: You have gone underweight on India even so is there a base you expect this market to hold and are there levels at you might look at re-entering or investing in India on a price to earning spaces. What looks more lucrative?

A: About 15 times forward earnings and even interest rates in US equity markets, were to move higher than they will still be lower than India. So a comfort zone would be US type valuations.

We are willing to have a slightly higher target price, which is 11,000 for the Sensex, which is a level still above, and needs to go down 4-5 per cent to get there. If the market was to drop before 11,000 then it will be certainly worth looking at.

It is worth highlighting the institutional investor base globally, which is now mostly underweight on India.

We have also seen some healthy inflows into Indian mutual funds and some of the cash is still to be invested. Although one should be always cautious about the statements since people can redeem mutual funds when one gets a day like today and the chances are that people will be thinking twice about buying equities.