Patrick Mange likes to view the stock market with optimism, especially at a time when investors around the globe are turning risk averse, so to speak.
The global head of research and strategy at BNP Paribas Asset Management kicks off the conversation saying the glass is half full, not half empty. In a free-wheeling discussion with The Smart Investor, Mange explains the investment process behind the asset allocation process and his views on the world markets.
Mange holds a doctorate in economics from the University of Freiburg, Germany. Prior to joining BNP in 2001, Mange worked with Merrill Lynch Capital Markets and Deutsche Bank.
What is your view on global equities?
Currently we are overweight in equities while we are still cautious on government bonds where we are underweight. The reason for our bullishness on equities is that while the global macro environment remains constructive, equity valuations globally are still reasonable.
Even though earnings growth momentum is slowing down, earning levels remain relatively high. Corporates across the world are re-leveraging their balance sheets, which again is a good thing.
And for us, the recent market fall, which suggests high levels of risk aversion, is a signal to buy, not sell stocks. We are overweight on the US and European equities and neutral on emerging markets. We are overweight on Latin America but underweight on Asia.
What's your take on fund flows and the impact on equities?
We believe that the tightening global liquidity will impact hot money flow. Out of the $60 billion that flowed into emerging markets in the first five months of this fiscal, 60 per cent has flowed out in the past two months.
How much more will move out is difficult to predict. But it is safe to assume that a large chunk of the money that flowed into emerging markets belongs to institutional investors who would like to hold for the long-term and not trade as frequently.
Unlike many others, we do not believe that this is the beginning of a secular bear market. We believe the recent slump in equity prices is only a correction.
Can you explain how EM compares with the US on a relative basis?
According to IBES consensus estimates, corporate earnings are likely to grow in the range of 10 per cent for Europe, 13 per cent for US and around 16 per cent for emerging markets. In the US, we believe that margins will contract a bit but will stay high.
Last year, US pre-tax corporate profits as a percentage of GDP stood just a percentage point short of the historic high of 13.27 per cent. The slowdown in profit momentum will only be modest.
Now, looking at most parameters, equity valuations look reasonable. But historic comparisons favour the developed markets.
For instance, the 12-month forward price-earnings multiple for US is at its lowest since 1999. The same metric for India is currently at over 35 per cent discount to the 2000 peak, and a little over 50 per cent premium to the low when the market hit the nadir just before the stock market rally began in 2003.
While Brazil is somewhere in the middle of the eight year P/E range, Russia seems relatively closer to the top. Thus on a relative basis US markets look better poised.
We believe that a P/E comparison across markets can be extremely misleading due to differences in structural factors. So we look at valuations in a historic context, looking at the trend line and how close or far are current valuations from the median.
So barring valuations, do you favour the emerging market story still?
The improvement in macro performance of emerging markets is not just cyclical but also structural.
Already, greater fiscal discipline and stronger external positions have reduced emerging market countries' vulnerability to exogenous shocks. Global EM fiscal balances have narrowed markedly in most markets.
Current account balances (currency reserves) have improved, even after excluding the windfalls attributed to a rise in commodity prices. For the record, 13 out of the 21 emerging market economies have now investment grade or above ranking.
More countries have now adopted inflation targeting (14 emerging countries) and this had to a great degree helped in reducing the level and volatility of inflation without affecting growth.
Additionally, volatility in exchange rate, real interest rate and international reserves has also reduced substantially. The emerging economies have thus shifted away from crisis-prone exchange rate regimes.
Since 1996, 21 EM countries have moved towards a more flexible exchange rate regime, though this change is coming about rather slowly in China. Emerging economies have also come a long way with more modern financial markets apart from a more diversified investor base.
So, we do believe emerging markets are in a better shape today and growth is sustainable. But, as I said on relative valuations basis, we favour US markets.
How big a risk is rising interest rates for emerging markets?
Major risk for EM is not interest rates but growth. If the rate rise is sharp, investors fear that it could impact growth and lead to a recession. But that is not my assumption. The growth story in EM is more led by domestic factors and less external, which reduces the risk.
What is your view on India?
India has a strong manufacturing and a roaring outsourcing business thanks to the vast English speaking population. But reforms are rather slow in India because it is a big country.
But the country is moving in the right direction and in fact sometimes it is better to be slow and achieve your target than the other way round. Even when compared to China, we like India because it has a democracy as against China where all decisions are made at the top in an autocratic manner.
Another point, which is relevant for the markets is that currently risk aversion is hitting markets with a high current account deficit. So countries like India and Turkey are hit more strongly while Russia, for instance, with no deficit is not affected as much.
Since India's deficit is financed more by portfolio flows, which tend to be more fickle, it is getting affected more. For example, despite a high deficit, Turkey is not affected as much as India because its deficit is more soundly financed. The answer lies in capital account convertibility.