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The CEO of Morgan Stanley Investment Managers, Narayan Ramachandran, comments on emerging markets. He says that the first few months of 2007 may be a bit choppy for emerging markets. Fresh money may also come into EMs during that point of time, opines Ramachandran.

Morgan Stanley Investment Managers observed there were no major interruptions in overall flows to EMs.However competition from global interest rates is a worry for EMs and India. Ramachandran states that a higher than expected US growth may be a short-term risk for it.

Morgan Stanley Investment Managers believe that India is a major gainer of minor disinflationary boom.

Excerpts from CNBC-TV18;s exclusive interview with Narayan Ramachandran:


Q: How are things looking to you globally? What signals are you picking up from your peers and your teammates globally on what the outlook could be in terms of flows into emerging markets in the next quarter?


A: It looks good; I do not think there is any major interruption in the emerging market story. Obviously, outside of India, in the first several business days of this year things have gone little slowly, India has done quite well but the others are sort of flattish. But, overall no major interruption in the story and in the flow story.



Q: How is India looking - despite all concerns expressed on valuations, we are at all time highs and do not seem to be particularly under performing the emerging market basket?



A: I think India is a beneficiary of this kind of climate in which global growth is good but not at a tear away pace, which then implies that inflation in general is sort of contained and India is one of the biggest beneficiaries even among emerging markets of a scenario of a minor disinflationary boom. That said, I have to say that as people adjust to a higher growth rate than expected, in the US in the next few months. I think the first couple of months of this year are going to be bit choppy for emerging markets, not just one way up.



I think the start of the year has been good for India particularly for midcap that’s been a little bit of catch-up from rather bad performance in the second half of last year after the May correction. But beyond that I see a bit of choppy immediate future for emerging markets but the medium-term is good indeed.



Q: How volatile do you expect it to get? What do you think might trigger it and tactically at this point, would you sit on more cash waiting for slightly better price levels?



A: It depends on whether you have big or small money. If you have big money, I wouldn’t worry about sitting on cash, in the meantime as I said the most important thing is that the medium-term looks good and it’s very difficult to catch these little gyrations.



The biggest worry for emerging markets in general and India in particular is competition from global interest rates. If you have a scenario in which for whatever reason global interest rates have to go up significantly, then emerging markets will under perform but I do not see too much of that situation. Now the short-term risk is that people are a bit pessimistic about US growth in the last three-four months; the Q4 of last year was not very good but that is most likely a bit of inventory correction compounded with the housing slowdown in the US.



So as people adjust to a slightly slower but more normalized growth pattern in the US maybe somewhere between 2.5-3 rather than between 3-3.5 that we saw in the first half of last year.I think, at that point people will get a little worried that the Fed is not ready to cut rates right away and the inflation bogeyman will come out all over again. That’s the point at which you get the choppiness but I think that’s choppiness to build further into rather then to reduce into.



Q: You made the point about liquidity. What exactly is it that you are seeing - money staying put and no large-scale redemption, or that fresh funds have been pumped into our market at more than 14,000?



A: I do not know it for a fact. Obviously it’s just been a few days but I would suspect there is actually new money, there was some money that’s been sort of locked away towards the end of the year once reasonable returns had been had for the calendar year 2006. So I suspect there is fresh money available now to comeback into the emerging markets since it’s the beginning of the year and usually at the beginning of the year there is more risk taking then towards the end of the year.



Q: You had a good calendar 2006 in terms of earnings and the debate is on whether 2007 calendar will see the first signs of slowdown or could there even be positive surprises on this base in the current year. Which camp are you on because some believe that we will be surprised once again maybe not to the same extent and that might fuel the kind of upward rerating this market has seen?



A: I do not know in what combination the returns come from - combination of earnings and PE expansion or mostly earnings. I come from the camp that says that there will be solid returns this year and by that I mean low double digit return perhaps not quite as much as we enjoyed last year. But I do not see the reason for us to have an eminent PE collapse, which is what you would require for markets to go down sharply.



So 12-15% earnings growth with probably no major contribution from PE expansion or if there is its very slight so those kinds of returns this year as oppose to the very good returns we enjoyed in 2006. But that would make it several years in a row now, I am not exactly sure but I think it would be the either fifth or sixth year, in which we had positive returns from emerging markets.



Q: What about the non-Index space then? If your case is that maybe we will see the Index expand by 12-13-14% this year not much more than that, can you build a case lower down where a stock portfolio of midcaps or several midcaps outperform this benchmark return by quite a margin since they have been under performing for the better part of the last half year?

A: That’s always the temptation; the temptation is to reach beyond the Index stocks into other stocks and my view is that in terms of smallcap or midcap, Index is behind us already. You can obviously get the odd stock doing well and if you are really good at stock picking you should go ahead and do that. But in Index terms I would stick with what we called secular growth stocks within the context of the largecap Index and time and again we have seen that in the second half of the cycle, which is where I firmly believe we are beginning to be this year - that is the largish companies that do well and the odd midcap companies that join the parade rather then a big smallcap effect that you might see more in the early part of the cycle which we did see in 2004 pretty much around all of the emerging markets.

Q: What have you made of the flux that’s come into the commodity universe very early in this year and how that might some stocks and families within our market?

A: I think emerging markets have begun the process of de-linking with the US and similarly I think they might have begun the process of de-linking with commodities. And there was this view that emerging markets were effectively a commodity surrogate pretty much through this cycle and at least the correlations did bear them our initially so that as the commodity boom started in the bottom of the cycle in 02-03 so did emerging markets.

But I think you are beginning to see that correlations fray the edges and if you look fundamentally, several markets - India being one of the major one, Korea to a lesser extent, China and so on are big beneficiaries of dollar price of commodities going down, macro economic situation of India is clearly helped by the fact that oil prices in dollar terms are going down for example other commodity prices are declining. So the strong correlations will fray and will get steady performance from emerging markets even if commodities hold their downtrend in dollar term.

Q: Just to get back to that Index return of 12-13% that you spoke about - in 2006, if you were within the Index if you chose to be in largecaps but stayed away from oil, metals maybe even FMCG, your return would be far in excess of Sensex return. Can you construct an Index within an Index leaving out what you expect to be the relative under performers in 07 and then expect or hope to get more then 20% return even this year?

A: Within the largecaps I think there is a decent shot at that obviously it’s a probability but I would say if you hold telecom and technology and very select FMCG stocks then you have a decent chance of making it into the high teens possibly even 20’s this year. Particularly if in the latter half of the year you get the first signal that global interest rates maybe on a downtrend. I think there is a 2/3 chance that that could occur in ‘07