Tapering is a storm in a teacup

If you could invest in anything, anywhere in the world, what would you buy? That’s a tough call but one that Geoff Lewis takes quite often.He labels as ‘nonsense’ the notion that tapering matters to emerging markets. Read excerpts from a colourful conversation at Chennai.

Both the Dow Jones Industrial and the Nasdaq Composite are at new highs. Should we be buying US-listed stocks?

If you’ve been overweight US equities, you should reduce the weight. But would we get out of US equities? Not really. The market is (trading) at fair value. The US economy is improving, there’s no fiscal cliff, you will have better politics next year, less fiscal drag, no inflation and unemployment is coming down.

Last year, there were a lot of macro risks but the markets did really well. This year, the risks may be lower but the markets may repeat that return.

If you take everything into account, a 6-7 per cent return (from the US) for next year would be realistic. But the problem is, when things are looking good, markets often don’t stop at fair value. So, you shouldn’t expect another 20 per cent, but maybe 10 per cent, with a correction in between.

We’ve seen foreign investors pull out of Indian bond markets due to Fed tapering fears. Where will that end?

Tapering is a storm in a teacup. The US government should call the market’s bluff, get on with it and do it. I think it was panic from new investors that caused people to pull out of the Indian bond markets. They have now waned.

From where we are in the interest rate cycle and inflation cycle, Indian government bonds look really attractive. If I were a domestic investor, I would buy them. I don’t think tapering is going to have a big effect on emerging markets.

Everybody has had so much time to adjust to tapering. Tapering just means that the US Fed is going to buy fewer bonds each month. The additional bonds that Fed buys each month are such a small proportion of the market that it shouldn’t matter at all.

But we hear so much about how the liquidity from quantitative easing fuels emerging markets. How does that happen?

That is a good question. That belief is just nonsense. The money that the US Fed infuses through bond purchases goes into US commercial banks and stays there. It is just that when US interest rates fall, re-allocation happens. If US bond yields are very low, people look for investment opportunities elsewhere that can earn better returns. There is ‘carry trade’ too, where hedge funds borrow in US currency and invest in other markets for better returns. It is as simple as that. So, when the US starts raising interest rates, there will be headwinds for emerging markets. That will happen maybe by 2015. Tapering isn’t going to raise US interest rates immediately.

We should be humble about predicting what markets will do because we are in uncharted waters. Look at what happened this year, you had the tapering fears, then panic with emerging market currencies and debt in summer, the US shutdown, the sequester and the fiscal cliff. Through all this, if you stayed in cash, you got zero. If you were invested in equities, S&P is up 25 per cent, Europe is up 17 per cent and even India is up in local currency terms.

Despite all these big shocks, gold is down this year. Isn’t that surprising?

Nobody thought gold prices would come down so much. But the reason they have come down is because three years ago, everyone said, if you have quantitative easing and inflation, you have got to have gold as a hedge. Now three years later, there is no sign of inflation, so people have realised that gold isn’t necessary as a hedge. At these levels, holding some gold is a good idea because you need to be diversified.

A few years ago, everyone was talking about the commodity super-cycle. Is that over?

The China-powered super-cycle is finished. China was the world’s largest construction site. It demanded steel, metals and all the rest of it. But now it is moving away from that. I think we will see real commodity prices improving over the next three-four years, but slowly, if the global economy grows at 3-4 per cent.

I think commodities are pretty awful as investments. They are terribly volatile and their supply is unpredictable. When commodity prices do go up, the one thing you do know for sure is that three or four years later the supply will shoot up and then prices will crash. They do bring you some diversification. But unless you are really smart, you don’t want to go in for soyabean futures or stuff like that. Soft commodities really depend on God, you know, weather patterns and so on. You really have to sit down and understand things like the lifecycle of corn.

Which Asian markets are the most interesting for the equity investor?

In this environment, don’t go heavily overweight on any one market. We like the long-term outlook for Russia but it is expensive. Thailand is slowing down a bit and Indonesia is expensive and needs to tighten policy. We are now overweight on the Asian manufacturers who will do well when the global economy picks up. We are overweight on Korea as their export numbers are picking up very nicely. We are overweight on Japan too. The Japanese market is up 30 per cent this year. But if you look at the relative performance of the last 20 years, it has still underperformed by a huge margin.

We think Abenomics is changing things. Jewellery sales in Tokyo department stores are up 25 per cent, prices of condominiums are going up, land prices are going up, asset price inflation is starting and business confidence as per Tankan survey is improving.

For the first time Japan’s retail investors are beginning to buy their own equity market. A recent survey showed that 30-to-35-year olds in Japan had 75 per cent of their portfolio in cash. They were invested for a dying, deflating economy. Japanese institutions have 40 per cent of their money in Japanese government bonds. That money could shift.

Many global strategists are recommending China because valuations are cheap. Do you agree?

China is very cheap, obviously. But there is all this worry about hard, landing, soft-landing, re-balancing and so on. The re-balancing theme is pretty much nonsense in my view. You cannot change from an investment-driven economy to a consumption economy overnight. It takes ten years. But China’s labour force is declining, it fell three million last year. It is similar to the way other economies are heading in demographics. You have terrible demographics in Korea, Singapore and Hong Kong already.

You often hear the ‘good demographics’ argument for investing in India. Do you believe in it?

I think good demographics is a necessary condition for growth but not a sufficient one. Somalia would be the top country in the world if having lots of young persons was the way to go about it.

There was this paper done a couple of years ago by Ashoka Modi where he said that the demographic dividend will add 2 per cent to India’s growth rate. It has been a little difficult for India because it did not get on the ‘cheap manufacturing’ bandwagon the way China did.

Now China has the logistics, the network and everything, but there is no sign of India aiming to be the mass manufacturer. I have some sympathy for Sonia Gandhi’s kind of policy where you want to alleviate poverty. But (unfortunately) it does not create prosperity in the long run. Domestic manufacturing needs to be improved, but not based on the Chinese model that is environmentally unsustainable.

aarati.k@thehindu.co.in

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