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Prefer US equities; see euro, yen weakening: George Magnus

In an interview to CNBC-TV18, George Magnus, Economist & Author, Corporate Advisor, UBS spoke about the global markets, global liquidity, the best asset class for investment and currency fluctuations.

In Japan, he says the government policies don’t seem to be working the way they intended them to and the fiscal stimulus announced by Bank of Japan is likely to put pressure on the central bank to print more money.

On the Asian currency front, he says any fall in the value of Renminbi will be significant not only for Asia but also the world currencies. He thinks Renminbi is likely to depreciate against the US dollar.

Yen too has been depreciating but rupee according to him has been strong amongst the Asian currencies. Euro according to him may not go down as far as yen from the current levels but could go to levels of 110 or 115 to the dollar in next 12 months.

When asked which would be the best asset class for 2015, he thinks there is still further to go for the US equities and would avoid buying emerging markets like India and China that have already had big run ups.

According to him as long as zero rates in the US continue and the ECB, Bank of Japan remain committed to quantitative easing, equities by default are likely to be a more attractive asset class relative to bonds, real estate or corporate credit.

Answering a query on when he thought Fed would start hiking rates – the dollar he says would play an influential role in the rate hike cycle and if it continued to strengthen then the rate hikes would be pushed back by the Fed maybe towards the autumn or the end of next year.  

Talking about the growth rate in China, he said for the government there a 7 percent rate would be acceptable and they would use policy measures to keep growth rate from dropping too much but since the trend in residential property and other investment spending will continue to slide in the foreseeable future, the growth there could end up around 4-5 percent in the next couple of years.

Looking at India through a global lens, one would say the new government has got a message that resonates well with both domestic and international investors, says Magnus. There are promising signs that the government will make good some of the shortfalls that have happened over the last 5-6 years.

On the global liquidity front, he thinks it is very important to keep a close watch on the US dollar because a strong dollar and higher interest rates in the US if they happen might disrupt global liquidity, which inturn could affect emerging markets in the same sort of way as they did in the Asian crisis in 1990’s.

Moreover, US dollar is the world’s reserve currency, he adds.

On the commodity front, he believes the long run-up in commodity prices is mostly over with exception of soft commodities or agricultural commodities. Industrial commodities are going to be under pressure aided by the strength in dollar, and also because China that had the biggest influence over industrial commodities is now changing its commodity centric growth model, he says.

He thinks some of the big trends in 2015 could be the declining commodity centric nature of China’s growth rate, and America’s remarkable shift in energy import intensity. 

Below is the transcript of George Magnus’s interview to CNBC-TV18’s Latha Venkatesh

Q: There are crisis pots across the globe so let me start with the land of the rising sun or the land of the falling yen. How do you see things panning out in Japan after that 80 trillion yen announcement from the Bank of Japan? Now there is a fiscal stimulus also that is underway. Do you see the yen at 120/USD in a few months time?

A: My view is that it is going to go even further than that. I think what we have learnt from Japan over the last 48 hours if not say over the last several months is that the governments policy is not working, the policies are not working the way they intended.

I am not sure that everything can be attributed to the rise in the consumption tax but it was an untimely change, it means that there will be even more pressure on the Bank of Japan to continue printing money. If there is an election which is now being speculated, then what we will really have to hope is that the government is capable of delivering the kind of reforms that everybody was so optimistic about a year ago but which ran dry pretty quickly. So all we have got left at the moment is monetary stimulus and perhaps a little bit of fiscal stimulus as well.

Q: What will be the consequences of this Japanese monetary cum fiscal stimulus on other emerging markets? I noticed in your blog a very interesting article saying that it will mean the long march of Renminbi appreciation is over. Can you elaborate on that because that could be direct competition to India if the Renminbi were to depreciate?

A: That is an interesting phenomena because so far the depreciation of the yen say from 75-80 yen to the US dollar to about 115-116 yen/dollar is a big move. But actually the trade weightage values of Asian exchange rates has held pretty stable and the rupee has been very strong. But I don’t think that is going to last if the yen drops another 20 percent which it could do. Under those circumstances there will be some decline in Asian exchange rates.

Interestingly, the Renminbi will be one of the currencies and because it is Chile’s it is very important one. It will be one of the currencies that will depreciate against the US dollar. It is partly for external reasons but also for internal reasons as well because China’s economy and its property market are continuing or will continue to slowdown. So the fall in the value of the Renminbi will be of some significance, not just currencies in Asia but wider world as well.

Latha: The more live news now is that the ECB is likely to indulge in more unabashed Quantitative Easing; it is advising buying government bonds. How will the euro pan out you think over the next few months and how will policy pan out?

A: This is turning into a bit an old chestnut as we saw in English because the ECB and the governor Mario Draghi has been telling us for sometime actually that the balance sheet of the European central bank might expand by a trillion euros. He is certainly sounding very dovish.

The problem is that Draghi has a big political problem which is to keep the German Chancellor Angela Merkel on his side in support, and we know that the German position is not quite as enthusiastic about sovereign bond purchases as the ECB might be. It is legally entitled to do that but they may be quite restrained in what they actually do. So this is a bit of a political tug of war game which may end up with full blown QE if the crisis in Europe deteriorates more.

Latha: You told me that you wouldn’t be surprised if the yen weakened even up to 120 and beyond to the dollar. What’s your best guess about the euro in the next six months or in the first half of 2015?

A: I think the euro — I mean my guess is it probably won’t go down as far as the yen from where we are today because I don’t think the ECB will choose the full freedoms available to it in terms of quantitative easing, but I do think that the euro will drop perhaps to around 110 or maybe even around to 105 against the US dollar, lets say by this time next year.

Latha: Now that quite a level. It was the strength of the dollar especially vis-à-vis the measures that made the Fed faltered a bit about its rate hiking cycle. We heard Stanley Fishers speak about it, as a worry. How does all this place the Fed rate hiking cycle? Where see it, is it mid-2015, is it further out?  

A: My view is that the economic case for higher policy rates in the Unites States is not proven convincingly whilst inflation is so low. But let’s suppose over the next six to 12 months that there is a little bit of pick up in wages, and maybe in the consumer price index, I mean I could see interest rates starting to go up little bit in the United States next summer.  

But the dollar could play a very-very influential role in the timing, and my guess is that if the dollar continues to strengthen a lot which I think it will, that it could push back the moment when the Federal Reserve raises interest rates perhaps even towards the autumn or the end of the year.  

 Latha: Now that I have completed the two key Western economies, let me refocus on the East and especially on China, a place on which you are focused so much, what is your sense about Chinese growth itself? Are you seeing it glide gently low from 7.5 percent to 7.3 percent, or will 2015 see much lower growth rates?

A: I am pretty sure that the Chinese Government would like to see growth come in next year at around 7 percent. I don’t think they are terribly religious about where the decimal point is but 7 percent would be an acceptable number. The question really is whether China’s economy is predicated to drop to a growth rate appreciably below that which it is actually and we could see maybe at the beginning of 2015 the first quarter could see a growth rate, if you look at it quarter on quarter in which economic growth could be below 6 percent.

So, one would have to expect that there would be moments when China will try to use some of its policy tools to keep the growth rate from dropping too much but my major kind of view about China is that the downswing in residential property and other investment spending is going to continue for the foreseeable future and growth in China is going to end up probably over the next couple of years coming down to around 4-5 percent. 

Q: You were telling me about the various big economies and all of them seem to be in a situation of economic downtrend. Under the circumstances how do you expect commodities to behave? Is the commodity super cycle definitely over? How will commodities behave in 2015 especially crude?

A: I think the long run-up in commodity prices or the super cycle as it was certainly called as you suggest, I think that is pretty much over, not necessarily for soft commodities or agricultural commodities because obviously we all go to eat and we have cattle to feed and animals to look after. So the agricultural side of this actually I look at rather differently from industrials and from oil and gas.  

The biggest single influence over industrial commodity prices during the last 10 years has been China which had a very commodity centric growth model. I think that growth model is now changing and whatever growth we get out of China whether it is 6 percent or 5 percent or 4 percent will be much less commodity oriented. So I think industrial commodities are going to be under pressure aided and abetted I might add by the strength of the dollar. So since a lot of these commodity prices are priced in dollars, dollar based commodity prices in the industrial complex will continue to be weak or weaken further over the coming year.  

Q: Of particular interest and importance to us are crude prices. Does it get worse for crude in 2015; are we going to see it average a good 10-20 percent lower than the average of 2014?

A: I am not sure that I want to give a hostage to fortune about what will happen to oil prices over the next three months, but I think that some of the big trends in 2015 at least two of them will be uninterrupted. One is the declining commodity centric nature of China’s growth rate and the other is America’s remarkable shift in energy import intensity.

Three-four years ago the Americans were importing 10 million barrels a day of oil or liquid fuel. Now it is about 5.5 million barrels. Next year people think it is going to be around 4 million barrels. So that is an amazing change which will continue to bias the price of fuel downwards. And of course as you say for countries like India this is like manna from heaven.  

Q: India has been one of the most favoured equity markets. At least the growth delta has been higher even if the level is fairly south of China. How are you assessing the prospects of the Indian economy? Is it looking much better going into 2015 and the equity markets as well?

A: I am not always best placed to actually relate GDP to equity markets. So the correlation doesn’t always work terribly well. But I would say this because I look at emerging countries obviously very much through kind of a global lens. The government change came in on the right foot, it started to do the right things, and it has got a message that resonates incredibly well with domestic and international investors.  

Lower energy prices will help you but obviously most of what has happened is home made and home grown and from an international perspective it is to be hoped that it will continue and that the government will continue to make progress in making good some of the short falls that have been allowed to fester in India in the last five-six years. The signs look quite promising I have to say.  

Q: You spoke about Japan definitely loosening its strings printing more yen and Europe as well. What is the global liquidity scenario looking like? Looks like there is going to be a lot of money printing?

A: Mathematically you can look at what the Bank of Japan is doing to its balance sheet and what the ECB promises or thinks might happen to its balance sheet, and mathematically, you could weigh that up against the termination of QE in the US and say well it is awash. It doesn’t really make that much difference and therefore the world is still awash with liquidity.  

In the real world, I am not really sure it works quite simply as that because dollar liquidity is different from yen liquidity or from the ECBs liquidity in the sense that of course the US dollar is the worlds reserve currency and it flows around the world more readily than to the other two currencies although the euro of course is much bigger than the yen.

But I think the principle focus we should have really is on the US. So QE may have ended but zero rates obviously still are very much with us for the foreseeable future. If that were to end at some point in 2015, even if there were a change in interest rates which didn’t go very far, I think that it would be quite shocking in the initial stages. It would have quite significant disruptive effects on capital flows at a time when the US external payments position is improving because of the energy balance in particular.

So, for next year I am quite watchful and quite sensitive to the impact which a strong dollar and higher interest rates if they happen, might disrupt global liquidity and of course that could affect emerging markets in the same sort of way as it did in the Asian and Tequila crisis in the 1990’s.

Q: That’s exactly what the Indian Central Bank governor constantly worries about and warns about. What should India be prepared for as soon as a first signs of a rate hike emerge will they be a massive capital outflow you think in countries including India?

A: Since we have had two or three taper tantrums, the first one of which India was very much a kind of victim of although that dissipated on the kind of second and third time not least due to policies of the Reserve Bank of India itself.

However the danger is for those countries that are heavily reliant on financial inflows to plug external deficits or by implication fiscal deficits as well. It may not be as much a source of vulnerability to India as it was 18 months ago. However, at the moment it still would be a sense of vulnerability and of course that’s the kind of context in which we need to kind of look at this.

But as much as anything, the probability is not that India would be singled out necessarily but if interest rates in United States did go up it would be a shocking development for investors who have been accustomed to a totally different monetary regime for the last six years.

It might increase what we call home buyers and it might increase the sensitivity of emerging countries to capital outflows. Not because conditions are the same as they were in the 1990’s many have much less external debts and much higher levels of reserves. But capital flows are more mobile; foreigners own much higher proportions of local currency bond markets, so I just think it is something we do need to be a bit watchful for.

Q: What might be the most wining assets or asset classes in 2015 at least in the first half according to you?

A: I say this slightly reluctantly because I am not sure or 100 percent believe it but by process of elimination, I actually think so long as we have zero rates in the United States and so long as the European Central Bank (ECB) and the Bank of Japan remain committed to quantitative easing (QE), equities by default are likely to be the more attractive asset class relatives to bonds and to real estate, to corporate credit and so on which are quite fully priced in my view.

Equities have had a great run and by many standards of valuation they are either well valued, little bit expensive but it has got further go to be honest but the higher they go the more nervous I become.

Latha: Within equities your pecking orders? I mean I want to know where India figures?

A: The main lesson in equity market investing that I always talk is that never to buy the markets that have had the biggest run ups today. So my temptation would be to look at some of the emerging markets that haven’t enjoyed what India and China have enjoyed over the last several weeks. I still think they old S&P – the US equities still look like they have got further to go.


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