Morgan Stanley says sentiment on India is souring



Excerpts from India Business Hour on CNBC-TV18 Watch the full show »
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India is definitely not in the good books of brokerages as Ruchir Sharma, MD & global head of emerging markets at Morgan Stanley points out, the sentiment on India is souring.

In his book - Breakout Nations, Sharma says the focus must shift to other emerging economies beyond China and India. Sharma speaks to CNBC-TV18's Udayan Mukherjee who began by asking him if markets are going to capitulate before we see an upside.

“The operating assumption is that the bear market regime is still something on the ascendant here,” says Sharma.

He feels it is very important that the correlation between markets breaks down next year. "Only after it breaks down, can we say, a new bull market is about to begin," he adds.

Below is an edited transcript of his interview. Watch the accompanying video for more.

Q: Last winter when we spoke, you said that it’s just a matter of time when markets head into a bear market zone. We certainly seem to have done that in 2011. How deeply entrenched are we in this bear market would you say now?

A: The operating assumption is that the bear market regime is still on. I know that the popular thing to ask just now is will 2012 be any different from 2011 and the key thing to remember here is that markets don’t care about calendar years. So just because a new year begins doesn’t mean a new trend is about to begin.

This bear market has now really lasted a long while compared to any historical bear markets that we have seen, this has really gone on for a while. We have to now be on the lookout as to what can cause a turnaround. The operating assumption is that the bear market regime is still something which is on the ascendant here, but what can turn this around.

In this regard, there are a few markers that we are looking for. A lot of people will speak about Europe etc, but I find that that is sort of lagging data, that by the time the European situation begins to improve you will know that the markets have moved higher, so to me that is not a very good forward looking indicator.

From an Indian perspective, the most important thing that I am really looking for is that these correlations across markets need to breakdown. We have been seeing this since about 2005-2006, but the last few months has been extraordinary – that if you tell me what is the price of let’s say copper or the Australian dollar, I can tell you pretty much what’s happening across the world, it’s that formulae the sort of macromania that you know the price of one asset and you know where the risk is on and risk is off and everything moves accordingly.

Q: Do you think that runs the risk of breaking down next year?

A: It’s very important for it to breakdown but I am not sure if it does. We know the bear market regime is still intact but the moment that shows some signs of breaking down then we can be confident that a new sort of bull market is about to begin. It is very important for this cross correlations across different asset classes in the world to break down.

Q: When you talk about the bear market regime which is on right now, would you say it holds for all classes of equities, across the world or is it certain geographies that you are talking about?

A: This has really been where the conventional wisdom is starting to go wrong. The bear market regime looks most entrenched in emerging markets. The big surprise in 2011 is how resilient the US market has been and the fact that the Q4 of this year, the US economy in the midst of all this talk of a global slowdown is likely to post a GDP growth rate in the 3.5% to 4% range, which is an extraordinary performance because we thought this is a US problem that the rest of the world is suffering from.

However, the big challenge to conventional wisdom which is likely to persist for a while is that many emerging markets, which we thought were going to be the superstars, are being questioned. So, at this time last year, the big debate was that when will India overtake China as the fastest growing economy in the world, that debate is now being turned on its head which is that both India and China are slowing down and the question is which economy will slow down even more in 2012?

Q: Would you say that emerging market equities are in a deeper bear market than the US and the US which has been in the bear market for the longest time amongst many of these countries or all these countries, could it be the first to come out of it?

A: Yes, I think that could happen and these trend reversals take place just when the conventional wisdom becomes very strong. So, over the past decade, it became popular to say- the decline of the West and the rise of the rest. That trend could well start showing some signs of reversal, the two economies showing the maximum resilience at this stage are US and Germany in the midst of this entire turmoil.

In US and Germany even the expectations became very low and hence, those expectations are now being easily surpassed. At the same time, in the emerging markets expectations got too high, in terms of what they could achieve, and those are now being undershot. Markets trade at the margin, in terms of what the rate of change is and the rate of change seems to be more positive in those markets and more negative in emerging markets.

Q: Are you prepared to take this one step further and take a big call that may be we are at the cusp of a new bull market in US equities and the US dollar?

A: On the US equities, I am a bit doubtful but on the US dollar I feel much more confident. The US dollar over the past decade, on an inflation adjusted trade weighted basis has lost one third of its value. We were looking at some of our long term charts and it shows that the US dollar now is at the cheapest level it has ever been in its history.

So, it is competitive and a lot of the emerging market currencies have become quite expensive and so the big reversal is taking place. For many foreign investors a big part of the returns in emerging markets, over the past few years came from currency appreciation and that trend has exhausted itself. Hence, I think that in the US dollar today is quite likely that the bear market we saw in the dollar, over the past decade where it lost a third of its value is coming to an end and we are likely to see a higher dollar versus many currencies over the next few years.