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High rates, oil prices remain biggest concern: Merrill Lynch
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July 06, 2006

Chief Equity Strategist-Asia-Pacific at Merrill Lynch, Spencer White says that the questions on growth, Fed rates, valuations and redemptions remain. He says that the markets can move higher in the short-term.

According to him, the markets may not retest previous highs; earnings risks will continue to keep gains in emerging markets capped. Interest rates and oil prices remain the biggest concern according to ML. However, selling pressure in Korea and Taiwan has subsided.

He further says that they have a 'Marketweight' call on India, and that India is trading at 15.5-16 times in the current year, and will trade around 14 times next year. He also says that there is renewed interest among Japanese investors in India funds.

Excerpts from CNBC-TV18's exclusive interview with Spencer White:

Where do emerging markets stand now after the pullback?

We have had some sort of a recovery. I think there are still a number of question marks, and over the next six months and they are going to revolve around four factors; the pace of growth, how far US rates actually go, oil prices, and specific to emerging markets, if we get any renewed redemption pressures which appear to have eased.

So I think in the short-term we can probably move higher. But further out i.e. two-three months ahead, there is a lot of concern about earnings, earnings risk, and that is going to probably keep things fairly capped.

What is your sense, do you see markets like India and other markets in region reclaiming their old highs if redemption pressures don't resurface in the next one-month or so?

Certainly that will be helpful, I suspect we are not going to reach those highs because there are a number of factors which are going to act as a drag on the multiples. The first ofcourse is the expanding risk premium, which is partly connected to interest rates. Also the fact that global liquidity is continuing to ebb at a reasonably steady pace and the level of oil prices is also going to drag things as well.

Where does risk reduction stand at this point. You mentioned the fact that redemptions have eased but have you heard, even anecdotally, about stronger inflows into these emerging markets funds again?

The data is mixed. To put it in the context of the last six-seven weeks, we had about $16-17 billion of redemptions, which was mostly US focused. A number of my other accounts spaced across Europe as well as Asia, have seen much less outflow. So anecdotally, now some clients see some modest inflows, some of them have still got modest redemptions, but net-net it feels pretty even.

When I look at the net buying, selling data for markets here in Asia, lot of selling pressure has been focused not just in India but more particularly in Taiwan and Korea, which have seen more than USD 4 billion in net selling in the last one month, and those numbers have stabilised.

For the time being, those risks have clearly passed, but I do not think they have entirely gone. I had an interesting conversation a couple of days ago with a Japanese client who was actually saying that there is renewed demand now for India funds.

For you what is the call on India now on a valuation basis at about 10500-10800?

My perspective is reasonably relaxed; I am carrying 'marketweight' as far as India is concerned. This is at a premium to the rest of Asia, which has contracted sharply from 25%, where we were at the beginning of the May, to about 15% more expensive that the rest of Asia.

It is trading on about 15.5-16 times this year and about 14 times next year. I would say that there are number of concerns domestically, about what the earnings results are going to put up and actually whether there is going to be a pull down on earnings on Indian stocks, related to factors such as rising domestic rates, the oil price and possibly the effect of the monsoon.

But for 10-11 years that I have been involved in investment in India, my sense is that the monsoon is becoming a lot less relevant. They create lot of noise and wall of worry, but at the end of the day it always seems to workout so I am not particularly concerned about that factor, I think interest rates impact on areas like banks as well as the consumer stocks as well as the impact of the high oil prices are probably lot more significant.

One word on the point you made about some renewed interest for Japanese inventors into India funds. Is that just one off or do you think, some new money is probably looking to get into India now. Have you heard of other strains of that?

There is no hardcore statistical evidence, I cannot produce the chart, but according to the conversation which I had, the view is very much that the market is off the top, but the long-term secular trends are in place. Japanese retail investors who bought these funds, and if one remembers they were launched back in July last year, are still very much in the money and appetite continues to be there. So I will be watching carefully for evidence of those funds beginning to be raised again.

Do you think we can get back to 12,600 levels over the next 2-3 months?

I know that my friends in Pakistan are very keen for the KSE 100 to get back above the level of the Sensex, but right here right now I think there is probably more momentum behind the Sensex. I am not sure about the next couple of months, whether we are actually going to achieve these highs, but I do think that certainly for the year as a whole, India is actually going to perform reasonably well and that is why I said 'marketweight'. We will come back and have a look at that relative to the prospects of some of the other markets over the next couple of weeks.

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