The European Central Bank (ECB) has been trying to boost bank liquidity by offering long term refinancing, which has calmed investor nerves, says Grant Bowers, portfolio manager and vice president at Franklin Equity Group. Bowers, lead portfolio manager of the Franklin US opportunities Fund, believes that the sustainability of the current rally in global stock markets will depend on the way how events in Europe and geo-political situation in the Middle East unfolds. Excerpts from an interview with Mehul Shah:
Global stock markets are off to a great start in 2012. Is this a bear market rally or something which will sustain?
Investors seem to be taking comfort from the positive data out of US and on signs that policy makers across the Atlantic are trying to address some of the tough issues. There is an increasing effort to balance fiscal consolidation with sustaining economic growth momentum. The sustainability of the rally will depend on the way various global events unfold (read Europe, geo-political situation in the Middle East etc). Overall, we are positive about the medium to long term prospects for equities and the US economy.
US stock markets outperformed emerging markets in 2011. Do you expect this trend to continue?
Strong earnings growth along with positive economic data led to the outperformance of US equities. Also, increased risk aversion in the second half of 2011 led to a flight to safety amongst global investors. The performance is also a clear reflection of the inherent strengths of the US companies that emerged stronger from the 2008 crisis with leaner operations and stronger profits. Operating margins are at new highs and many of the leading firms are witnessing good free cash flows. Also despite the outperformance, valuations remain attractive compared to historical levels, making it a good time to take exposure to a portfolio of US companies. It would be difficult to predict market direction over the short term, but we expect markets to track earnings growth trends over the medium to long term.
Recent economic data in the US has been encouraging. Do you think the risk of double-dip recession has subsided?
Yes, we believe that the US economy has exhibited good resilience amidst the various headwinds that set since 2008. Recent data on various fronts such as employment, manufacturing and retail sales points towards improving economic conditions. The extension of payroll tax cuts should help in sustaining demand. If we don’t see a deterioration of the situation in Europe, US Markets should witness steady growth over the coming years.
What's your sense about the sovereign debt crisis in the euro zone? Will that continue to bother investors or some kind of resolution is in sight?
We have seen increased commitment by policy makers in Europe to address the structural issues in the region since the last quarter of 2011. ECB has been trying to boost bank liquidity by offering long term refinancing, which has calmed investor nerves. Europe will remain a key driver of global investor sentiment over the short term.
How are you viewing the escalating geopolitical tension in the Iran and its impact on global markets, especially crude oil prices?
We have seen similar issues in the region starting from the Libyan crisis, which have been supporting energy prices despite the overall slowdown in global growth. The continued high levels of energy prices have been one of the reasons for relatively higher inflation levels in energy import dependent countries. IEA (International Energy Agency) has recently indicated that energy demand in 2012 is likely to be much lower due to fall in demand. However, any embargo on Iran could squeeze supplies.
What are the major risks you foresee for global stock markets?
The key risks are the situation in Europe, impact of de-leveraging on global growth and energy prices. Hence, financial markets are likely to remain volatile. Developed economies should continue to unwind the excesses of the past and the situation in the euro zone will be a key driver of investor sentiment. The global economy is expected to witness varying degrees of recovery in the coming years. Emerging economies will continue their fast growth path while the developed economies will grow at a slower pace as they continue to absorb the costs of the recent excesses in the financial sector combined with declines in productivity. Central banks could continue to pursue quantitative easing as a tool to boost liquidity and support growth.
We have seen $1.2 billion inflows in Indian stock market in this year so far. Have foreign investors changed their view on India or is it just a temporary boost due to global rally?
The flows are probably a reflection of the fact that few investors are finding India attractive after last year’s declines and increased global risk appetite. India is facing short term cyclical challenges in terms of inflation and fiscal deficit, but the long term growth potential remains attractive.
Our advice to investors is to focus on the long term potential and build a portfolio of well managed funds providing exposure to India as well as overseas markets. Research clearly suggests that such diversified investments tend to provide better risk-adjusted returns over the long term.
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