Citigroup expects the MSCI All Country World Index to end 13% higher from current levels of 380. It is based on expectations of an equity rally with expected rise in US interest rates. In an interview with Muthukumar K and Chirag Madia, Hasan Tevfik, global equity strategist at Citigroup, said that he is more bullish on cyclical than defensive stocks, given that the recovery phase of the global economy will benefit such stocks and equity markets with a bias towards cyclical businesses. Citi is underweight currently on India while remaining overweight on the Korea and Taiwan, among Asian markets. Excerpts of the interview.

Citi has set a bullish target for global equity markets. You expect MSCI All Country World Index to finish at 380 this year.

The World economy is expected to grow sluggishly in some regions this year, yet we expect corporate earnings to grow at a solid rate, because of high revenue beta. Over the years, revenues of listed corporations are showing higher sensitivity to global GDP growth, partly due to higher composition of commodity companies in world equity benchmarks. So, corporate revenues expand more rapidly during economic expansion and slow more rapidly during economic downturns. What we saw during the financial crisis was a big downturn in revenues and profits, which was a reason why markets collapsed. Through time we find stock markets generally move in anticipation of profits growth. We forecast global profits growth of 18% for 2011 and 11% for 2012. We expect stock markets to rise by a similar amount.

Can you tell your regional equity investment strategy?

When we look at valuations across the world, one thing that is seriously unusual right now is that different regions are valued at similar levels. Investors are not really differentiating between the fast and slow growing regions. We believe at this juncture when everything is valued at a similar level, it makes sense to go and buy the fastest growing markets, which are currently emerging markets.

But your investment theme is more bullish on cyclical stocks rather than defensives.

As we are still in an economic expansion phase, sectors most exposed to the economic growth will outperform other sectors. Some sectors like telecom, utilities and consumer staple companies have topline growth of 0-5% and EPS growth of 5-10%. But if we look at more cyclical companies and also cyclical countries like Taiwan and Korea, they might have a topline growth of 10-15%, but EPS growth of over 20%.

So right now are you underweight or overweight on India?

We are underweight India, partly because this is one area where valuations are already high. While Indian equities should rise from here, we think they will rise lesser than other countries. Within emerging markets, we like Russia. It stands out as one of the cheapest markets in the world right now. It is cheap for several reasons. One is that they have a large portion of oil and gas companies in their indices and the other being the uncertain political environment. But even accounting for these concerns, we think stocks in Russia are

still undervalued.

Do you think the US Fed will start increasing interest rates which could in turn positively impact global equity markets?

There is a positive correlation between the US bond yields and equity markets, even though its not a simple one-way correlation. And usually during the early phase of rate hike, when interest rates begin to rise from the lowest levels, economic recovery comes in, building confidence among investors to buy equities.

How do global investors think while investing? Currently, their risk appetite is waning.

A lot of these investors are backward looking, so the asset class which sees the flows now, is the asset class which has provided the best risk-adjusted return in last 3-5-10 years. If we look back 10 years bonds have given better return than equities, especially US corporates bonds. There is still that bit of cautiousness among developed market investors to put money into equity markets.

Do you foresee a possibility of QE3?

If we start to see weaker US economic growth and financial conditions worsening, then prospects of QE3 might be real. Right now it?s amazing that despite the US bond market yields falling in the recent past, equity markets have remained resilient. And given the current bond yields in the US markets, their equity markets should have been down by 10-15%. But they are not and credit spreads have in fact remained tight. So I look at the equity market, the credit market and the government bond market, and ask, which one is out of tune? Our group view is that it is not the equity market.

QE1 and QE2 have led to higher commodity prices, so what is your learning on QE2 as it ends this month? Has it benefited the real US economy?

When I see the current US economic condition and question the impact it has had on the bond and equity market, I am not sure, but it certainly did have some effect on the US dollar. The Fed has increased its monetary base by $600 billion; theory has it that if you increase your monetary base you should see a weaker currency. It is too early to say if QE has had an impact on the real economy given the lags in monetary policy.

Is ending of QE2 good for India as commodity prices will soften, benefitting Indian corporates?

We are generally forecasting slower increase in commodity prices. While commodities like coal and iron ore might see double-digit price increases, copper prices might see a minor price rise from hereon. Overall, if I look at the commodity prices, we have seen the biggest gains already. What that means is that any commodity importing country like India and China should benefit somewhat.

How do you think higher interest rates in the US might impact India and emerging markets?

I think in the first stage of recovery when interest rates rise, things will look good for emerging markets. But the second stage might be relatively negative for them as this will be the time when US 10-year bond yields are expected to go to higher levels of 5-6% perhaps. We believe that in the US, interest rates will start to rise in the first half of next year.

If we look at the earnings for the March quarter, companies in the US and UK have posted better-than-expected earning? Is that good for emerging markets?

Yes, earnings in the US and UK were strong, but the key point here is that markets go through a cycle. And in the first phase of recovery, earnings growth is driven by margins. Last year, companies listed in developed markets managed to generate faster EPS growth than emerging markets. But going forward, earnings growth is driven more by sales and less by margins. This is why EPS growth will be stronger in emerging markets, so our portfolio continues to show positive bias towards emerging markets.

What?s your view on the European market?

Many European companies surprisingly have managed to be profitable in this low-growth environment. They have found new areas of growth and gone global, by increasing revenues from emerging economies. So today an average European company has a larger exposure to emerging markets than that of an American company. In that sense, if we pick the right European companies, it?s beneficial. We are cautious on the financial sector though, particularly in Europe. European banks today have excessively leveraged balance sheets, with little to no margins as well as loan growth. So there is less of a reason to invest in these companies over the long term.