In the U.S. Manufacturing PMI, Services PMI, CPI, PPI and the Conference Board’s Consumer Confidence all beat expectations indicating a heating up economy. So why should the Fed cut rates at all? Pressure from Trump can be a cause and Powel has “diplomatically” balanced out an emphatic rate cut with a language tone in the FOMC meeting that did not suggest a rate cut cycle has started.
The U.S. is pulling its weight against China where all sorts of macro indicators point to stress – trade war effects much? The EU is battling its own internal demons of sluggish growth with Poland, Spain and even Germany having to pull up their socks in monthly manufacturing output, Deutsche Bank’s capital getting eroded from its decision to exit derivatives and its quarterly results painting nothing but a bleak picture. The change of guard at the ECB will be keenly watched. Throw in an uneven Brexit steered by the “radical” new Boris Johnson and volatility is clearly the winner of the month.
GLOBAL MACRO – IN WANT OF SOME FORM OF EASING
In the U.S. Manufacturing PMI, Services PMI, CPI, PPI and the Conference Board’s Consumer Confidence all beat expectations indicating a heating up economy. So why should the Fed cut rates at all? Pressure from Trump can be a cause and Powel has “diplomatically” balanced out an emphatic rate cut with a language tone in the FOMC meeting that did not suggest a rate cut cycle has started.
The U.S. is pulling its weight against China where all sorts of macro indicators point to stress – trade war effects much? The EU is battling its own internal demons of sluggish growth with Poland, Spain and even Germany having to pull up their socks in monthly manufacturing output, Deutsche Bank’s capital getting eroded from its decision to exit derivatives and its quarterly results painting nothing but a bleak picture. The change of guard at the ECB will be keenly watched. Throw in an uneven Brexit steered by the “radical” new Boris Johnson and volatility is clearly the winner of the month.
GLOBAL EQUITIES: EM & DM – TILTING TOWARDS DM
U.S., EU (barely), UK (surprisingly) and Japan ended the month in the green in local currency. Undoubtedly China bore the brunt of Tariff-Man and ended in the red. Translate the local returns to USD, however, and we get red numbers for EU and the UK thanks to the strengthening Dollar index.
Forward valuations for both EMs and DMs are near their +1 SD levels, but relatively DMs appear more attractive. Policy uncertainty measured by the number of global news articles which cite negativity around economic measures of a nation’s central bank is on the rise like wildfire for China. No wonder then, earnings expectations for DMs have been ratcheted up over the past 3 months while have been tempered for EMs.
GLOBAL FIXED INCOME: ONUS YET REMAINS ON CENTRAL BANKS
For the major part of July, markets were praying that Powel heed Trump. Powel 11% attempted to keep both parties happy and did cut rates, though Trump wasn’t having it and doled out another set of tariffs seemingly in response. The onus of any “tangible” easing lies yet again on the shoulders of monetary policy. Powel has played the middle ground and did not resort to an exceedingly dovish tone in his policy leaving things hanging. Iran continues to play havoc 10% in Hormutz but this has not been able to spike Oil prices as global demand remains anemic. Oil prices don’t spike implies a softer inflation meaning limited yield hardening entailing a not so rosy outlook for Fixed Income.
GLOBAL COMMODITIES: THE “GOLD”EN RUN
Crude price dynamics for Jul-19 continue to be dominated by sluggish global demand. Supply disruptions are not proving enough to offset this. Having to bank on a disruption to boost prices instead of other positive levers points to the state of the markets – a lack of any meaningful catalyst.
Lack of catalysts automatically spurs Gold higher. Our call to bulk up on the yellow asset since 31-Mar-19 has translated to a gold return of ~10% in INR terms. Comparing that with the blooming G-Sec return of 9% over the same period highlights the state of fear in markets. With the Fed not yet willing to bend its back and offer a rate cut cycle and world-over rightist sentiments on the rise in the form of Boris Johnson and PBOC (eagerly pushing the button on Yuan devaluation) – it would seem but natural to seek shelter under Gold.
INDIA MACRO: WHEN DOES THE CYCLE TURN FROM VICIOUS TO VIRTOUS?
Starting with the IL&FS/NBFC crisis, Indian macro fundamentals seems to have been slipping into a vicious cycle. Demonetization efforts do not seem to have worked as our arm-chair analysis shows Currency in Circulation (CIC) escalates upwards in a rampage even with elections-spending now a closed chapter. Deposit growth is fast catching up with slowing credit growth and the RBI – true to its word – has turned the tables on the liquidity deficit thanks to its relentless OMOs with the system now boasting a INR 2,13,000 Cr. surplus. SBI has also encouragingly cut its deposit rates signaling that deposits have indeed gone up. But what is perplexing is that even with the trio of liquidity glut, rising CIC and steady deposit growth, corporate top-lines are not showing commensurate growth as customer demand seems tepid still. So, transmission from macro to micro at the moment is the missing cog in the wheel.
INDIA EQUITIES: NEUTRAL VS. BONDS, MID CAPS TWEAKED A LEVEL DOWN
Equity valuations, particularly mid-caps, have corrected to mouth watering levels in the last 2 months on tightened budget announcements viz. FPI taxation. Earnings to date of the NSE500 have been a bit surprising. Of the 120 companies that have reported Q1FY20 results, majority of them were small caps (40% of reported) and the numbers show a uniform trend – that financials across all capitalizations are reporting stronger numbers. Mid caps in this small set of reported companies have also shown better top line and bottom line both qoq and yoy.
Net-net, we remain neutral between equities and bonds and within equities, slightly tone down our overweight stance on mid caps given the FII flight away from large caps. In this heightened risk environment wherein a travel services firm, a coffee enterprise, a gym company and a real estate developer are becoming some of the new faces of stress, caution is advisable. Axis Bank’s increase in provisions, Bajaj Finance’s incremental loan writing prudence, Jaguar’s unabated slide in China, SBI issuing memos of caution for auto loans, the renewed heightened security and tensions in Kashmir and the promoter spat in a leading airline are secondary signs of weakness. We await some clarity from the Government acknowledging that it has certainly kept a long- term vision of growth for the country – the new Companies Act promotes better corporate governance and the sovereign bond issue should alleviate any supply glut of G-Secs.
INDIA FIXED INCOME: TONING DOWN CORPORATE; MORE OW SHORT END
Our Overweight stances is reduced a notch on corps vs. G-Secs as the foreign borrowing reduces crowding out of domestic G-Secs and Corporate bond yields are trending below MCLR rates which could revive corporate issuances and in turn limit spread compression. Having said that, corps are still relatively attractively priced vs. G-Sec cousins with yields having some more cushion to soften.
Tenure-wise, we believe the macro risks mentioned above along with the humongous INR 30,000-50,000 Cr. NBFC bonds coming up for re-financing in Aug/Sep-19 still warrant an avoidance of the long end of the curve and with it already rallying significantly, an incremental overweight stance at the short end seems prudent.
CURRENCY OUTLOOK: USD BETTER POSITIONED THAN INR
The Dollar Index has lashed out and strengthened ~2% in Jul-19. With the Fed yielding only one 25bps rate cut, supply of dollar has relatively increased vs. the scenario markets had priced in which involved a rate easing cycle. The dollar should likely strengthen as China over the weekend has devalued its reference rate to below the 7 CNY/USD mark. With the PBOC openly willing to cross this “psychological” line in the sand, its on like donkey kong between Trump and Xi as the latter relentlessly banks on volume growth to offset the former’s ruthless tariff hikes.
We have tweaked our asset allocation to go overweight on the USD as the country is on the path of heating up, the depreciation bias between India and U.S. CPI kicks in and the Baltic Dry Index has shown slight crack of weakening from its peak in the face of renewed geo-political tensions.
Trade wars have de-grown exports globally
Source: Bloomberg
EM/DM Valuations suggest favourable tilt towards DMs
Source: Bloomberg
MSCI DM has shown a more pronounced earnings expectation recovery with a higher growth
Source: Bloomberg
Deposits growth still in deficit, but credit growth has reversed from the peak levels seen last year
Source: Bloomberg
CIC moderating sequentially but has remained elevated post elections
Source: Bloomberg
Financials are the key performers so far
Source: Bloomberg
RBI FX swaps and OMOs brought Liquidity into Surplus helping yields to soften
Source: Bloomberg
NBFCs face huge refinancing risks given the liquidity concerns and rating downgrades; prefer non-NBFC/HFC good quality Corp.
Source: Bloomberg
Trade activity starting to cusp down after a surge, while contraction in Oil storage demand suggests subdued Oil price outlook helping INR
Source: Bloomberg
TAA VIEWS & PERFORMANCE
Source: Bloomberg. Assuming a 6% annualized yield for cash.
GLOBAL ASSET PERFORMANCE SNAPSHOT
Source: Bloomberg Equity/Fixed Income Returns/Yields in local currencies. Commodities in USD. Numbers for Fixed Income are Yields. As of 30-Oct-19.
ROUTES TO MARKETS: MODEL ALLOCATIONS
