Macroeconomic data continued to soften through the month, indicating a continuous slowing of the global economy. Composite PMI for Jul-22 moved into the contraction zone for the US (led by Services) and Europe
GLOBAL MACRO: CROSSING OVER TO CONTRACTION TERRITORY
Macroeconomic data continued to soften through the month, indicating a continuous slowing of the global economy. Composite PMI for Jul-22 moved into the contraction zone for the US (led by Services) and Europe (led by Manufacturing), whereas Manufacturing PMI did it for South Korea and Mexico. Historical data suggests that every turning point in inflation except one incided with a past recession. This is the necessary progress needed to bring inflation under control. During such periods, unemployment has also tended to ise. The US met the definition of a “technical” recession post the Q2CY22 GDP print of -0.9% QoQ, but Powell refuted it by stating it is not a “true” recession as labour markets are still very tight. It appears he was under political pressure to avoid using the R-word given the mid-term elections in the US in Nov-22. The biggest risk heading into the end of CY22 is the threat of a complete loss of Russian gas supply into Europe. According to Bundesbank’s analysis, this will ost likely lead to a recession in Germany and Europe. Pelosi’s unscheduled Taiwan visit has revived the US and China’s fight for supremacy in Asia as the Chinese military fired missiles into the Taiwan Strait. The World was facing great uncertainty already; if this issue worsens, there could be more of it.
Can inflation be subdued without a recession? History says “no”
Note: Grey marks US recessions; Source: NBER, BLS, Bloomberg, LGT
GLOBAL EQUITIES: BACK WITH A BANG
Markets have a mind of their own. They are also very quick at discounting incoming data. So, when expectations of a central bank pivot began to emerge, the Equity market participants jumped on to it fervently. As a result, benchmark indices catapulted significantly, making investors feel FOMO. The exception was MSCI EM and AEJ, wherein the Chinese real estate debacle overshadowed a strong show from India and South Korea. The sharp correction in equity prices in the 1H22 was primarily driven by PE devaluation as interest rates surged. Except for Asian equities, consensus EPS forecasts for all other markets rose. We believe a phase of earnings downgrade will occur in 2H22 as analysts account for slowdown risks. The current US earnings season is the weakest since Q1CY20. We retain our tactical OW stance on Equities vs Bonds and favour large-cap market leaders over small-cap stocks with promise of growth. We turn Neutral from UW on Asia ex-Japan while retaining our tactical OW tance on the US, Japan and UW on Europe, EMs ex-Asia. We also downgrade interest rate-sensitive sectors Consumer Discretionary, Real Estate, Financials and Industrials from Neutral to Underweight.
Equities rebounded strongly in Jul-22; China hurt EM and AEJ returns
Source: Bloomberg, ACWI – All Country World Index, AEJ – Asia ex-Japan
GLOBAL FIXED INCOME: ALL FOR FRONTLOADING; STAY OW ON IG VS HY
Inflation surprises pushed interest rates higher in 1H22; however, from Jul-22, higher inflation caused US long-term interest rates to fall as fears of recession increased. This ultimately led to the inversion of the US yield curve. US Fed delivered a second consecutive 75bps hike on expected lines but sounded slightly dovish on future hikes. ECB announced its first rate hike since 2011, and that too of 50bps was above expectations. To counter “unwarranted market dynamics”, ECB also launched a new Transmission Protection Instrument (TPI) tool. The BoE also hiked by 50bps – largest since 1995, troubled by soaring inflation forecasted to hit 13% in Oct-22 and stay in double-digits through CY23. It also predicted the UK economy to enter a lengthy recession by the end of CY22, which is expected to last for five quarters. We favour short-duration IG bonds over HY bonds and stay UW on Sovereigns.
DM central bank policy rates are at the highest level in last 5-years
GLOBAL COMMODITIES: END OF THE SUPERCYCLE? RETAIN UW GOLD
Essential commodities are starting to show signs of demand destruction as the prices have tumbled from their Mar-22 peak amid growing fears of recession. Only natural gas price was up last month, rising by 45%, although it has remained flat for three months. Russia’s closing and subsequent reopening of the Nord Stream pipeline below capacity have been the primary reason. There is a fear that Germany’s gas crisis could lead to the total collapse of its industries’ production and supply chains. With the DXY hitting its highest levels and waning of risk-off sentiments in Jul-22, there could be more pressure on Gold prices. Thus, we retain one notch underweight on Gold vs Cash.
Rising dollar index is expected to put pressure on Gold prices
INDIA MACRO: SHOW OF STRENGTH
Despite IMF trimming India’s GDP growth forecast by 80bps to 7.4% for FY23, it appears to be better than its peers. The trade deficit in merchandise goods surged to a historic high of USD 31bn in Jul-22, with exports contracting and imports increasing further, indicating rising domestic demand. The deficit now stands at USD 100bn for the period of Apr-Jul-22, significantly higher on a YoY basis. Windfall taxes on exports of certain petroleum products have been cut, and the government directive on mandatory coal imports by power generators has been relaxed as well. In addition, the Indian government gathered over INR 1.5tn in proceeds for the 5G spectrum auction, much higher than budgeted. On the other hand, INR 1.64tn bailout package was announced for the loss-making state-run telco, BSNL, which has lost its market share to the private players.
For Jul-22, GST revenues were up 28% YoY to INR 1.49tn, the second highest collection since GST was introduced. While the Composite PMI contracted to 56.6 in July, due to slowing sales growth and inflationary pressures faced by the service providers, manufacturing activity in India expanded to the highest level in eight months, driven by increased business orders. PV and 2W sales increased month-over-month, while some CV makers reported a decline. The sequential improvement in PV wholesales reflects the easing of chip shortages and a healthy demand environment. IMD has forecasted normal rainfall, which is 94-106% of the LPA for the country, which is supportive of the Kharif harvest target of 163mt for FY23. The country’s unemployment rate dropped to 6.8% in July from 7.8% in Jun-22, with recovery mainly in rural areas as the monsoon progressed and Kharif sowing activities gathered pace.
Capacity Utilisation at 75.3% (above LTA of 73.7%) could drive investment / capex plans for corporates
Latest Composite PMI for India is highest amongst larger economies
INDIA EQUITIES: SOLID BOUNCE; STAY OW EQUITY; TURN OW MID VS LARGE
Benchmark indices posted a sharp comeback in Jul-22, almost entirely wiping out the 1HCY22 drawdown. Several sectors, including Metals, Realty, Capital Goods and Consumer Durables, recorded double-digit monthly returns. Savvy investors quickly hooked to BofA FMS contra indicator of max bearishness and took advantage of the prevailing peak pessimism. They were rewarded more than generously for the risks undertaken. The steep deceleration in FII selling was a big factor underlying July’s equity rally. Cooling-off in commodity prices and above-normal monsoons have aided risk-on sentiments. 1QFY23 earnings season is also turning out to be better than the worst expectations driving only marginal downgrades to FY23/FY24 estimates. Though corporate profit margins have come under pressure from inflation, management commentary on future demand is quite optimistic. MF and SIP flows have been resilient, highlighting the critical support from new-to-market retail investors. As greed overtook fear, the VIX index corrected 25% MoM. In addition to macro variables, even momentum indicators are now favouring Equity vs Bonds making us move one more notch higher in our Overweight stance on Equities. As relative valuations and EPS growth upgrades are looking better for Midcaps vs. Large caps, we are also turning one notch Overweight on the former even as technical factors support the latter.
FII flows turned positive after 9 long months of relentless selling
INDIA FIXED INCOME: SINGULARFOCUS; RETAIN OW CORP, NEUTRAL ON ST VS LT
The MPC continued with its tightening by unanimously voting for another 50bps hike on 5-Aug-22, taking the policy repo rate to 5.4% – above pre-Covid levels of 5.15%. It also retained its “withdrawal of accommodation” stance, thus, implying further hikes are not off the table. FY23 GDP growth forecast has also been kept at 7.2%, but it is critical to note the quarterly variation. RBI’s Sep-22 quarter forecast indicates CPI to be higher than the upper threshold of 6% for three successive quarters. If this does play out, RBI would have to give a statement to Parliament explaining its failure to meet the given mandate. Hence, the Governor cannot afford not to take stern steps to douse uncomfortable inflation. In addition to price rise, RBI is also engaged in a battle to ensure the INR’s slide against the USD is orderly, and on this front, it announced several measures. But, this could be a classic case of the “ Impossible Trinity” wherein capital flows, exchange rate stability and monetary policy independence are at play against each other. The rising upgrade/downgrade ratio and credit growth further support our thesis of favouring Corporate Bonds / Funds. On the other hand, G-Secs could be under pressure from refinancing, oversupply and the risk of fiscal deficit overshooting the budgeted target. Faster-than-expected withdrawal of the surplus systemic liquidity has led to the short-term yields also moving closer to the levels before the pandemic. Therefore, we maintain our Neutral stance between ST and LT from a duration perspective.
RBI’s tools have sucked out banking system liquidity quite quickly
CURRENCY: REVERSING OW TRADE ON USD TO NOW, OW INR
The USD had its golden run almost cut short vs the INR in Jul-22 as the greenback fumbled towards the fag end of the month. Moreover, with the US going into a technical recession, the USD could face some pressure even though unemployment trends are not as alarming as in previous recessions. The RBI, too, seems to have upped its game by intervening in the FX markets and selling the USD, stating that there would not be any tolerance for INR volatility. On the other hand, healthy FX reserves and reasonable external debt-to-GDP lend confidence. Net-net, with RBI likely to hike rates and the US Fed indicating some slowdown in the pace of future hikes, we now turn OW INR vs USD.
The RBI has swung into action and intervened to stem the INR depreciation by selling USD
TACTICAL ASSET ALLOCATION (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 July 31, 2022.
ROUTES TO MARKETS: MODEL ALLOCATIONS