The trade talks between U.S. and China appear as volatile and fickle as it can get. After apparent clarity on trade truces gaining momentum, TariffMan springs back into action with a fresh Twitter vow to increase rates on nearly $200bn worth of Chinese goods to 25% from 10%. China’s Policy Uncertainty index has once again spiked up alarmingly. Brushing this aside, the U.S. SSSG has comfortingly recovered (though UK counterpart, Debenham’s Plc. has cracked under its debt load), global PMIs cruise along at 50+ levels and misery indices world over happily show signs of fatigue.
GLOBAL MACRO
The trade talks between U.S. and China appear as volatile and fickle as it can get. After apparent clarity on trade truces gaining momentum, TariffMan springs back into action with a fresh Twitter vow to increase rates on nearly $200bn worth of Chinese goods to 25% from 10%. China’s Policy Uncertainty index has once again spiked up alarmingly. Brushing this aside, the U.S. SSSG has comfortingly recovered (though UK counterpart, Debenham’s Plc. has cracked under its debt load), global PMIs cruise along at 50+ levels and misery indices world over happily show signs of fatigue.
The U.S. in particular seems to be nearing the equilibrium of a Goldilocks economy featuring steady economic growth that doesn’t stoke the flames of inflation and also steers clear of recession.
The recent U.S. jobs report had something for everyone on Friday, bolstering views that the economy is rebounding from a soft patch but not by enough to revive inflation. Surprisingly strong payroll gains of 263,000 in Apr-19 and the lowest unemployment rate since 1969 calmed some fears that a recession could be brewing. Meanwhile, the lack of a surge in wages kept alive speculation on Wall Street that the Fed will still be forced to cut interest rates.
GLOBAL EQUITIES: NEUTRAL BETWEEN EM AND DM EQUITIES
Valuations of EM and DMs are both in upswing. However, the U.S. CAPE trends near its averages and so does the relative EM/DM valuation thus highlighting the case of choosing two equally priced assets.
On the other side of the scale, weighing what one gets for the price one pays, we see that earnings upgrades over the last 3 months for EMs has made them almost as valuable as a DM asset. Digging deeper, only select EMs with a back- ended earnings delivery (i.e. earnings growth story pushed out further into the third year) prop up the aggregate EM asset. Consequently, we remain neutral between EM and DM equities asset classes.
GLOBAL FIXED INCOME
DM sovereigns at the long end witnessed some hardening of yields as the Fed deferred any populist rate cut. Coupled with the IMF sounding caution on a slowdown of global growth, this spooked bond markets and Trump’s tariff announcements did not help. Tighter global supplies pushing the price of oil marching higher has also not helped the case for DM sovereigns.
GLOBAL COMMODITIES
In Apr-19, Crude spiked up 6.5% as the U.S. waived off sanction exempts for countries importing Oil from Iran creating supply shortage concerns. However, at the same time, President Trump is widely recognized as a champion of lower oil prices, and his actions (/Tweets) towards the OPEC would be closely monitored. The Baltic Dry Index has dramatically slumped since Feb-19 and this has hit trade globally.
Gold was marginally flat (USD) with the U.S. TIPS (Treasury Inflation-Protected Securities) falling in Apr-19. With the fall in real rates, the attractiveness of holding interest bearing assets has waned and flows should resultantly gravitate towards the yellow metal.
INDIA MACRO: FAVOURABLY POISED
Heading into elections, the Indian economy appears to be a tale of two halves. One half has been seeing signs of distress in the form of weak Consumption. Cases coming to mind being: Maruti, slowing volume growth of FMCG companies and “Trump”-like fluctuations of India’s monsoon forecasts.
The other half paints a better picture with capacity utilizations of firms seemingly bottoming out coupled with a likely pick-up in GFCF formation. With much of the election expectations already priced in, markets now look for delivery on growth – be it investment led or consumption led or if the (rain) Gods smile upon us, firing of both cylinders of the GDP growth engine.
Misery Index showing encouragingly strong deceleration
Source: Bloomberg. Note: Misery Index = Unemployment + Inflation
3Y Fwd. Earnings CAGR Expectations: EMs catching up
Source: Bloomberg. Note: Much of the EM catch-up coming in third year due to upgrades in China, India, South Africa, Russia & Thailand
Historically, a decrease in bond yields results in a re-rating of PE multiples
Source: Bloomberg
Sensitivity Analysis: ±25bps change in repo rate could move markets ∓ 3%
Source: Bloomberg. Based on linear regression of historical change in yield vs. change in Fwd. PE
Cap Exposure: Multicap Funds piling onto Mid caps at cost of Small Caps
Source: ACE MF. Analyzed over 58 Multicap MFs
INDIA EQUITIES: NEUTRAL VS. BONDS, OW ON MID CAPS
While we acknowledge that markets appear to have priced in Elections already (courtesy the swelling FII in-flows seen in the last month), firstly, certain event risk yet prevails and it would be prudent to avoid any black swans. Secondly, inflation could rear its ugly head on the back of receding tailwinds from easy comps, oil price volatility and the imminent ending of the long streak of food deflation. 3m, 6m and 1Y OIS spreads over repo have already turned mildly positive indicating debt market nervousness about the RBI abandoning any rate cuts.
Looking back in time, rate cuts translate to softening bond yields and this reduces the cost of capital for corporates. Consequently, interest outlays go down and earnings go up and equity markets react positively. A regressive sensitivity analysis estimates a ~3% rise in valuations for a 25bps repo cut.
Markets appear to have priced in most of this good news for now, incl. recent rate cuts and potential electoral outcomes supported by strong FPI flows. Expect profit booking in the event of meeting expectations with focus shifting back to macro fundamentals and long term valuations. Hence, we turn back to Neutral from our earlier call of Overweight in tactical asset allocation (back to originally proposed strategic asset allocation viz. between equities and bonds) and believe this should be the strategy heading into “D-Day” (elections). This tactical call has been initiated by us in early Jan-19 and has captured the gain of ~5.9% from equity market rally.
Mid caps though continue to remain more attractive vs. large caps in terms of growth prospects and valuations. In fact, from the admittedly limited 59 companies reporting their Q4FY19 results, mid caps have so far outperformed large caps across most income statement line items and across most time frames (QoQ and YoY). Multicap funds have no wonder then, stuck to their guns and held on to mid cap allocations as well. We as well, continue to reiterate our overweight stance on Midcaps Vs Large Caps.
INDIA EQUITIES: NEUTRAL VS. BONDS, OW ON MID CAPS
Relative valuation spreads across tenures paint a uniform picture of attractiveness of Corps. Vs. G-Secs. Further, prominent private banks like Axis Bank and HDFC Bank reported robust QoQ growth in deposits outpacing their loan growth which augurs well for liquidity and rates.
Some dynamic bond fund managers, in last few months, beefed up duration by more than 2 years despite the likelihood of CPI tailwinds waning away – with food commodities getting out of deflation and oil price volatility rocking the commodities space.
Our discussion with some of these fund managers reveal that most duration hikes have now been rolled back in end April-19 and our call on being OverWeight at the short end of the curve stands ground. Further, with much of the GOI issuances remaining in the 10-14 Year bucket, over-supply concerns yet loom at the long end of curve. RBI continues to infuse liquidity to ease liquidity deficit via OMOs again in FY20 and this would support short end.
CURRENCY OUTLOOK: NEUTRAL
Post the INR rally towards end of Mar-19, we revert towards Neutral/Strategic Asset Allocation. We acknowledge that much of this strengthening was thanks to the ebullient FII inflows into Indian assets. The overarching theme of a persistent inflation differential between the U.S. and India should likely take center stage going forward with the RBI also playing its part in maintaining export competitiveness of India.
Policy makers generally do not like roller coaster-like fluctuations in fund flows. Markets, ergo central banks (RBI being no exception), prefer stability and steady forward premiums in currency markets help attract sticky FII inflows and shore up a country’s asset attractiveness.
The INR should remain range-bound in the near term with the RBI expected to opportunistically “buy on dips” any cheaply available USD should the INR strengthen. Jun-18 and Mar-19 immediately comes to mind when the RBI intervened to stabilize any sharp currency movement at these levels. For now RBI seems to be comfortable at around 69.50-70 levels against dollar, on the basis of the recent trend of its direct interventions and Buy-Sell Swap windows.
Q4FY19 mid caps earnings has started to outperform large caps
Source: ACE Equity. Note: 59 companies reported within NSE500
As of Apr-19 end, Bond Funds had increased duration, though recent interactions point to them reversing their positions
Source: ACE MF. Note: Interactions with SBI, UTI, Quantum, IDBI, Canara Rob and Tata Dynamic Bond Funds
Rs. 1 Lakh 43k Cr. issuance in 10-14 Yr bucket to keep G-Sec 10Y elevated
Source: RBI borrowing calendar
RBI interventions suggest comfort lies ~69.5-70 levels
Source: Bloomberg. Note: FX Intervention defined as difference of change in liabilities and foreign assets of RBI’s balance sheet
India-US Inflation differential seems to have bottomed out giving further scope for INR depreciation as India CPI rises
Source: Bloomberg. Assuming a 6% annualized yield for cash
TAA VIEWS & PERFORMANCE: MACRO CALLS ON MOST ASSET CLASSES HAVE WORKED OUT
Source: Bloomberg
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-Apr-19.
ROUTES TO MARKETS: MODEL ALLOCATIONS
