October saw a small breakthrough in the ongoing US-China trade tussle with the announcement of what Trump has called “Phase One Trade Deal”. The deal calls for China to commit to substantially increase purchases of US Agri products, further opening of its financial sector and keeping currency stable. But a resolution seems distant for a couple of reasons: Firstly, President Xi doesn’t seem equally enthused about a quick-fix as Phase One pushes thorniest issues about punitive tariffs to Phase Two. Secondly, polls show US voters continued skepticism towards fairness of Chinese trade practices. Trump will be forced to play to the gallery and ramp-up anti-China rhetoric given 2020 is Election year. As if it was jinxed, social unrest in Chile has led to cancellation of APEC summit where the deal was to be signed. Nonetheless, US-China soft talk and postponement of Brexit to Jan 31, 2019 (risks of NoDeal Brexit abated for now) lifted sentiments of everlasting gloom.
PHASE ONE TRADE DEAL – CAN IT HAPPEN FOR REAL?
October saw a small breakthrough in the ongoing US-China trade tussle with the announcement of what Trump has called “Phase One Trade Deal”. The deal calls for China to commit to substantially increase purchases of US Agri products, further opening of its financial sector and keeping currency stable. But a resolution seems distant for a couple of reasons: Firstly, President Xi doesn’t seem equally enthused about a quick-fix as Phase One pushes thorniest issues about punitive tariffs to Phase Two. Secondly, polls show US voters continued skepticism towards fairness of Chinese trade practices. Trump will be forced to play to the gallery and ramp-up anti-China rhetoric given 2020 is Election year. As if it was jinxed, social unrest in Chile has led to cancellation of APEC summit where the deal was to be signed. Nonetheless, US-China soft talk and postponement of Brexit to Jan 31, 2019 (risks of NoDeal Brexit abated for now) lifted sentiments of everlasting gloom.
GLOBAL EQUITIES: RISK-ON FOR NOW – FORGET THE WEAK MACRO
Risk assets outperformed traditional safe havens in October as markets welcomed signs of easing in geo-political tensions. From West to East, be it DM or EM, Equities rallied in USD terms closing-in on their life-time highs. Weak macros were thrown to the wind: Germany is on the brink of recession with latest quarter GDP expected to show contraction (out on Nov 14, 1Q growth was -0.1%), Eurozone Composite PMIs remain anaemic at 50.2 with manufacturing in contraction for 9 successive months, Japanese factory activity has been in contraction for 6 months in a row, China 3Q GDP was at 27 year low, HK is technically in recession. US appears to be doing relatively better with GDP growth beating estimates but PMIs and job growth have started weakening. IMF, thus, lowered its 2019 global growth forecast to decade-low 3% driven by growth downgrades across all major economies.
EMs beat DMs this month, but we continue to be a notch overweight on DMs basis relative valuation attractiveness, higher trailing ROEs and better corporate earnings consensus outlook.
GLOBAL FIXED INCOME: DOVES MOVING TO WAIT-AND-WATCH
In pursuit to revive growth, global central banks did a concentrated burst of interest rate cutting reaching a crescendo in August 2019 when 21 central banks eased rates. As early as last week, US Fed cut rates for the 3rd time in a row but hinting at a pause in Dec. Draghi at ECB did the last cut of his tenure before making space for Lagarde. BoJ wants to hold on to its limited ammunition rather relying on pledges of more accommodation. There is no magic bullet or one-size-fits-all approach to revive growth and central bank policymakers want their political counterparts to now step-up their stimulus efforts while waiting on the sidelines to see how what they did plays out.
GLOBAL COMMODITIES: OIL UNDER PRESSURE, GOLD STEADY
US EIA and OPEC both have lowered their oil demand forecasts over the medium term as global economy sputters and electric vehicles ‘gain momentum’. OPEC has lost its legacy control on oil prices as shale revolution in US enabled it to become a net exporter of oil. Even, world’s largest oil producer, Saudi Arabia’s Aramco had to compromise on $2tn valuation to make its IPO attractive for global investors who value it close to $1.2-1.5tn.
Industrial metals like Copper, Aluminium have seen 2-3% MoM moves after being subdued for long. GSCI Commodity Index/S&P500 has reached lowest levels since 1971 – at below 1x vs median 4.1x – indicating risks emanating from spike in commodity prices in the medium term.
Despite risk-on sentiment prevailing in Oct, safe-haven Gold attracted investors as Fed eased further and DXY weakened. We stay just a notch OW on Gold as any further de-escalation of trade war and subsequent setback in recessionary fears can be negative for Gold.
INDIA MACRO TEETERING: NOTHING SEEMS TO BE ENOUGH
India finds itself in a precarious situation where doing some things will never be enough to have an effect. Ex-RBI Governor complained that ill-conceived demonetization & wrong execution of GST broke the back of the Indian economy and Govt. focused more on public welfare and distribution instead of new sources of growth. At the same time, Ease of Doing Business Index rank improved from 130 to 63 in 4 years due to exactly these long-expected reforms being undertaken. 8-core industries growth has come in at -5.2% and Composite & Services PMI is in contraction for 2 months in a row. RBI has noted muted readings of business expectations and consumer confidence index. But, GDP growth forecasts indicate bottoming out and quick recovery towards 7% number in the next fiscal.
After having given an unprecedented corporate tax bailout, Govt. is mulling changes on personal income tax and equity capital gains tax front as well including reviewing DDT, buyback tax and STT. Though, such bonanza announcements cheer the markets, a recent survey by India’s leading ratings agency paints a different picture: only 10% companies plan to pass on benefits from tax cuts directly to consumers in the form of promotions and discounts. Many of them are still undecided and 45% would spend it towards deleveraging and capacity expansion which ultimately is an indirect measure to push demand but not as effective as putting cash in consumers hands.
While Auto manufacturers reported huge YoY drops in wholesales, some companies did see MoM gains due to heavy discounting and festive season demand which also improved retail volumes. Telecom is the new pain point for industry with Supreme Court upholding DoT’s demands from 14 years ago. Penalty and interest included INR 92,600 Cr. are to be paid by legacy private telecom service providers many of whom have either shut shop or have merged with Airtel or Idea Cellular. On the other hand, state telecom players BSNL & MTNL will be merged as a part of INR 56,000 Cr. revival plan.
INDIA EQUITIES: NEUTRAL VS. BONDS, A NOTCH OW ON MID CAPS
Equity earnings yield came as close as attractive to bond yields post corporate tax cuts but not materially enough to offset macro concerns. About 65% companies reported positive & in line results for Q2FY20 so far vs. 51% in Q1FY20. Financial, Industrial and Material sectors have done well. Relative valuations continue to favour Mid-caps over Large-caps. Liquidity flows are now in favour of Mid-caps and actual Q2FY20 results show Mid-caps have done better. But, earnings downgrades have been worse than Large-caps though both yielding CAGR of ~29% on a 2-year forward basis.
INDIA FIXED INCOME: CORP. SPREADS ATTRACTIVE; PREFER SHORT
RBI, at its Oct 4 meeting, maintained its Accommodative stance and cut the policy rates by 25bps from 5.4% to 5.15%. The MPC just about met estimates as some sections of consensus were expecting as high as 40bps. FY20 real GDP was downgraded from 6.9% to 6.1% and CPI expectations raised by 30bps in a span of 2-2.5 months which only does raise questions. Recent data shows deposit growth exceeding credit growth which should enable better transmission of rate cuts. Govt. spends (both capital and revenue) accelerated in last 3 months despite feeble tax collections (both GST and corporate advance tax) which is likely to lead to recovery in H2FY20 but at cost of slipping of the fiscal glidepath and not meeting 3.3% target.
Corporate Bonds look attractive on a relative yield basis with spreads further widening on a MoM basis across tenures. G-Sec supply to meet higher expenditure and any disinvestment shortfall is a spoilsport for yields. Duration-wise, any truce on the trade war front will support the short term more than long-term. Also, with RBI expected to pause just as other central banks – OIS for India suggests NO rate cut – going long now will likely not be beneficial.
CURRENCY: FAVOUR GREENBACK
With No-Deal Brexit out of the way, GBP rallied strong vs USD and EUR this month. In India, astute liquidity management by the RBI along with the recent corporate tax cut and murmurs of further tax rationalization across various asset classes which attracted FIIs has resulted in “overflowing” inflows from FIIs and has propped up the INR vs. the USD. The inherent inflation differential between India and the U.S. is bound to kick in and spur the USD. Also, the narrowing trade deficit over last several months, which is holding up the INR, is due to imports falling more than exports, the widening of which will have negative effect on the INR. US also offers attractive short term yields relative to negative yields in Europe and Japan. Consequently, we still remain bullish on the USD.
IMF World GDP growth projections for 2019 at decade low, growth revised down for every major economy; Revised US 2020 sees a slight uptick
Source: Bloomberg
US-China trade war disruption benefited peer Asian EM countries as global supply chains are getting rebuilt
Source: Bloomberg
Central Banks have been on a rate cutting spree to revive economic growth
Source: Bloomberg, MSCI
Easing US FED policy with increasing fears of recession and Dollar index weakening are positive for Gold
Source: Bloomberg
India corporate tax cut alone may not seed the demand growth as indicated by valuations re-rating
Source: Moneycontrol Research
8-core index declined -5.2% in Sep, 7 of the 8 core components exhibited weakness; Coal & Refineries slumped
Source: Bloomberg
India GDP growth seems to have bottomed out as all estimates point towards a quick recovery
Source: Bloomberg
3m and 6m OIS spreads vs. repo suggest NO rate cut; transmission to bank’s lending cost not yet meaningful
Source: Bloomberg
RBI interventions kicked in likely to buy USD in order to stabilise 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
