The twists and turns in the Brexit tale finally draws us to Boris Johnson stating that the UK must leave on 31-Oct-19 – the fate of (Northern) Ireland is in focus as has been the case over the last couple of years as the backstop agreement of Brexit remains the debate. If the deadline for exit gets pushed back to 31- Jan-20 it’s a sign of “can-kicking”. The Trump impeachment talks are fast gaining momentum as the Democrats build up on Joe Biden’s son’s, Hunter’s, probe by the Ukraine Government. Trump allegedly withheld military aid to Ukraine in exchange for the probe which could hurt the Republicans’ chances in the U.S. elections come 03-Nov-20. No wonder, CDS spikes have been observed in DMs. One could argue for a rosier world without Trump – back to free trade and booming economic welfare.
GLOBAL MOOD IN A SENSE OF LIMBO
The twists and turns in the Brexit tale finally draws us to Boris Johnson stating that the UK must leave on 31-Oct-19 – the fate of (Northern) Ireland is in focus as has been the case over the last couple of years as the backstop agreement of Brexit remains the debate. If the deadline for exit gets pushed back to 31- Jan-20 it’s a sign of “can-kicking”. The Trump impeachment talks are fast gaining momentum as the Democrats build up on Joe Biden’s son’s, Hunter’s, probe by the Ukraine Government. Trump allegedly withheld military aid to Ukraine in exchange for the probe which could hurt the Republicans’ chances in the U.S. elections come 03-Nov-20. No wonder, CDS spikes have been observed in DMs. One could argue for a rosier world without Trump – back to free trade and booming economic welfare.
GLOBAL EQUITIES: DMS SLIGHTY EDGE OUT EMS
The S&P 500 has gone nowhere significantly in the last 1 year (as of this writing), JPM’s Volfefe index (inspired by the “covfefe” mis-tweet, engineered on U.S. treasury volatilities) has reached elevated levels and global economic agencies ranging from the IMF, Fitch, Moody’s etc. have belted out a chorus of forecasted growth cuts over the same period. The Brexit “yes-no-yes” saga has claimed yet another victim forcing the CEO of a renowned luxury carmaker, to shut down production at his UK plants. German factory orders sink for Jul-19 on mounting trade uncertainty (courtesy, Trump) pushing recession probabilities higher in the EU and the U.S.
Having said that, corporate earnings consensus outlook is better for the DMs as are their trailing ROEs recently eclipsing their EM cousins and we remain a tad overweight on DMs.
GLOBAL FIXED INCOME: FURIOUS EASING BY CENTRAL BANKS
Trump’s to-and-fro on supposed restrictions of U.S. investments in China has spooked U.S. yields with the 10Y hardening 20bps and The Fed itself feeling jitters. Powel already cut rates by -25bps and on top of that has infused multiple cash infusion rounds of $75bn+ each, all of which have been over- subscribed by U.S. banks.
GLOBAL COMMODITIES: BLACK VS. YELLOW
Crude Oil saw a temporary spike up on the drone attack on Saudi’s Aramco. But the disruption was short lived as the burgeoning U.S. stock pile inventory coupled with the global malaise that is plaguing world demand gripped the black-gold markets.
Gold’s luster has dimmed a bit as the relative valuations vs. Oil is now uncomfortably above +1 Std. Deviation – asking for a correction downwards. Should the negative chatter around Trump gather momentum, this could transpire to markets riveting back to yester-yore governance of economic camaraderie and unfettered, friendly trade. No doubt, then a further risk-on sentiment away from “safe-haven” gold could ensue leading us to downgrade our OW stance on Gold a couple of notches.
INDIA ATTEMPTING TO REGAIN ITS SWEET SPOT: ARMCHAIR MUSINGS
Taking a few steps back, the economy was injected with growth stimulants via RBI’s repo doses. That wasn’t enough. In steps FM Nirmala Sitharaman and her daily-to-weekly cameo reforms made over her hawkish image at the Union Budget on 05-Jul-19. Amongst all the initiatives ranging from PSU Bank reforms, to their recapitalizations, to attempting to reinvigorate the export- oriented sectors, the one which stood out as not “more-of-the-same” was her corporate tax cut.
Animal spirits unleashed: An INR 1.45 Lakh Cr. tax cut to corporates would % entail an INR 32 Lakh Cr. market cap expansion (i.e. assuming a P/E of 22 multiplied by the tax savings flowing to EPS). But in reality, the BSE500 companies account for only a third of the corporate tax collections, so only ~ 32/3 = INR 10 Lakh Cr. gets reflected in the listed companies’ valuation re- rating. India’s market cap on 19-Sep-19 (just before the tax announcement) was INR 140 Lakh Cr. So, an index appreciation of ~7% (10/140) is/was due – which did pan out.
But on the other side, negativists (read certain auto companies) argue that on an assumed revenue base of INR 100, a PBT (assumed typical auto company PBT margin of 8%) of INR 8 earlier translated to a tax (assuming 33%) INR 2.64 and with the new 25% tax rate would now result in a tax incidence of INR 2. The “savings” amount to INR 0.64 and on the revenue of INR 100 translates to a maximum price cut of 0.64%. Demand would certainly have to be VERY elastic for volumes to pick up given this miniscule price drop. Given the oligopolistic nature of markets in the real world, one could then argue that firms are caught in the familiarly uncomfortable Nash Equilibrium: they are forced to cut prices (marginally) in the face of a hopefully VERY elastic demand curve when actually they just might be better off reinvesting the freed-up cash.
As if on cue, the sagas of a renowned, now troubled HFC, a corporation bank and its exposure to an “infamous” real estate firm and the RBI’s PCA (Prompt Corrective Action) on the said HFC’s merger partner reared their faces. Pains of a certain PE-backed NBFC don’t seem to be going anywhere and various brokerage reports about banks’ exposures to suspected stressed companies – likely all understating the exposures given the information asymmetry – puts India’s banking systems once again under the scanner and the tax cuts take a back seat.
INDIA EQUITIES: NEUTRAL VS. BONDS, MID CAPS REMAIN ATTRACTIVE
While the Government has stuck to its debt schedule at the Center, the RBI has slyly offloaded slightly more debt onto States’ balance sheets. Their borrowings for the Oct.-Dec-19. quarter (3 months) is expected to be INR 1.71 Lakh Cr., with gross level at INR 1.98 Lakh Cr. already for FYTD ending Sep-19 i.e. 6 months. The two sides of the corporate tax cut coin make us remain perched on the fence between equities and bonds. Compelling valuations and slightly better earnings trajectory tilt us towards mid caps within equities as has been the case for a while.
INDIA FIXED INCOME: STICKING TO SHORT END; A NOTCH MORE ON CORPS
News has already been emanating that the Government may ask for an interim dividend from the RBI. The GST council meetings remain focal events with the most recent one making hotels cheaper and colas costlier. Theory states that the fiscal multiplier effects on the economy would have been much higher had the Government increased its spending rather than cut its revenues. Theory also states that a fiscal stimulus could fall head over heels should Ricardian equivalence prevail i.e. consumers anticipate that an increase in the fiscal deficit would entail greater taxes at some point in the future, so instead of consuming, saving takes preference thus defeating the purpose of a fiscal push.
The increased pressure on G-Secs coupled with an observed slightly better demand-supply eco-system for corporate bonds makes us gravitate more towards the latter. Duration-wise, short term remains more attractive.
CURRENCY: A NOTCH DOWN ON USD, BUT STILL FAVOUR GREENBACK
The Dollar index has strengthened versus major currencies in the month gone by, but not as much as the INR strengthening vs USD thanks to the announced fiscal stimulus. The tax cuts have put India in a sweet-spot to attract global manufacturing investments and FDI flows, which arguably are more sticky than even FII flows (given direct ownership stakes are involved), have been soaring recently. Thirdly, tourism remains an evergreen driver of the INR strength. However, the inflation trajectories of U.S. and India seem to be reverting back to their old glide path of heating up India inflation (food inflation (read mainly Onions) rearing its head now and easy comps for headline CPI) and cooling down U.S. inflation (not having crossed 2% since Apr-19). This implies a weakening INR per currency-inflation parity. Consequently, net-net we reduce a notch on our USD call, but still remain bullish on the same.
EM CDS remain close to their Long-Term Avg.; DM CDS are below LTA but have spiked on recent concerns
Source: Bloomberg
Probabilities of US and EU going into recession increasing YTD on trade war and Draghi going into full easing mode
Source: Bloomberg
ROEs have shown steady improvement for both, but DM ROEs are higher than EMs
Source: Bloomberg, MSCI
Auto Volume Growth: Latest print for Sep-19 shows mainly only, Maruti capitalizing on price cuts
Source: Bloomberg
Government Borrowing and fiscal deficit targets continue to be a concern; SDL on the rise but Centre is stable
Source: Bloomberg, DBIE
Tax cuts should make India a beneficiary of US-China trade disruption
Source: Edelweiss, reports
India on pace to attract 2x of CY2018 net FDI flows – doing better than Asian neighbours
Source: Bloomberg
Foreign Exchange Earnings from Tourism have been growing at a steady rate (5Yr avg. of 13%)
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-Sep-19.
ROUTES TO MARKETS: MODEL ALLOCATIONS
