Continued volatility in sentiment has been the norm for the past 2 months. Jackson Hole Symposium of central bankers didn’t exactly turn out to be convention of camaraderie. The animosity between nations rampaged on: Hong Kong in the month raged against China (though likely signs of a truce seem round the corner), China raged against the U.S., UK raging with itself over the modalities of Brexit with Boris Johnson stirring more turmoil. Throw in an Argentine Peso plummeting like a falling knife in Aug-19, on talks of President Mauricio Macri intimating the IMF that his government would need more time to pay back a $56 billion loan it received months ago and no wonder our global equity indices screens sport red.
GLOBAL MACRO – STILL FAR FROM PINK OF HEALTH
Continued volatility in sentiment has been the norm for the past 2 months. Jackson Hole Symposium of central bankers didn’t exactly turn out to be convention of camaraderie. The animosity between nations rampaged on: Hong Kong in the month raged against China (though likely signs of a truce seem round the corner), China raged against the U.S., UK raging with itself over the modalities of Brexit with Boris Johnson stirring more turmoil. Throw in an Argentine Peso plummeting like a falling knife in Aug-19, on talks of President Mauricio Macri intimating the IMF that his government would need more time to pay back a $56 billion loan it received months ago and no wonder our global equity indices screens sport red.
GLOBAL EQUITIES: DM IN FAVOUR FOR NOW
There aren’t any clear-cut winners in a trade war. The U.S. 10-1Y and the 10-2Y markedly inverted in Aug-19 as markets fear the connotations of a world where the PBOC fearlessly devalues its reference rate without batting an eyelid. Bloomberg estimates that the U.S. interest rate (Fed Funds rate) should be ~4.7% if Taylor’s rule prevails (which theoretically takes into account inflation, employment and real short term rates). Powel has it pegged right now at 2.25% implying that he sees the trade war as a strong deterrent to the U.S. economy – not priced in by theory. Trump on the other hand seems agnostic to economic theory and ravages on with tweet after tweet and tariff after tariff.
Net-net, our own asset allocation model suggests valuations and corporate earnings tilt favourably towards DM though macros are relatively stronger for EM – the latest blow for DM coming in the form of a “first in 3 years” contraction in manufacturing (reference: the U.S. ISM manufacturing index).
GLOBAL FIXED INCOME: ONUS YET REMAINS ON CENTRAL BANKS
Bond yields softened in the U.S. by 52 bps in the month, European nations saw a 13 to 55 bps reduction as global investor monies chased safe-haven bonds over equities against the backdrop of escalating political trade wars. India however, bucked the trend with its sovereign getting “riskier” by ~20bps in the month as the Government unleashed its much-awaited fiscal stimulus and the revelation of NHAI’s mounting debt pile hit India sovereign bonds.
GLOBAL COMMODITIES: GOLD THE ONLY BRIGHT SPOT IN THE COMPLEX
The entire commodity complex has cracked in Aug-19, barring Gold. Reuter’s CRB commodity index cracked down 4.6%; no doubt led by 7.3% decline in Crude. Basic metals like Aluminium and Copper were down 3 and 5%, agricultural commodities like Corn and Soya were not left behind registering 11% and 1% falls. The outlook for Crude doesn’t seem very appealing, marred by inverting yield curves portending a bleak demand scenario and the Middle East nations themselves at varying degrees of economic recalibration of their sovereign balance sheets as they look to insulate themselves from oil shocks. Case in point being the replacement of the already power-diminished Saudi ArabianEnergyMinister’sroleaschairmanoftheboardofARAMCOwiththe head of the Saudi Wealth Fund.
We further increase our overweight stance on Gold, having first issued the call at the start of the Fiscal Year and already panning out a whopping relative 21.5% outperformance.
INDIA MACRO: LINGERING SENSE OF UNEASE
PMI Services has thankfully rebounded with a spurt at 53.8 for Jul-19 vs. a decline of 49.6 in Jun-19. The lagging indicators for Jun-19 of Industrial production, eight core infrastructures and of course, the GDP came in starkly below estimates, while on the other hand CPI started rearing its head in Jul uncomfortably beating estimates. RBI has signaled its intent with an unconventional 35bps rate cut and the Government aware of the brakes being slammed on the economy has hastily spewed out reform after reform towards the end of the month albeit admittedly, they were more of the same : PSU Bank recapitalizations and their mergers. While the intent is noble (as always) i.e. that of spurring banks to dish out credit and streamlining the lending process by amalgamating the myriad of PSU banks, the path of execution remains long. So in a sense, past reforms (GST, RERA, demonetization) seems to have been sterilized with a stinging iodine bandage of some more long term reforms.
INDIA EQUITIES: NEUTRAL VS. BONDS, MID CAPS REMAIN ATTRACTIVE
The last week of the month saw a 1.8% rally in the NIFTY50 no doubt fueled by speculation that the Government would announce a stimulus (read by the G- Secs simultaneously rising ~8bps in the same period). Reliance also played its part propping up the index as it furiously explores options for paring down debt: partnerships with BP, Tiffany & Aramco in one way or another should turn out accretive. On the other hand, sentiment does remain cautious as companies like CG Power, Coffee Day and Eveready spring open a can of worms and their ripple effect on their lenders (read: Yes Bank among others) needs to be watched. In a nutshell, bottom-up Q1FY20 earnings have seen some bright spots, though the top-down weak macro pegs us back to a neutral between equities and bonds and the relative valuation attractiveness of midcaps continues to look compelling.
INDIA FIXED INCOME: STICKING TO SHORT END AND CORPORATE BONDS
The RBI has dutifully stuck to its guns announcing rate cut after rate cut. They have now begun chasing banks and with lending rates now also benchmarked to repo/FBIL benchmarks the pressure is being ratcheted up on monetary transmission. The Government is mindful of the burgeoning debt on its balance sheet be it the well-publicized fiscal debt, the off-balance sheet liabilities weighing on the Food Corporation of India (FCI) and more alarmingly now, the NHAI and even the ballooning State Development Loans. It has however, finally drawn its wild card i.e. the RBI dividend which no doubt on face value at INR 1.76 lakh Cr. has overshot the Budget FY20 estimates but its detailed allocation remains to be seen. The end-to-end cost of the stimulus would affect the internal and external debt and any more clarity on the issuance of the overseas sovereign bonds would be welcome news for the now slightly hardened 10Y G-Sec.
Overall, we continue with our calls of favouring the short end of the curve in the current domestic environment which is yet fraught with undertones of greyness and high-quality corporate bonds as the (over)supply of G-Secs in light of the fiscal stimulus looms
CURRENCY OUTLOOK: USD LOOKS EVEN MORE ATTRACTIVE
The CNY has taken upon itself to be China’s war-head in thwarting any potential volume decline of the nation’s exports. While the PBOC may have the wherewithal to assume this mantle, other EM currencies have been sent teetering over the brink. The Fragile 5 currencies (i.e. Indonesian, South African, Indian, Turkish and Brazilian) have synchronously belted out a rapid depreciation vs. the USD. India’s external debt does not seem likely to evaporate any time soon and the inflation differential between India and U.S. seems poised to widen as the former’s CPI trajectory has shown signs of hardening MoM and the latter’s urban CPI has been below the 2% mark since Apr-19. Any widening of this inflation differential theoretically would result in a depreciation of the INR vs. the USD and cements our Overweight stance on the USD.
U.S. yield curves inverting in Aug-19 due to trade war concerns
Source: Bloomberg
U.S. ISM PMI falling sub 50
Source: Bloomberg
Commodities did not have a good month
Source: Bloomberg, Reuters
Q1FY20GDPgrowthcameinatabysmallylow5%(6Yrlow,muchlowerthan est. of 5.7%) pulled down by Mfg. & Agri.
Source: Bloomberg
About 51% of NSE500 companies reported positive & in line results for Q1FY20 only vs. 47% in Q4FY19 and 52% in Q3FY19
Source: Bloomberg, ACE Equity
Q1FY20 Earnings have seen moderate with top line and operating growth slowing QoQ
Source: Ace Equity, Bloomberg
India-US Inflation differential seems to have bottomed out giving further scope for INR depreciation as India’s CPI starts rising
Source: Bloomberg
INR and the “fragile 5” both weakened
Source: Bloomberg. Note Fragile 5 is a simple average
External debt is rising yet again with recent RBI flexing foreign borrowing rules for NBFCs and Corporates
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
