Countries policy responses post COVID-19 has been of varying degrees. Across countries, policy rate easing and bulking up of the central bank balance sheet via QE tools and FX reserves
GLOBAL MACRO: REALIZATION DAWNS THAT REAL YIELDS MATTER
Countries policy responses post COVID-19 has been of varying degrees. Across countries, policy rate easing and bulking up of the central bank balance sheet via QE tools and FX reserves (in turn having a multiplier effect of excess liquidity sloshing around) led to a massive monetary stimulus. India was arguably a laggard in policy response vs. other nations. However, an arm-chair analysis now, dictates that this might actually be proving to be a boon as excessive easing has yielded extreme negative real rates in most global markets due to their economies overheating.
This is one of the primary reasons why most global EM fund managers in their attribution analysis see that the worst performing stock in India has returned more than the best performing stock in other EMs.
MSCI India trading at steep premiums vs. EM (PE)
GLOBAL EQUITIES: CHASING FED PIVOT DREAMS
U.S. equities have seen an aggressive short term rebound as most participants are betting on the elusive moment when the Fed shows some form of easing as the USD continues to soar to new highs. But many economies remain in over-heated space. UK, most recently, has resorted to large scale unfunded tax cuts (biggest since 1972) – still seemingly stuck in the rut of economic easing. Fiscal relaxations generally have a much stickier and large multiplier effect on the economy than monetary tools. Such is the irony in UK, that a fiscal stimulus (thankfully via tax cuts at least, and not direct Govt. spending) has been offset with Fed-“coerced” monetary hawkishness (BOE hiked by 50bps on 22-Sep). To throw another spanner in the works, the BOE even launched a mini QE to stem the rot in UK Gilts, courtesy the tax cuts.
India, in contrast due to refraining from extreme accommodative policy support in the last 2 years, has seen its economy smooth out the COVID recovery bumpiness. This makes India decoupled from the rest of the world. We retain our tactical OW stance on Equities vs Bonds. We remain Neutral on Asia ex-Japan while retaining our tactical OW stance on the US, Japan and UW on Europe and EMs ex-Asia. We also remain UW on interest rate-sensitive sectors Consumer Discretionary, Real Estate, Financials, Utilities and Industrials.
Global PMI trends down
Source: Bloomberg, LGT
GLOBAL FIXED INCOME: FED TIES UP HANDS OF ALL CENTRAL BANKS
Inflation has reared its head and how – across the world. Central bank balance sheets are rapidly unwinding and yields are creeping up slowly but surely. Certain renowned MNC banks have cited multiple reasons for CDS spikes though underlying bond yields might not have risen commensurately. Some of these banks have certainly lent out to a certain Indian conglomerate which raises concerns on their liquidity, but repeated comments by the bank’s new CEO assuring of stable CET ratios etc. has helped keep their bond yields in check. Overall, global monetary policies continue to tighten in Sep-22, post Jackson Hole, with hikes of 50 bps or more being common. The upward trajectory of interest rates is expected to persist for the rest of the year and should lead to a material deceleration in global economic growth ahead. However, there should be almost no further monetary policy rate hikes in H2CY23. By this time, global economy should be at or below trend growth, with perhaps periods of technical recessions. We continue to favour short-duration IG bonds over HY bonds and stay UW on Sovereigns.
More than 50 bps hikes expected in many G7 countries till year end
Source: Bloomberg, LGT
GLOBAL COMMODITIES: DEMAND CONCERNS SPARK RISK-OFF
Commodity prices slumped as a deteriorating economic outlook and surging USD weigh on the value of the world’s raw materials. Copper, and Zinc at 2.5 year low, Oil at 8 months low, Aluminum at 20 months low, Palm oil at 21 months low and Cotton at 2 months low. On 27-Sep-22, Bloomberg commodity spot index was at its lowest level since 24-Jan-22. The USD advanced to a record having been propelled by the most aggressive trajectory of interest-rate hikes by the Federal Reserve since the 1980s. The benign outlook has transformed the picture of commodity markets in recent times. Gold slid to the lowest in more than two years as tighter Fed policy and Europe’s worsening energy crisis has pushed up the greenback, weighing on the metal that’s priced in it. Higher Treasury yields are also hurting bullion, which bears no interest, resulting in pressure on the yellow metal. But, Given the global risk indices much above the long term averages and VIX shooting up, we upgrade Gold by to neutral vs prior -2.
Oil supply should see some form of moderation (after cuts) as demand could get impacted
INDIA MACRO: BOP TO REMAIN A LITMUS TEST
India’s CAD has been weakening with Q1FY23 widening to 2.8% of GDP vs. 1.5% in Q4FY22. Much of this weakening has been mainly driven by poor trade merchandise data – lower exports and more imports. However, the silver lining has been strong invisibles with IT services exports here buoying up the CAD. The counter to the Current Account viz. the Capital Account has thankfully recently seen some revival as India stands ready to benefit from Europe+1 and China+1. Should global risks materialize, the CAD (particularly the trade merchandise) should see some alleviation as was seen in COVID-19 period where India actually reported a CAD surplus. Basically, India’s CAD shines when the world is gloomy. Hence, should we have a BoP surplus (when the world is in recession) then
India’s economy should in all probably, stay a cut above.
Other high speed indicators are broadly in fine fettle but the path ahead remains to be seen: Auto volumes are singing along, FIIs and FDI flows for the moment seem to have revived, external debt is well managed, PMIs (Sep-22) are higher than Aug-22 and banks which were earlier (immediately post COVID-19) flagged off by the RBI and policy makers as torch-bearers for pushing out “cheap” loans to spur the economy, now finally appear to be dishing out the much-needed credit impetus.
Current account stretched mainly due to trade deficit
India 8 – Core sees some moderation sequentially
INDIA EQUITIES: FED MODEL DICTATES OVERVALUATION
Starting with a back-of-the-envelope yield differential analysis between U.S. and India G-Secs. Historically, India’s 10Y used to trade at ~4.5% yield premium to the U.S. 10Y. Currently, this differential is only at ~3.5% (US @ 4%, India @ 7.5%). A mean reversion of yield differential implies India’s 10Y should trade at 8.5%. The Fed model applied to NIFTY indicates an average of 0.8x EY/BY ratio. This indicates an EY of 6.8%, translating to a P/E of 15x – ~25-30% fall from current levels.
While most global equity markets are down ~20% on YTD basis, Indian markets held on driven by factors like strong corporate earnings growth and expectations of a healthy performance over next two years. In the upcoming 2QFY23 corporate earnings, though aggregate Nifty earnings likely to be remain flat, BFSI and Autos segments expected to report strong numbers.
India’s 8-Core index has also seen some form of a minor speed bump – growth persists, albeit at a less vigorous pace. Consequently, some rub-off of global nervousness should spill over onto India – in asset prices as well as underlying economic fundamentals. Hence, we bring down our earlier 2 notches OW stance on Equities back to SAA levels (i.e. neutral tactically). Within equities, we maintain our OW stance on midcaps primarily driven by lesser earnings cuts vs. large caps.
10-1 yield spread of India G-Secs still has room for inversion
INDIA FIXED INCOME: YIELD CURVE LEVEL TO SEE POTENTIAL PARALLEL HARDENING; RETAIN OW CORP
The RBI like most other central banks had its hands tied by the Fed. Except here, India’s central bank would likely be a happy camper as the scope for providing real yields here would not be as tough a challenge as with other nations seeing extremely over-heated economies. There was a slight hope trade that India would get included in FTSE and JPM global debt indices but certain issues on taxation has kept India yet out of both indices. Overall, some flattening of India’s yield curve has happened
– no doubt this would raise concerns of recession, should it invert. However, the 10-1 still has room left before turning negative. Further, India’s macro does not seem to be too much in a spot of bother. GST collections have been encouraging which has led the government to marginally cut the gross borrowings for FY23 by ~Rs. 10,000 Cr. And this, per the Finance Ministry, should not dent the Fiscal Deficit target of 6.4% for FY23.
Net-net, a general hardening of level of the yield curve can be expected as both, monetary tightening and spiking inflation expectations per RBI household surveys should play their parts in keeping short and long ends respectively elevated. Consequently, we maintain our neutral position in terms of duration as some form of a likely parallel upwards shift could be seen in India’s yield curve. Sectoral preference within Fixed Income remains unchanged (i.e. OW Corporate Bonds / Funds).
India GST collections
Source: RBI, Bloomberg
CURRENCY: INR ONE OF THE FEW TO WEATHER THE USD STORM
The INR has held its stead fantastically against a host of currencies. The REER is trading at a 10% overvaluation vs. fair level (of 100) which can be justified given the relatively strong fundamental macro position of India vs. ROW. The greenback has been almost scaling new highs (looking at last 20 years) and the Fed will no doubt be mindful of any further strengthening thanks to its rate hikes. However, the Fed pivot should likely not be any time soon and some further upside in the USD could be possible as market participants flock to earn the carry yield on a fairly safe-haven currency. We turn OW on the USD vs. our prior UW stance – risks to the call could be larger than anticipated cuts by OPEC/OPEC+ which spurs up Oil prices that could lead to a softening of the USD (since USD and oil are generally inversely related).
CYTD performance of INR heartening vs. other currencies
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 September 31, 2022.
Glossary: PMI: Purchasing Managers’ Index, US: United States, GDP: Gross Domestic Product, QOQ: Quarter on Quarter, CY: Calendar Year, FOMO: Fear of Missing out, MSCI: Morgan Stanley Capital International, EM: Emerging Markets, PE: Price to Earnings Ratio, EPS: Earnings per Share, OW: Overweight, UW: Underweight, IG: Investment Grade, HY: High Yield, BPS: Basis Points, ECB: European Central Bank, BOE: Bank of England, UK: United Kingdom, DXY: Dollar Index, IMF: International Monetary Fund, GDP: Gross Domestic Product, FY: Fiscal Year, INR: Indian Rupee, BSNL: Bharat Sanchar Nigam Limited, GST: Goods and Services Tax, YOY: Year on Year, PV: Passenger Vehicles, 2W: Two Wheelers, CV: Commercial Vehicles, IMD: India Meteorological Department, LPA: Long Period Average, BOFA: Bank of America, FMS: Fund Manager Survey, FII: Foreign Institutional Investors, MF: Mutual Funds, SIP: Systematic Investment Plan, VIX: Volatility Index, MOM: Month on Month, ST: Short Term, LT: Long Term, MPC: Monetary Policy Committee, RBI: Reserve Bank of India, CPI: Consumer Price Index, G-SEC: Government Securities, FX: Foreign Exchange
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