Category: Macro Posts

Keith writes a very interesting outlook at Ice Cap http://icecapassetmanagement.com/wp-content/uploads/2018/10/2018.10-IceCap-Global-Market-Outlook.pdf .

His strategy on various asset classes is as follows

Bonds

Still no changes. Keith finds it interesting that US High Yield has held steady (even I am surprised) Once the bond crisis escalates (yes it will but I still think we will see a last bond rally as market is heavily short bonds and US yield curve will invert) , this market is set‐up for a hard fall (higher yields). Some of their best investment ideas are on the short side within different fixed income markets.

Stocks Changes :They decreased their exposure to US markets . The current correction has turned their models negative . Further moves are likely – Ice Cap remain agnostic towards the asset class .

Currencies No changes . They remain structured to benefit from a strengthening  USD.As the crisis spreads from emerging markets to Europe and then elsewhere,it is creating a perfect environment for a very strong USD .

Commodities No changes .Kudos to them, they have been completely right on gold .As USD surge develops, They expect gold to have one final leg down .Then the  opportunity for significant upside exists. ( I believe possibly 1600 first then last fall to 980-1100 before breaking out to  new all time high)

Harris writes “The nine-year rally in the U.S. (and to some extent the global equity markets) has stretched valuations as ultra-cheap money has pushed investors into taking risks larger than what many money managers and retail investors would do “normal” circumstances. The long-term problem for investors is that Bernanke and Janet Yellen were terrified of market reactions whenever they desired to halt the massive QE programs and their beloved use of FORWARD GUIDANCE.”

When Bernanke in 2013 floated the idea for slowing asset purchases, the markets reacted with the infamous TAPER TANTRUM. Bond yields soared and equity valuations immediately dropped almost 10 percent. In response, the FED immediately walked back its plan to tapering its QE program. Because of Bernanke’s and Yellen’s fears about the market, the Fed helped inflate global assets via rapid debt expansion. What has compounded the problem is that the ECB and BOJ have both followed the Bernanke playbook.
The difference that Wall Street is failing to appreciate is that Powell is not an academic and wedded to economic models. Chairman Powell is an experienced market participant and respects the signaling mechanisms that MARKETS provide instead of theoretical probability-based models. Powell is certainly providing a different format to what the crowd had become accustomed to over the last nine years. It seems this group of governors doesn’t fear volatility nor rational asset prices.

Conclusion

Adjust your trading and investing based on a change in the previous accepted wisdom. If forward-looking profits can sustain current prices then the market is priced correctly but if rising interest costs and wages erode record profits the price-to-earnings ratio of the market will adjust, especially as liquidity is drained from the global financial markets. 

Shyam Sekhar writes….The last few weeks have left the NBFC growth story in India badly shaken
Last Published: Thu, Oct 04 2018. 09 30 AM IST

The sharp fall in financials could not have come at a more inopportune time. The indices were driven to new highs mainly by financials. Private banks, home finance , insurance, asset management companies, non-banking finance companies (NBFCs) and microfinance companies were heavily weighted in public portfolios. Consensus around them was near total. Public sentiment ruled high on financials and it looked like the party would last for a long time. Then, the tide turned suddenly, taking everyone by surprise.
To understand what caused this sudden reversal in sentiment, let us appreciate what catalysed the current boom. Firstly, everybody had forgotten the pain from past cycles suffered by leading banks and NBFCs after their unsecured personal loans books grew. This time, players who suffered in the last cycle waited out the aggressive personal loan book growth. They moved into newer avenues like vehicle loans for growth. The troubled public sector and private sector banks were busy dealing only with legacy loan issues from the previous boom. Aggressive players from the previous boom vacated the growth space in lending.
This space got taken over by newer NBFCs. Softening interest rates helped NBFCs grow their books aggressively. Liquidity was ample, raising easy money and finding borrowers was no problem. Scorching earnings growth took valuations to dizzy heights. NBFCs became the preferred growth stocks to individual and institutional investors alike. Even private banks started NBFCs to fuel lending growth as this model was easier to scale up fast. Briefly, it appeared everybody had hit the perfect business growth model. Markets factored in all future good news imputing absolute certainty to growth and financial performance. But the last few weeks have left that growth story badly shaken.

Lending and leverage are no strangers to each other. In fact, every economic boom makes them great bedfellows. They come together, combine, grow, expand, balloon and implode in every cycle. Then, the same sequence gets played over once again in the next economic cycle. Public memory is short. Elasticity is always underestimated early into every cycle, then re-evaluated mid-cycle before getting stretched as the cycle matures. Just as elasticity is stretched to the maximum, the very cycle gets busted.
Lending and leverage grow together in a very virtuous manner. One helps the other grow. And they return the favour continuously to each other. As cycles grow and economies expand, lending takes off in a big way opening the doors for more leverage. The availability of leverage grows lending even faster. Even raising equity becomes easy. The ability of lenders to borrow grows further. Then, lenders aggressively scout for borrowers. The cycle simply seems never ending; lenders only need to find the right people to borrow and the money to lend will be easy to find. Often, lenders almost over-simplify their models as if business were an excel sheet with endless, infinite possibilities. On paper, the whole arrangement looks forever sustainable. Investors start to believe lending is simple and easy. But, that belief doesn’t last too long. Companies tend to borrow the most and lend at the fastest rate exactly when they should be slowing both down.
Every virtuous cycle simply pours out money like a bottomless glass of cola. It looks like money will never stop pouring. Loans are given at a faster rate to more borrowers. Then, interest rates tend to go further down as inflation dips. More money becomes available to lenders who leverage fully and grow their loan books. Borrowers become spoilt for choice. Lenders swarm eligible borrowers even as people shop in retail stores. Everybody is happy as money floods markets. But floods have a pattern of their own. They give you a feeling of plenty before leaving you dry and desolate.

Liquidity can flood and dry up at will. The pace of flooding and drying up is never easy to control once momentum picks up. Often, investor confidence gets unexpectedly shaken. A sudden disruption can shake up all activity and be the last straw on the camel’s back. Everybody is caught off guard at the wrong moment. We are seldom prepared for such sudden financial shocks. Our behaviour in lending and borrowing is too well-set for us to swiftly adapt and change. Recent events only prove that.
Shyam Sekhar is chief ideator and founder, iThought

I believe that we are on the verge of regulatory action which will restrict the leverage for NBFC’s and HFC’s. This will not only restrict the lending capacity of these companies but will also restrict the overall credit growth in the financial system.

This can lead to medium term equity multiple derating of these companies but will also make them more safe for debt investors.

I always follow capital flows but it is better to have more information in the form of technical perspective

Below is the take on market from Neppolian,an excellent technician.

Nifty @ 10475 – update

Nifty has fallen by 1300 points from the top as it failed to sustain the channel breakout at 11300 for the second time.

However Nifty is getting oversold in the near term as it gets closer to its 20MMA at 10300 and 100WMA at 10100. The trendline support drawn from Feb 2016 bottom of 6825 is placed at 10200.

The internal breadth indicators are reaching historical oversold levels too as under:

% of Nifty50 stocks trading above:

20DMA = 6%
50DMA = 14%
200DMA = 32%
50>200DMA = 58%

The near term 20DMA and medium term 50DMA gauges are now trading at historical oversold levels which is likely to bring support to Nifty if it were to fall further. In our experience when breadth reaches such oversold levels markets bottom out within max of next 2-3% fall.

So we can expect a pullback rally to emerge sooner than later. Any portfolio course correction need to be done only in pullback rather than at current panic levels.

Trend Qualifications:

The long term bull trend, though intact, has certainly suffered a serious setback with two failure breakouts abv the channel once in Jan 18 and now in Sep 18.

Both Nifty and Bank Nifty are yet to print a lower top. In our sense the next pullback rally may probably facilitate a lower top at 11000-11200 in Nifty and 26000-26500 in Bank Nifty. Only post printing a lower top we can conclusively turn bearish.

Few other factors which could keep near term downside limited include a possibility of USD-INR staying under 74 and Nymex crude holding under 78 on a closing basis. Both are at important resistances.

Challenges in the near could come from the possible correction in US indices (signs are emerging in short term ) and raising 10 year yields.

Madan Writes……one area which has not really been discussed in detail is the currency market, which is probably the burning issue in the economy with the rupee falling quite prodigiously and few solutions on hand. Quite clearly the MPC has preferred to look at the inflation target exclusively and pay less attention to the currency market where an increase in rates could have stalled the decline in FPI flows which are negative presently. Therefore, it does appear that there may not be too much of intervention of the RBI in the currency market which will find its own level.

Two things could happen now…..Higher nominal GDP (inflation on a rising trajectory) along with steepening yield curve and falling currency.

 

https://thewire.in/banking/in-holding-rates-what-is-rbis-thinking-on-how-oil-prices-msp-hikes-will-impact-inflation

Brahma chellaney writes….The fact is that China has grown strong and rich by flouting international trade rules. But now its chickens are coming home to roost, with a growing number of countries imposing antidumping or punitive duties on Chinese goods. And as countries worry about China bending them to its will by luring them into debt traps, it is no longer smooth sailing for the BRI.

Beyond Trump’s tariffs, the European Union has filed a complaint with the World Trade Organization about China’s practices of forcing technology transfer as a condition of market access. China’s export subsidies and other trade-distorting practices are set to encounter greater international resistance. Under WTO rules, countries may impose tariffs on subsidized goods from overseas that harm domestic industries.

Now, Chinese President Xi Jinping finds himself not only defending the BRI, his signature foreign-policy initiative, but also confronting domestic criticism, however muted, for flaunting China’s global ambitions and thereby inviting a US-led international backlash. Xi has discarded one of former Chinese strongman Deng Xiaoping’s most famous dicta: “Hide your strength, bide your time.” Instead, Xi has chosen to pursue an unabashedly aggressive strategy that has many asking whether China is emerging as a new kind of imperialist power.

Read more

https://www.project-syndicate.org/commentary/backlash-against-china-trade-policy-debt-traps-by-brahma-chellaney-2018-09

Martin Armstrong writes an interesting summary of today’s market action….The FED was blamed for stopping yesterdays US rally in equities and has had a similar effect in Asia. Jerome Powell commented that they are a long way from neutral and that hit the long end of the Treasury curve. Now the market must decide whether rising rates are bullish or bearish for stock markets! Sounds easy, but really depends how you view markets and liquidity. The Hang Seng lost 1.8% on the day, but worse still was the SENSEX that was down 2.24%. Worse for India is that the INR continues to be hit, with record lows (74.15) seen again today. The Nikkei held in rather well, falling just -0.56% whilst the Yen traded down to mid 114’s.  They is a lot of talk that USD funding is being bid-up now that we are over the ‘Term’ (Year end). Talk is that Chinese banks are aggressive buyers of dollars  for reasonable size.

Currency could well be the key to watch Q4 developments.
Europe opened to weak global equities and a declining currency. The Euro had already breached 1.15 and was trading heavy even before peripheral debt started to trade. However, as the day wore on so we saw the currency bounce, as did Sterling but well off of the days highs. Both the CAC and UK’s FTSE closed off around -1.3% whilst the DAX lost just -0.35%. The DAX did post a positive few hours in afternoon trading, but couldn’t hold on and fell at the close. Worth keeping an eye on the Turkish BIST 100 as it fell 2.77% today, with the Lira also down 2%, but probably more worrying was that 10yr Bond fell (price) 108bp! Fixed-Income also lost ground rather than saw a flight to quality on concerns of inflation, but also Italian headlines yet again.
US futures were heavy before cash opened, so a 200 point decline really was no surprise. The NASDAQ led much of today declines and even closed down -1.8%. The Russell 2k ( small cap) fell with volume. All indices climbed off of their days lows, but even the core DOW and S+P closed down -0.8%.  The market has been shaken by the rapid rise in Treasury yields and are still balancing the question of why is this negative for stocks! The global capital flow has been towards the USA for a while now and rising rates will only accelerate that demand. This is going to be interesting battle to watch and will probably be very volatile too!

Below is my june interview to wealthforum zine http://www.wealthforumtv.com/FundTalkBNPParibas.html#.W7YZQPZFzD4

before I left BNP Paribas. The whole purpose of interview is to just explain the interplay between various asset classes and what lies ahead……..in nutshell “Picture abhi Baki hai mere Dost”

Full interview below

Ritesh Jain
CIO
BNP Paribas Mutual Fund

Ritesh – widely regarded as a macro expert – is worried about signals emanating from outside as well as within the country. Rising oil prices and sticky core inflation could lead India towards stagflation.
By this stage of the cycle, corporate capex should have picked – which hasn’t happened, and Govt spending should be reducing – which is not: the question therefore is whether we are in day 3 or perhaps already in day 5 of this test match (market cycle)
With a fundamental shift in US policies, countries dependent on global trade or dollar funding can run into serious trouble.
Simultaneous rise in US dollar, US bond yields and US equity markets will spell significant trouble for many economies and markets – and we are already seeing signs of all three asset classes rising in unison.
WF: It looks like the stage is being set up for the perfect storm! Looking internationally first, how do you read the situation in the EU, the US decision to commence a trade war with the rest of the world and the rise of US treasury yields beyond 3%? What implications does this have on global markets in general and Indian markets in particular?
Ritesh: Trade and tariff barriers are never good for markets. Having said that, I believe Europe and China would bear the brunt of this battle, not so much the US. The European situation is particularly precarious because, in spite of all ECB support, the European economy is still very weak with almost flat bank lending. When Greece was in trouble, it could be bailed out because of the small size of its economy but Italy is a behemoth because of its size and its high debt/GDP. It was actually ridiculous that Italy bond yields traded lower than US bond yields simply because of ECB bond buying. Markets don’t like uncertainty and concerns over Italy and Deutsche Bank is reflecting on European equity markets. Another worry for markets could be rise in the US bond yields which make them attractive in comparison to the rest of the world. For any reason (due to FED quantitative tapering, rise of FED rates or widening US fiscal deficit), if the US 10 year bond yields sustainably breaks out above 3% then capital from the rest of the world can shift back to the US and would lead to disproportionate rise in Emerging Market bond yields including India. I am not much concerned about the impact of trade war on Indian equity markets simply because India is largely a domestic oriented market. What I am worried about is rising crude prices and sticky core inflation; because at some point in time it will lead to stagflation in India which will negatively affect corporate profitability and equity markets.
WF: Indian macros seem to be deteriorating even as some fund managers prefer to focus on the micros of stocks they own. How do you read the Indian macro situation and how do you see this impacting Indian debt and equity markets going forward?
Ritesh: Oh yes no doubt, the culprit is rising oil prices and very low agricultural commodity prices along with rising government spending and lower corporate capex. Rising global oil prices, if passed on as it is now, is the best thing for Indian macros because it shifts the burden from the government deficit to the consumer leading to lower demand for crude without compromising on government finances. So watch out for any compromise of sharing burden with PSU which will be negative for markets. Lower agricultural prices will actually be inflationary because the government has already committed to a safety net and that entails higher outlay. At this stage in the economic cycle, the corporate capex should have started rising and the government spending should have come down but I don’t see this happening so I will be keeping a tab on this over the next few months to determine whether we are on the third day of five day cricket match or fifth day.
WF: Does the 9 year old global equity bull market appear fragile now? Are we now close to the end of this cycle or does the bull market still have some more way to go? What signs would denote topping out of this cycle?
Ritesh: I can see the cycle topping for almost all major economies except US simply because the US small caps (Russell 2000 Index) has broken out to a new high and this supports my theory that capital is moving back to the US. This also means that the periphery economies (economies with deteriorating macros) are very vulnerable to any shift in capital flows. I am not getting into the fundamentals but simply dipping into the capital flow model. The US has shared its GDP with the rest of the world since the last 30 odd years of petrodollar system and now with them being energy independent and a big exporter of oil they don’t see the need to carry the burden of the world. Hence they are withdrawing from the world and are going to take back their capital so the economies which are dependent on global trade or dollar funding to run their economies are in deep trouble. The final sign for me would be when all the three asset classes in unison will be rising, the US dollar, US bond yields and US equity markets and we are already seeing some initial signs of it.
WF: What is your strategy now in the fixed income space – on duration funds as well as accrual based funds?
Ritesh: We are not into accrual space but I think we will see spreads widening for lower rated corporate bonds as liquidity tightens. Indian G-Sec yield curve shouldn’t be this flat in this kind of nominal GDP so instead of duration we prefer liquid government bonds more from a tactical purpose rather than owning for long term because I believe rates are headed higher this calendar year.
WF: Where do you see the best opportunities in Indian fixed income now and what product categories appear the best bets now?
Ritesh: The ideal opportunity is in short term bond/ FMP/Roll down types of product. Investment in accrual should be on hold till the time the spread widens further. Instead of accrual an investor may look for retail bond issues which have started giving more attractive yields.

Emkay writes in a strategy report…Tightening global liquidity, rising rates, and weakening INR are coalescing into an
equity market correction, and is now challenging the perceived Teflon coating of local participation which have consistently challenged since mid-2017. We believe that our reflationary recovery thesis has peaked out due to emerging global and domestic headwinds. While our base case for the stands at 10400-11000, increased
volatility can potentially trigger a pessimistic scenario of sub-10000 levels. Even after the 19% decline in the mid-cap index, the trailing PE of 35x is still a 50% premium to the benchmark indices. The risk is that it can go back to an average discount of 12-15%, instead of a premium, as it existed prior to May’14.

The INR/USD decline until now still partial; maintain near-term target of Rs75, but Rs80 is possible if strong USD sustain 

Despite recent measures tightening liquidity conditions to intensify further; maintain 10 year Gsec at 8.4%:* a) we believe that carving out of SLR by 300bp for meeting LCR is irrelevant; banks are holding large excess SLR, b) Indicative OMO target of Rs 360bn in Oct’8 adds up to Rs 400bn already done. Our earlier estimate for FY19 was Rs 2tn; so more will be required. C) GoI has reduced the H2FY19 market borrowing target by Rs 700bn. We think it will be replaced by other forms of borrowing, Fiscal deficit remains unchanged with a high possibility of slippage.

Tapering domestic and global liquidity are risks to market multiples amid potential earnings downgrades:We believe that our reflationary recovery thesis has peaked out due to emerging global and domestic headwinds. Q1FY19 results look statistically robust, but they cannot be extrapolated for the full year. In our view, core earnings growth trajectory is ~10%, with a downside risk. Consensus earnings estimates for Nifty have undergone downgrade for FY19, and yet the expected growth stands at 25%, which is considerably optimistic. We expect earnings downgrades to continue.

Tightening liquidity to adversely affect valuations: We see a tapering of liquidity emanating from both portfolio flows of FII and mutual funds. In our assessment, the market is still fairly overvalued, and we maintain that the
capitulation in the broader market is still sometime away despite the recent sharp correction in the mid-small cap space. The 6.3% decline in the Nifty from the recent all-time peak is a fairly shallow correction.

While our base case for the Nifty stands at 10400-11000 for the next 12 months vs.the current 11000 levels, increased volatility can potentially trigger a pessimistic scenario of sub 10000 levels.

Sector impact-Margin pressure to emerge, prefer sectors gaining from weak INR & lenders with strong ALM* (pg 14-26): We assess the possible impact on various sectors from 1) rising commodity prices, including global crude oil; 2) currency depreciation; and 3) rising interest rates. Overall, within the risk-to-valuation outlook we anticipate, better positioned sectors are those that have visible exports or global revenue potential (Pharma, IT, and select Auto and Capital Goods companies). The sectors with natural hedge against INR depreciation such as metals also enjoy domestic trade policy support. Most other sectors will likely have an adverse impact of rising operating costs; consumers, autos, cement, agro chemicals are particularly susceptible. Rising interest rates are a risk for rate-sensitive sectors such as capital goods, BFSI, and infrastructure. We like banks and lenders with robust growth capital and solid asset-liability management outlook .

Full report Below

http://research.emkayglobal.com/ResearchDownload.aspx?Pid=WAhUVvIWw6c%3d&Cid=Vf2Bhqab77w%3d&fName=YIP155GNl2Wq7zXjc%2f8ARUH9d%2byH%2fQpjlU1iWgP%2btAHUEoIhobB3RtkjsfIIK7D0obCRaYjbAc8%3d&typ=APSSeVhmQ%2b8%3d