Less Bearish on India

Conclusion: India is flirting with a bullish TREND breakout and, should prices confirm, this is an explicit sign that our nearly eight month-old call for economic stagflation in India has been fully priced into Indian stocks.

 

On June 7, we published a note titled, “Still Bearish on India”, the conclusion of which was:

 

Our call that Growth Slows as Inflation Accelerates continues to play out in spades and we see more stagflation in India’s intermediate-term future.

 

From the day of that report, India’s benchmark SENSEX Index exhibited a peak-to-trough decline of -5.3% (June 20). It has since rallied +6.8% (largely due to declining crude prices and marginally dovish comments out of the central bank) and, for the second day in a row, it closed above our intermediate-term TREND line of 18,467. While two days of positive TREND is hardly a trend in and of itself, it is still highly noteworthy on the margin. Further confirmation of this bullish breakout in Indian equities is an explicit sign that our nearly eight month-old call for economic stagflation has been fully priced into Indian stocks.

 

Less Bearish on India - 1

 

As we wrote in a research report on Friday afternoon titled, “Emerging vs. Developed Markets: Aggressively Framing Up the Debate”, our contrarian Deflating the Inflation thesis bodes well for strength in bombed-out equity markets across the EM universe (please email us for a copy of the full analysis). Recall that at one point in the current cycle, India was the worst performing equity market in the entire world (-16.9% from November 5th to February 10th).

 

India is the poster child for a market that could do well in 2H as deflating prices across the commodity complex reduce upward pressure on WPI readings. To be clear, however, we’re not necessary comfortable with getting long right here and now, as there are some key issues that we are monitoring which we’d like additional color on: 

  • The Federal Government raised the prices it pays farmers for raw rice, soybeans, and peanuts in a range of +8% to +17.4% to all-time highs and those increases are expected to impact food inflation readings around October when the new crops come to market;
  • India is continues to rely on pollyannaish assumptions around subsidies, growth, and state asset sales to meet its current year fiscal deficit reduction goal. We’ve been bearish on their ability to hit the target since the day the budget was unveiled and nothing has changed on that front (bearish for the Indian rupee; bearish for Indian sovereign debt). Notably, Finance Minister Pranab Mukherjee came out overnight and “affirmed” his full-year growth assumption of +8.5% YoY. In actuality, this was a -75bps haircut (recall that the growth projection released alongside the budget was +9.25% YoY);
  • We’re not sure if consensus is bearish enough on Indian growth yet. It’s pretty clear from our daily analysis of sell-side and buy-side commentary that our Accelerating Inflation call (and the accompanying monetary tightening) is well understood. While the Slowing Growth component of our economic stagflation thesis has been getting priced into India’s currency and its credit market to a large extent over the last 2-3 months, we’d like to see consensus GDP forecasts come down a bit from current projections that range about +70-100bps above our model’s most bullish scenarios for India’s real GDP growth (2Q11-4Q11). This morning’s data supports our contrarian view on Indian growth as the number of stalled projects and the number of new projects in the corporate sector grew and fell +18.1% YoY and -9.3% YoY, respectively; and
  • As our long-term Sovereign Debt Dichotomy thesis continues to play out in Europe, it will be interesting to see if the market starts to look toward other PIIGS as Greece’s short-term fiscal woes are resolved with the “elixir” of more debt. Heightened global risk aversion is always a risk for the SENSEX due to India’s lax capital controls that encourage foreign investor participation. In the YTD, foreign investors have purchased a net +$322.3M worth of Indian stocks. In February, the net amount was closer to -$2.2B, which suggests that there is enough volatility for the current positive trend to reverse course in a meaningful way. 

Less Bearish on India - 2

 

Less Bearish on India - 3

 

Less Bearish on India - 4

 

Net-net, the likelihood that the YTD bottom in Indian equities is in the rear-view mirror is a growing possibility that needs to risk managed. And taking a cue from our quant model, at the bare minimum, India is no longer a key short idea. Analyzing India at this critical juncture lends us a great opportunity to highlight a bit of our process as it relates to putting on and taking off exposures. Essentially there are three buckets a company, country, security, currency or asset can be in: 

  • Long Idea: Positive fundamentals supported by a bullish quantitative setup;
  • Short Idea: Negative fundamentals supported by a bearish quantitative setup; and
  • Neutral: This is the “do nothing” bucket whereby fundamentals and quantitative signals do not confirm one another. One of the key skills a risk manager must possess is the ability to know when to move his or her favorite long or short ideas into the neutral bucket – a troubling task for anyone that tends to get married to their theses. 

As we say repeatedly, an investor can be bullish, bearish, or not enough/too much of either. To that point, we don’t want to risk being too bearish on India as prices signal to us our bearish thesis is largely priced in. For now, we are comfortable moving India from the “Short Idea” bucket into the “Neutral” bucket.

 

Darius Dale

Analyst


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