Conclusion: Our-once long list of fundamental concerns appears to be priced in from a quantitative perspective and the go-forward outlook augers well for mean-reversion to the upside over the intermediate-term TREND.
Position: Long Indian Equities (INP).
Earlier this morning, we added a long position in Indian equities to our Virtual Portfolio. After having been the bears on this market since early November ’10, we have been explicitly warming up to India (and other bombed-out emerging markets) of late.
As we wrote in our 6/24 piece titled, “Emerging vs. Developed Markets: Aggressively Framing Up the Debate”, our Deflating the Inflation thesis is explicitly bullish for equity markets like India which have underperformed due to their central bankers hiking rates to quash inflationary pressures. Though the US Dollar Index is flirting with a TREND line breakdown, it appears to be registering a higher-low on an intermediate-term basis. Further, the CRB Index remains broken from a TREND perspective – alongside a variety of other key commodities including crude oil. It appears that neither Obama nor Boehner can help extend the Inflation Trade indefinitely.
Turning back to India specifically, we like what we saw out of the Reserve Bank of India overnight, hiking their benchmark interest rates +50bps to 8% (repo) and 7% (reverse repo). This marks their 11thrate hike since last March and takes India to being as close to positive from a real interest rate perspective since 4Q09. On the margin, this hawkishness should continue to perpetuate lower-highs in Indian credit and money supply growth over the intermediate-term TREND.
This is bearish for Indian growth on the margin and we remain 70-100bps below the Street on India’s real GDP growth in 2H11. That said however, this certainly isn’t new news (the SENSEX Index is down -10% YTD; -14% since we turned bearish) and our quantitative models continue to suggest that this is nearly priced in. Additionally, our models point to a bottoming of Indian economic growth in 3Q and an eventual rebound in 4Q11. Recall that Indian GDP growth has been decelerating since 2Q10, so this inflection in growth may prove rather bullish for Indian equities over the intermediate-term TREND.
When we last published on India, we had four major concerns which we would’ve liked to see addressed prior to going long this market. They are as follows:
- Accelerating inflation driven by rising domestic crop and energy prices;
- A highly likely miss in the government’s deficit reduction target;
- A capitulation by consensus on Indian economic growth; and
- A near-term winding down of the Sovereign Debt Dichotomy.
With the borderline exception of issue #4, we’ve seen some bullish developments in these regards.
First, both the RBI and Finance Minister Pranab Mukherjee have publicly acknowledged that recent food (rice, soybeans, and peanuts) and energy price (diesel, kerosene, and cooking gas) hikes will take some time to filter through the economy and could provide incremental upward pressure to India’s WPI reading. Additionally, a revision to the base year of the WPI calculation caused June’s +8.7% YoY reading to be revised up to +9.4%. Both give us confidence in our model’s forecasts that inflation in India will not be in the area code of the RBI’s +6% target by March ’12. Still, we do expect it to peak in August and see limited scope for additional rate increases over the intermediate-term TREND and long-term TAIL.
The interest rate swaps market agrees with our longer-term view that the magnitude of interest rate hikes in India has more than likely peaked, with the reverse repo yield above historic averages and the repo yield a mere 100bps away from its 2008 high. We suspect it will also conform to our shorter-term view as Deflating the Inflation continues to play out across certain key segments of commodity complex.
Secondly, our once-contrarian view that the Indian government will miss its deficit reduction target and cause interest rates to incrementally back up is becoming more and more consensus. Recall that in a 2/28 research note titled, “India: Missing Where It Matters Most”, we aggressively ripped apart the assumptions embedded in Mukherjee’s FY12 budget and suggested that India was likely to miss the target by a considerable margin as a result of lower than expected growth (less tax receipts) and higher than expected commodity prices (more subsidy expenditures). Now, as recently as a couple of weeks ago, even the prime minister’s chief economic adviser C. Rangarajan admitted that the target of 4.6% of GDP is “difficult to achieve.” Another top economic planning official, R. Goplan, recently launched a public defense of the target and associated borrowing requirements. We view this as the first step toward official capitulation and recent lower-lows across India’s sovereign yield curve support our view that the market has already come to this realization.
Thirdly, we recently received an important data point regarding how consensus views Indian economic growth. Earlier this week, Fitch revised down their estimate for India’s FY12 real GDP growth to +7.7% vs. a prior forecast of +8.3%. We’ve been vocal about our bearish bias on both the timing and accuracy of ratings agency and sell-side economic forecasts, and we welcome Fitch’s capitulation as a sign that growth in India is indeed bottoming from an intermediate-term perspective. We expect further capitation from sell-side forecasts in the coming weeks, as economists scramble to adjust their Keynesian models to account for today’s +50bps rate hike – a move that was correctly predicted by none of the 22 Bloomberg survey participants.
Lastly, we continue to remain bearish on the EU’s sovereign debt woes and continue to strongly believe that we are in the earlier stages of a 3-5 year sovereign debt default cycle. Understanding the research behind this backdrop grants us the conviction needed to manage the headline risk associated with Europe’s current and pending issues on both sides of the trade. Given, we are likely to remain Risk Rangers in Indian equities with a bullish bias over the intermediate-term TREND.