Conclusion: Policies designed to inflate are particularly bearish for emerging market economies like India. While the short thesis may be changing, our outlook for Indian equities remains lower over the intermediate term.
Position: Short Indian equities (INP)
Late yesterday, Keith used strength in the iPath MSCI India ETN to re-short Indian equities in our Virtual Portfolio. Since JAN 9, been caught on the wrong side of one of the largest short-squeezes across Asian equity and currency markets in the YTD (SENSEX +10.9%; INR/USD +5.8%).
Since that initial position (partially a hedge against being naked long of Chinese equities), the fundamental outlook for the Indian economy has changed direction not once, but twice. Recall that in our 1/9 note titled “Awful Fundamentals: Our Updated Thoughts on Indian and Shorting INP Trade Update”, we thought Indian monetary and fiscal policy – particularly on a relative basis to its EM peers – would remain a headwind to India’s equity market multiple and fund flows.
Specifically, we thought that inflation would not slow substantially enough relative to policymakers’ expectations to warrant a major inflection point in monetary policy, which would, in turn exacerbate India’s already-woeful debt/deficit dynamics by allowing growth to slow further.
Inflation did, however, come in far, far more dovish (in DEC) than even our most aggressive downside scenario, which dramatically pulled-forward India’s scope for monetary easing, as evidenced by the RBI’s -50bps cut to the cash reserve ratio two days ago. The prospect of further easing has been quite positive for both India’s equity and fixed-income net foreign inflows, which is the largest factor supporting rupee strength in recent weeks (equities: +306.7% YoY in the YTD; fixed income: a record +$3.9B in DEC).
Looking forward, we can glean from recent data that our long-held view that policies designed to deflate the market value of the world’s reserve currency are implicitly policies to inflate assets priced in dollars – which certainly include energy and agricultural resources, the prices of which carry large weightings in EM inflation indices.
That’s negative for Indian (and other EM) growth, particularly if today’s trading pattern (dollar DOWN; commodities UP) develops into a sustained trend. Recall that this emerging Growth Slows as Inflation Accelerates theme was exactly the same thesis that had us make the contrarian call to get aggressively bearish on emerging markets (particularly India and Brazil) in 4Q10 and hold that conviction largely through 3Q11.
Quite ironically, as EM growth slowed throughout 2011, Chairman Bernanke repeatedly attributed the sudden and dramatic ascent of commodity prices largely to “rapid emerging market demand”.
While we aren’t sure what to make of that, we are sure that we aren’t afraid to pull out the ol’ bearish playbook if the quantitative signals tell us to. For now we’ll continue to manage the immediate-term risk of Big Government Intervention.