THE TOPPING PROCESS IS UNDERWAY IN INDIA

Takeaway: India’s stock market appears to be undergoing a topping process ahead of a likely deterioration in economic fundamentals.

SUMMARY BULLETS:

  • The introduction of these recent POLICY initiatives – which are indeed positive on the margin and supportive of positive headline risk that tend to drive inflows higher – do very little to correct India’s TREND and TAIL duration GROWTH concerns; nor do they adequately address rampant domestic INFLATION that the RBI has called out on multiple occasions.
  • In fact, as recently as today (ahead of their OCT 30 policy meeting), the RBI was out reminding investors that India has not come close to turning the corner on INFLATION.
  • All told, amid continued political infighting and ahead of another potential embarrassment for the Congress Party in state elections in Gujara and Himachal Pradesh, we see limited scope for further upside surprises to Indian POLICY from here.
  • With respect to the intermediate term, much of the good news has likely been priced in – potentially setting Indian equity investors up for demonstrable disappointment.

On SEP 20, we published a note titled, “IS IT TIME TO GET OUT OF INDIAN EQUITIES” which introduced our bearish fundamental bias on Indian equities w/ respect to the intermediate term. The key takeaways from the note were as follows:

  • We are now fundamentally bearish on Indian equities with respect to the intermediate-term TREND duration and view the current price setup in the SENSEX as asymmetrically stretched relative to India’s economic fundamentals.  
  • From a GROWTH and INFLATION perspective, India’s economic outlook looks quite poor when applying a forward-looking (3-6 months) analytical lens. Moreover, India’s POLICY outlook is rapidly deteriorating and we believe this risk is not being appropriately discounted by the market – no doubt a side-effect of the global yield chasing born out of QE3.
  • From a long-term perspective, we think the Indian economy represents a classic turnaround opportunity, as policymakers there have quite a few POLICY levers that they can pull that would be positive for sustainable organic economic GROWTH. In the interim, however, there will have to be some short-term economic pain as it relates to quashing structural INFLATIONary pressures and reigning in the fiscal deficit. Unfortunately for anyone currently buying what we view as a cyclical top in Indian equities, the India of today is not the “India of tomorrow” just yet.

As it stands today, we continue to think that India’s POLICY outlook is rapidly deteriorating and that investors allocating funds to Indian equities up here are doing so at the risk of getting long a cyclical top in the Indian stock market. The SENSEX, which had ripped +15% in more-or-less straight line from its late-MAY lows to SEP 20, has now stalled out (up +1.6% from our note) and is now broken on our immediate-term TRADE duration. We see downside risk to the TREND line roughly -3% lower; if that doesn’t hold, we could see a retest of the aforementioned MAY lows (a correction of -14.4% from current prices).

THE TOPPING PROCESS IS UNDERWAY IN INDIA - 1

As we signaled in our directionally-bullish JUN 4 note titled, “BACKING OFF OF INDIA – AT LEAST FOR NOW”, our call for SENSEX/INR-supportive inflows ahead of favorable POLICY adjustments did, in fact, come to fruition. In recent weeks, Prime Minister Monmohan Singh (w/ the aid of new Finance Minister Finance Minister Palaniappan Chidambaram) have overcome staunch political opposition and a critical coalition defection to deliver a handful of decent-sized economic reforms, including:

  • Lowering diesel subsidies by raising fuel prices;
  • Allowing overseas supermarket chains to open stores;
  • Easing investment restrictions in the electricity generation and broadcasting markets;
  • Allowing foreign airlines to own minority stakes in local carriers;
  • Lowering the withholding tax paid by Indian corporations that borrow funds in international debt capital markets; and
  • Introducing a fiscal plan to gradually reduce the budget deficit from an estimated 5.3% of GDP in FY13 to 3% by the fiscal year ending MAR ’17.

The introduction of these recent POLICY initiatives – which are indeed positive on the margin and supportive of positive headline risk that tend to drive inflows higher – do very little to correct India’s TREND and TAIL duration GROWTH concerns; nor do they adequately address rampant domestic INFLATION that the RBI has called out on multiple occasions. In fact, as recently as today (ahead of their OCT 30 policy meeting), the RBI was out reminding investors that India has not come close to turning the corner on INFLATION:

"Monetary policy needs to be cautious in the interim, focusing on inflation while using the available space to support growth to the degree it can. If threats from inflation and the deficits recede, that could yield space down the line for monetary policy to respond to growth concerns."

From our vantage point, “threats to the deficit” – on both the fiscal and current account front – have not receded nearly enough for the RBI to justify any further easing measures over the intermediate term. Furthermore, our predictive tracking algorithms suggest Indian economic growth will slow from the rate of change that is to be recorded in 3Q (released NOV 30) through 1Q13E. Inflation, as measured by the benchmark WPI series is also likely to accelerate over that time frame, effectively putting the RBI in a stagflationary box from a monetary policy perspective. That may also prove bearish for the INR on the margin if the RBI opts to continue monetizing sovereign debt and pumping incremental liquidity into the financial system via reverse repos.

THE TOPPING PROCESS IS UNDERWAY IN INDIA - INDIA

 

THE TOPPING PROCESS IS UNDERWAY IN INDIA - 3

All told, amid continued political infighting and ahead of another potential embarrassment for the Congress Party in state elections in Gujara and Himachal Pradesh, we see limited scope for further upside surprises to Indian POLICY from here. With respect to the intermediate term, much of the good news has likely been priced in – potentially setting Indian equity investors up for demonstrable disappointment. Singh’s coalition government, which has recently lost its governing mandate and now is reliant on smaller regional parties to push through further initiatives, potentially faces a vote of no-confidence over the intermediate term – an event that could lead to outright reversals of some of the recent positive POLICY events.

Darius Dale

Senior Analyst