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Takeaway: If you have to remain invested in the EM space, we like Brazilian and Indian consumer exposure on the long side from here (TREND duration).

SUMMARY BULLETS:

  • Consistent with our #StrongDollar/commodity deflation theme as reiterated throughout the past six months, we want to be consistently taking up our exposure to consumption-oriented names and sectors in lieu of those names and sectors that require commodity inflation to drive revenue and earnings growth. With respect the emerging market space, this call was most recently reiterated on our EME Crises Black Book & Conference Call (i.e. long consumption oriented countries and currencies vs. short commodity producing countries and currencies).
  • In line with this view, we like Brazilian and Indian consumer exposure on the long side from here (TREND duration), as the fundamental research signals confirm. This is a good relative play for those analysts and PMs that must maintain a healthy allocation to emerging markets (we're bearish on them, broadly speaking).
  • Regarding Brazil specifically, Brazil is a 81% consumption-based economy (household = 60.3%; government = 20.7%), so negative commodity beta is a positive factor for GDP growth and equity market sentiment/valuations – as it was during late 2008, when Brazil bottomed ahead of most other major equity markets and economies. Flipping over to India, #StrongDollar commodity deflation is supremely positive, at the margins, for the country’s inflation, balance of payments and fiscal policy dynamics – three factors that have weighed on Indian GDP growth and equity market sentiment/valuations in recent years.

BUY BRAZILIAN CONSUMPTION (etf: BRAQ)

Brazilian swap rates are reversing their hawkish trend amid recent confirmation that inflation may finally be headed in the right direction after last month’s +25bps SELIC rate hike and inclusive of the BRL’s +2.1% YTD gain vs. the USD. 1Y OIS are pricing at 54bps above the benchmark SELIC rate, a spread that has tightened -13bps MoM after widening +51bps over the past three.

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Regarding the aforementioned inflation confirmation, on Monday the Getulio Vargas Foundation reported that its IGP-M index of wholesale, construction and consumer prices – which has historically led the benchmark IPCA index by two to six months – rose +7.3% YoY in APR after climbing +8.1% YoY in MAR. Regarding the recent moves in the swaps market, it’s clear investors are now pricing in a more dovish outlook for Brazilian monetary policy, on the margin, than they had been as recently as a few weeks ago. Again, everything that matters in macro occurs on the margin.

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As we have outlined in our 1/13 note titled: “WILL BRAZIL HOLD THE LINE?”, Brazil is a particularly interesting economy with respect to global inflation/deflation cycles. On one hand, the predominance of Brazilian industrial production and equity exposure (44.3%) is in the Energy and Basic Materials sectors (Bovespa Index). On the other hand, Brazil is a 81% consumption-based economy (household = 60.3%; government = 20.7%), so negative commodity beta is a positive factor for GDP growth and equity market sentiment/valuations – as it was during late 2008, when Brazil bottomed ahead of most other major equity markets and economies.

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All told, we want to be increasing our allocation to Brazilian consumer stocks here in anticipation of further upside over the intermediate term.

BUY INDIAN CONSUMPTION (etf: INCO)

The SENSEX was up over one full percent today on rate-cut speculation.  According to 33 of 40 economists in a Bloomberg survey, the RBI will lower its repurchase rate to 7.25% from 7.5% in tomorrow’s monetary policy announcement; six see no change and one predicts a cut to 7%. Consensus has indeed finally come our way on RBI rate cut expectations and we’re seeing that reflected in the swaps market: 1Y OIS are pricing at 31bps below the RBI’s benchmark REPO rate, a spread that has narrowed -27bps MoM.

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#StrongDollar commodity deflation continues to auger positively for India’s inflation (at a 40-month low of 6% YoY as of MAR), balance of payments (imports of gold account for ~80% of current account deficit and India imports ~80% of its crude oil consumption) and fiscal policy (subsidies are budgeted at ~14% of total FY14 expenditures) dynamics – as outlined in greater detail in our 3/19 note titled: “BUY INDIA ON WEAKNESS?”.

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Also positive for the INR was the recent reduction in the foreign investor withholding tax on rupee-denominated debt (from 20% to 5%); that should accelerate private capital inflows into the Indian economy – something the country desperately needs in order to prevent the Finance Ministry’s bloated FY14 borrowing plan from crowding out much-needed domestic investment. Needless to say, any marginal strength in the rupee (+80bps MoM) is only additive to the aforementioned dynamics.

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All told, we want to be increasing our allocation to Indian consumer stocks here in anticipation of further upside over the intermediate term.

Darius Dale

Senior Analyst