- As the facts change, we do. An increasingly convoluted policy mix complicates Brazil’s intermediate-term GIP outlook. As such, we are content to book the gain and may look to potentially revisit the country on the long side as campaigning heats up into the OCT general elections.
- Taiwan has been a country we sort of missed not pounding the table on in the YTD (on the long side), but we now anticipate meaningful upside from current levels. For intermediate-term investors, GIP fundamentals support chasing Taiwanese equities up here – particularly amid heightened prospects for M&A activity in the global semiconductor space.
- Unnecessarily fearing a volatile market response, we were wrong to have booked the gain in India just ahead of the final election tally. That being said, we are now content to look through likely near-term economic softness (i.e. the “G” in our GIP model) with the intention of playing for likely structural improvement in India’s inflation and policy dynamics (i.e. the “I” and the “P” in our GIP model).
STEP ONE: SELL BRAZIL
Since our bullish conference call titled, “TIME TO BUY BRAZIL?” (2/27) the following has occurred in Brazilian capital and currency markets:
- The BRL posted a total return of +4.7% vs. the USD, which compares to a sample mean of +2.7% of and is good for the 6th largest gain amongst the 24 EM currencies tracked by Bloomberg over that timeframe.
- The iShares MSCI Brazil ETF (EWZ) has appreciated +11.2%, which compares to a sample mean of +6.5% and is good for the 5th largest gain over that timeframe across the 24 country-level EM ETFs we track.
- Petrobras (PBR) – our preferred single-name exposure in the Bovespa Index (refer to slides 57-71 of the aforementioned slide deck) – has appreciated +21.4%. That more than doubles the +10.6% gain for the Bloomberg Industries Global Integrated Oils Index, for which Petrobras is a constituent.
While that’s obviously a fair degree of global macro alpha, we aren’t simply content to relinquish our research view simply because the trade has worked well. Rather, we see a confluence of deteriorating GIP fundamentals supporting an exodus of investors from Brazilian capital and currency markets.
Brazilian growth data is flat-out awful; as you can see in the table below, there is a hardly a meaningful economic indicator in Brazil that isn’t rapidly decelerating on both a sequential and trending basis. That this is coming amid accelerating headline inflation means Brazilian policymakers are now forced to choose between promoting growth or combating inflation – the latter of which we still view as the country’s key political issue.
Unfortunately for investors, the Rousseff administration is resorting to the tired Keynesian playbook of fiscal stimulus ahead of the election, choosing ramp up deficit spending ahead of what is likely to be Brazil’s most contested presidential race since 1989. Recent policy initiatives include:
- A +4.5% increase in income tax exemptions starting next year;
- A +10% increase in Bolsa Familia cash transfers starting next year worth R$9B… this latest increase takes Bolsa Familia transfers – which benefit ~25% of the Brazilian population – up +64% in real term since the Rouseff administration took office on JAN 1st, 2011; and
- Extending a $9.7B payroll tax cut for various manufacturing industries.
These promises of fiscal sweetness come amid heighted pressure to raise the minimum wage, which has increased +42.2% in real terms since 2007. Both Rousseff and her runner-up in the latest polls, Aecio Neves, are on board with another hike.
The problem with hiking the minimum wage now is that many government salaries and pension benefits are indexed to the federal minimum wage in Brazil. In fact, roughly 80% of all federal expenditures are earmarked by law. That is obviously not helpful for a government that has promised investors fiscal retrenchment in 2014. The 1.9% primary surplus target appears to be in danger and the nominal budget balance – which is what really matters to the currency – remains bloated at -3.1% of GDP.
While Rousseff continues to get tagged in the latest polls (37% support as of MAY 7-8), we view the recent retreat from promises of fiscal austerity and monetary policy tightness out of the Neves camp (20% support as of MAY 7-8) limits pressure upon the Rousseff administration to tighten policy heading into the election.
Eduardo Campos (11% support as of MAY 7-8) is a fiscal and monetary hawk and we would view any ascent by him to 2nd place in the polls as positive for our original long idea. That remains to be seen at the current juncture, however. As such, we are now content to take down our intermediate-term growth estimates and take up our intermediate-term inflation estimates for Brazil.
All told, it appears increasingly likely that the Brazilian government is choosing stimulus over prudence at the current juncture and we think international capital allocators have begun to sniff this out.
Specifically, the BRL, Bovespa and Petrobras have all recently broken their respective immediate-term TRADE lines of support and are now flirting with TREND line breakdowns on our proprietary three-factor quant model. The latter two are in the process of confirming lower-highs from technical perspective as well. We don’t recommend buying either signal, as both tend to be leading indicators for further downside.
STEP TWO: BUY TAIWAN
Let’s assume you’ve just booked your Brazil allocation for a nice profit and have some capital to put to work. You’re likely well aware of how we feel about chasing the domestic growth style factor up here in the US equity market, so naturally we are looking abroad for our preferred allocation. Taiwan passes our fundamental and quantitative screens and looks like an interesting play on the long side of global equities from current levels.
Up +5.9%, Taiwan’s benchmark TAIEX Index is on a slow-and-steady march higher in the YTD. While being up +590bps might not seem like that much, that compares to a sample mean of +4.7% across the 21 equity markets we track across Asia & Latin America and is besting the +4.4% YTD gain for the S&P 500.
While it’s hard to argue in favor of the predictability of YTD gains, Taiwan does have idiosyncratic country risk factors that support allocating capital to this market at the current juncture. Specifically, improving GIP fundamentals support chasing Taiwanese equities up here – particularly amid heightened prospects for M&A activity in the global semiconductor space. It’s worth noting that the Tech sector accounts for a whopping 46% of TAIEX market cap, with semiconductors alone accounting for 23%.
Contrary to Brazil, it’s particularly difficult to find a meaningful economic indicator in Taiwan that isn’t accelerating on both a sequential and trending basis. While headline inflation is indeed accelerating, it’s accelerating off of extremely low levels and does not warrant any attention from the central bank – especially with WPI trends being so subdued.
Both the sequential momentum and base effects embedded in our predictive tracking algorithm support our above-the-Street forecast for Taiwanese real GDP growth in 2014 and we see it accelerating through at least the third quarter.
Annualized currency weakness supports a marginally hawkish CPI outlook as we progress through the year, but as previously mentioned, this catalyst is unlikely to result in monetary tightening over the intermediate term. READ: the coast is clear for Taiwanese exporters.
Not surprisingly, the benchmark Taiwan TAIEX Index has registered a +0.83 correlation with the MSCI World Semiconductors GICS Level 3 Index in the YTD, which is up a bit from the +0.80 correlation registered over the trailing 3Y. Indeed, it would seem that getting the semis cycle right is really all investors need to have a handle on to get market beta right for Taiwanese equities.
For those of you who are not yet aware, we’ve recently hired a Global Semiconductors analyst to co-head our Information Technology vertical at Hedgeye. While it would not be compliant nor appropriate for us to discuss his incubating ideas and themes at length in this note, office chatter supports our existing view that #InflationAccelerating will continue to perpetuate a robust M&A cycle across many industries globally – including semiconductors.
Needless to say, semiconductors is in fact an industry with far too many public companies and is ripe for M&A activity over the intermediate term. Perhaps that’s why both the semiconductor stocks and the iShares MSCI Taiwan ETF (EWT) continue to make new highs. Moreover, semiconductors aren’t levered to slowing US consumer demand, as the US accounts for only 20-25% of all consumer electronic consumption globally.
Another style factor we have and continue to support across global capital markets in the YTD is a reach for yield – i.e. allocating capital to long-duration fixed income and bond-like equities. As the chart below highlights, Taiwan is outclassing many of its EM peers with respect to its highly attractive real yields.
All told, if you’re looking for places to put money to work in global equities, then we are firmly in support of any decision to allocate capital to Taiwan on the long side.
STEP THREE: BUY BACK INDIA
In our 5/12 note titled, “BOOKING RESEARCH ALPHA IN INDIA”, we advocated for booking gains in what we are now dubbing the “Modi Trade” across Indian capital and currency markets. At the time, it seemed like a good call in the context of the research alpha we generated and the likelihood that much of the good news was priced in – seemingly only leaving room for election-day disappointment. From that note:
- “Indian capital and currency markets have performed quite remarkably since we outlined our bullish thesis back on OCT 29th of last year.”
- “Specifically, the EPI etf has appreciated +21.6% since then, which compares to a sample mean of -1.4% across the 24 country-level EM etfs we track and good for the second-best performance over this duration.”
- “Moreover, the INR has appreciated +3.2% vs. the USD since then, which compares to a sample mean of -2.4% across the 21 currencies we track across Asia and Latin America and good for the third-best performance over this duration.”
- “Going back to the EPI etf, this fund has ripped +19.2% in the last ~3M alone (note: we reiterated our bullish bias in a detailed note on JAN 22) – implying some degree of investors crowding into this trade.”
As mentioned at the onset of this note, that was the wrong call. Specifically, the WisdomTree India Earnings Fund (EPI) has appreciated another +8.6% – on admittedly thinner volume of late. While the latter signal is cause for worry, it’s easy for investors to interpret the heavy volume amid the late-MAY melt-up as the entrance of “real money”, strategic buyers who now view a Modi-led India a core holding in an international equity portfolio. @JohnnyComeLately money aside, we do think the chase is generally warranted.
While the aforementioned storytelling has little to do with our fundamental process, we do think it’s worth considering in the context of what has been one of the most hyped capital and currency markets in the YTD.
Indeed, while Modi and his BJP Party did take care of business in last month’s elections, capturing an outright majority with 283 of 543 available seats in the lower house of Indian parliament (accounting for BJP allies, this figure jumps to an overwhelming majority of 335 seats), the BJP coalition is still on very shaking footing in the upper house where they control only 61 of 245 seats. The former ruling Congress Party, which had been in control of Indian parliament since 2004 dropped -175 seats from their 2009 election total.
The aforementioned consternation in the upper house consternation is critical in the context of some of the prospective economic reforms being bandied about the press, many of which require upper house consent – particularly on anything related to foreign direct investment, taxes and constitutional amendments. Such reforms include, but are not limited to:
- Significant capital account/capital markets deregulation;
- Broad-based foreign direct investment deregulation;
- Implementing a goods and services tax in order to simplify India’s convoluted tax code that often results in double taxation at the interstate level; and
- Deregulating the labor market in order to decrease the frictional cost of doing business in India, which we detailed in our JAN 22nd note is extremely high.
While it is unlikely that any of this gets done in the near term, it’s become increasingly clear that international investors are willing to propel the hope-fueled rally in Indian capital and currency markets higher.
Moreover, while we believe that fiscal and economic reforms are likely to disappoint intermediate-to-long-term expectations of what is likely priced into the SENSEX at its all-time highs, we do think the prospect for Indian monetary policy supporting structural improvement in India’s GIP fundamentals is a meaningful enough catalyst to warrant reallocating to India on the long side.
As mentioned throughout our bullish work on India over the past few quarters, RBI governor Dr. Raghuram Rajan’s monetary policy soundness has been integral to restoring the country’s credibility amongst global inventors after last year’s fiscal and monetary policy-induced currency crash. A key indication of this is India’s current account balance improving markedly from -4.4% of GDP to -2.8% in 4Q13.
Thus far, we’ve received little-to-no indication that his job or the RBI’s monetary policy independence is at risk under the Modi regime. Recall this was a key worry of ours a few weeks back.
Digging into the most recent data, the RBI’s decision to stand mostly pat on rates today was both well telegraphed (e.g. predicted by all 38 analysts surveyed by Bloomberg) and well-received given that they maintained their previous guidance of maintaining appropriately tight monetary conditions until inflation converges to their targets (i.e. +8% YoY by JAN ’15 and +6% YoY JAN ’16).
The board did implement some targeted easing measures, such as lowering rates in both its statutory liquidity ratio (SLR) and its export credit refinance facility (ECR), but these moves appear more administrative in nature and rhyme with the marginal trend-duration improvement we’ve seen in India’s CPI and WPI readings.
As the table above highlights, India’s growth data is good, but not great. Recent sequential and [marginal] trend-based improvement in PMI data is offset to some degree by waning consumer confidence, passenger car sales and money supply data. As such, we continue to maintain a choppy intermediate-term outlook for Indian growth. If it’s any consolation for investors, our model has Indian CPI converging to the aforementioned targets by EOY ’14.
All told, we are now content to look through likely near-term economic softness (i.e. the “G” in our GIP model) with the intention of playing for likely structural improvement in India’s inflation and policy dynamics (i.e. the “I” and the “P” in our GIP model). Giddy up!
Have a wonderful evening,
Associate: Macro Team