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THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – September 22, 2014


As we look at today's setup for the S&P 500, the range is 19 points or 0.67% downside to 1997 and 0.28% upside to 2016.                                                      

                                                                         

SECTOR PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

EQUITY SENTIMENT:

 

THE HEDGEYE DAILY OUTLOOK - 10

 

CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 2.01 from 2.01
  • VIX closed at 12.11 1 day percent change of 0.67%

 

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Chicago Fed Natl Activity, Aug. est. 0.33 (pr 0.39)
  • 9am: ECB’s Draghi speaks in Brussels
  • 10am: Existing Home Sales, Aug., est. 5.20m (prior 5.15m)
  • 10:05am: Fed’s Dudley speaks in New York
  • 11am: U.S. to announce plans for auction of 4W bills
  • 11:30am: U.S. to sell $24b 3M bills, $23b 6M bills
  • 7:30pm: Fed’s Kocherlakota speaks in Marquette, Mich.

 

GOVERNMENT:

    • Senate, House out of session
    • 8:15am: FDIC Chairman Martin Gruenberg speaks at American Banker Regulatory Symposium in Arlington, Va.
    • 4pm: Treasury Sec. Jack Lew gives speech on economics of climate change at Hamilton Project-hosted event, followed by roundtable discussion with former Treasury Sec. Robert Rubin
    • 4:15pm: Comptroller of the Currency Thomas Curry speaks at American Banker Regulatory Symposium in Arlington, Va.

 

WHAT TO WATCH:

  • Siemens buys Dresser-Rand for $7.6b to expand in oil equipment
  • Tesco starts probe after overstating profit guidance by ~$408m
  • Alibaba’s bankers said to increase shr sale size to record $25b
  • Apple iPhone 6 Plus outselling smaller model: Piper survey
  • Apple iPhone weekend sales preview
  • Deutsche Bank says currency trader dismissed on misreporting
  • U.S. Treasury seeking to close tax address loophole, Lew says
  • Blackstone halting efforts to find deals in Russia: FT
  • Google selects HTC to make 9-inch Nexus tablet: WSJ
  • Emirates airline plans U.S. expansion as widebody fleet grows
  • Insider buying dries up defying $275b of buybacks
  • Clorox said to reject takeover offer with 20% premium: NYPost
  • Mitsubishi Corp. offers to buy Norway’s Cermaq for $1.4b
  • Total to cut costs, sell assets after lowering output forecast
  • SK buys shale gas asset from Continental Resources: MoneyToday
  • German union calls strikes at Amazon warehouses: Reuters
  • China Finance Chief Lou say eco growth faces downward pressure
  • UN’s Ban joins 310,000-strong march for climate action

 

EARNINGS:

    • AutoZone (AZO) 7am, $11.26
    • Neogen (NEOG) 8:45am, $0.23

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Nickel Leads Industrial Metals Lower on Outlook for Slower China
  • Commodities Extend Declines to Five-Year Low in ‘Capitulation’
  • Hedge Funds Make Record Bet on Lower U.S. Diesel Prices: Energy
  • Gold Is Little Changed Near Eight-Month Low as Silver Declines
  • Corn Declines With Soybeans to 2010 Lows on Increasing Supplies
  • Brent Crude Declines on Concern China Growth Slowing; WTI Drops
  • Indonesian Police Probe Clears 82 Tin Containers for Exports
  • Iron Ore Futures Decline Below $80/MT to Record Low in Singapore
  • Rubber Production Seen Declining by Consortium of Top Exporters
  • Merkel’s Taste for Coal to Upset $130 Billion Green Drive
  • Al-Amoudi to Invest $500 Million in Ethiopian Coffee, Oranges
  • U.K. Royal Mint Starts Online Trading Site for Gold Coins
  • Libya Crude Oil Production at 700k B/D, NOC Spokesman Says
  • Gasoline Pump Prices Seen Falling After Slump to 7-Month Low
  • Gold Bulls Extend Longest 2014 Exit as Prices Drop: Commodities

 

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES


THE HEDGEYE DAILY OUTLOOK - 6

 

GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4

 

EUROPEAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 8

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Investing Ideas Newsletter

Takeaway: Current Investing Ideas: EDV, FXB, GLD, HCA, OC, OZM, RH, TLT and XLU.

Below are Hedgeye analysts’ latest updates on our nine current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.

 

We also feature three recent institutional research notes that offer valuable insight into the markets and the global economy.

Investing Ideas Newsletter    - lev5

 

Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less

CARTOON OF THE WEEK

Investing Ideas Newsletter    - Apocalypse Fed 09.18.2014

IDEAS UPDATES

TLT | EDV | XLU

 

Be prepared to get positioned defensively in the U.S. Quad #4 includes both economic growth and reported inflation slowing domestically. Based on negative reflections into Q3, i.e. slowdown of actual economic activity into 2H14, we notably caution investors that:

 

  • Headline inflation: CPI is now averaging +1.85% on a YoY basis, down from average of 2.1% in Q2
  • #ConsumerSlowing: Contrasting positive trends in both consumer credit and survey data, domestic consumption trend data shows ~70% of actual GDP that is Real PCE slowed to a +2% YoY in JUL
  • Recent survey data from the Fed, shows Median US consumers are severely impacted by all-time highs in key expenditure buckets and #HousingSlowing due to slowing home price appreciation
  • Labor market deterioration in recent months: the seasonally adjusted MoM nominal growth rate of Nonfarm Payrolls slowed sequentially to +141k in AUG

With both economic growth and reported inflation slowing domestically, we are now in a markedly different economic environment than what we saw in the second quarter. For the Q314 in particular, we see Real GDP growth in a range of +1.6% YoY to +1.8% YoY (that would translate to +1.3% on a QoQ SAAR basis) – i.e. less than half the rate of the Bloomberg consensus forecast of +3%.

 

We continue to expect a marginally dovish response from the Federal Reserve – particularly relative to near-consensus expectations of a tightening cycle commencing in 2H15. According to this week’s FOMC statement, a dovish Fed has revised their 2014 and 2015 Real GDP growth projections down +2.0% to 2.2% and 2.6 %to 3.0% respectively, narrowed their forecast for 2015 PCE Core Price Inflation to +1.6% to +1.9%, and failed to the remove the “considerable time” language in their Fed Fund Rate post the end of their large scale asset purchase programs.

 

From a tactical asset allocation perspective, our GIP model would suggest Quad #4 requires a defensive allocation. We think investors should be in bonds and defensive, bond-like equity exposure and out of both the domestic growth style factor(s) and inflation hedges. Note: Quad #4 is not a good place to buy REIT securities.

 

This is why we continue to favor TLT, EDV and XLU on the long side.

FXB

The voting results are in: the Scots squashed independence 55% NO to 45% YES, and with it we witnessed a relief bounce in the GBP/USD. As the chart below depicts, we fortuitously bought the bottom. 

Investing Ideas Newsletter    - hed

Over the medium term, we continue to like the cross based on what we see as relatively healthy underlying fundamentals for the country in 2H (to propel strong UK = strong Pound), versus our forecast for decelerating growth trends in the U.S. and Eurozone, combined with dovish policy expectations from central bank heads Mario Draghi and Janet Yellen.

 

This week we got encouraging high frequency data:

 

  • UK Retail Sales rose 3.9% in August Y/Y vs 2.5% in the month prior
  • UK ILO Unemployment Rate dropped 20bps to 6.2%

 

Recent BOE Minutes showed that for a second straight meeting there were 2 votes to increase interest rates (by 25 basis points). We expect this marginally more hawkish tone taken together with the outperformance of UK growth over the US and Eurozone in 2014 to push the GBP/USD higher.

GLD 

Gold was for sale Wednesday from Janet Yellen’s 2:00p.m. statement, but the follow through was less confirmatory:

  • Gold fell from $1236 to $1216 from the time she took the stage until after the close of U.S. markets at 4:00p.m.
  • The U.S. 10-year yield ticked up ~7 bps over the same time period (continued higher Thursday)
  • The U.S. dollar caught a solid bid finishing Wednesday +79bps

Investing Ideas Newsletter    - 890

 

The gold market bounced slightly on the week off the Wednesday afternoon lows and the dollar pulled back on Thursday. The immediate reaction from the market suggests she used a more hawkish tone, but U.S. economic data this week certainly didn’t support this assumption:

 

  • Building Permits m/m -5.6% August vs. -1.6% est.
  • Housing Starts m/m -14.4% August vs. -5.2% est.
  • CPI y/y +1.7% Aug. vs +1.9% est.
  • Industrial Production m/m -0.1% Aug. vs. +0.3% est.

 

With central planners abroad forcing a weaker EURO YEN combating the Federal Reserve’s reaction to growth slowing and inflation missing, does the USD run vs. Gold sell-off have room to run into the end of the year? Our takeaway from Yellen’s commentary leads us to believe the non-consensus outlook for a marginally weaker dollar into Q4 remains intact:

 

  • The conveyance of the timing for a rate hike did not change (the “considerable time” language remained)
  • Growth expectations were cut as we expected (Full-year 2014 expectations are still below our internal forecasts)
  • We are sticking with what has been a consistent and straightforward asset allocation in 2014:
    • Long growth-slowing (Utilities and Long-term treasuries with an exhaustion of rates on the back end of the curve)
    • Long gold from here on an easier fed/weaker USD vs. expectations

HCA

As we’ve been writing in recent weeks, the job from here is to keep our head on a swivel, monitor trends closely, and tread carefully as we approach the question of selling the stock.  Incremental this week was a meeting with a very large holder of the stock (who remains very positive), a consumer survey, model review, and macro update.

 

Google Consumer Survey:  We initiated a survey using Google’s Consumer Survey and have linked the results here.  Initially, the survey is designed to capture a baseline value for future samples, but what we found was interesting.  The results appear to explain one of the more confounding data relationships we have seen over the last 6 years, the inverse relationship between consumer confidence and medical spending.   What has happened historically is that when consumer confidence is rising, medical spending is falling, and vice versa.  In presenting this to institutional subscribers I often get raised eyebrows and in one case a laugh. 

 

Investing Ideas Newsletter    - tobin

 

The survey shows why this strange relationship exists.  The top ranked response to If you have put off seeing a doctor, what is the main reason?”  is “I can’t take time off of work” and was cited at 2X the rate over high co-pays and deductibles.  The values in the table are for the entire sample population including Medicare beneficiaries, but for working age people, the difference is even greater.  It would follow, as employment grows as it has, employees are busier and have less time to make doctor appointments.  Consumer confidence becomes not the cause of slower medical spending, but a coincident indicator. 

 

On the other items, we continue to see upside to 2015 consensus numbers in our model and massive cash flow generation while the macro updates for factors that drive their admissions and pricing continue to trend positively.  

OC

The Architecture Billings Index (ABI) is sitting at a post-financial crisis high of 55.8.  The index is supposed to lead nonresidential construction activity by approximately 11 months. Nonresidential construction activity is still growing year-over-year per the latest U.S. Census Bureau data, but the residential side is diverging from nonresidential construction activity. While the NAHB Market Demand Index is sitting at a post-financial crisis high like the ABI, the divergence between sentiment and market conditions is noteworthy. Single family building permits actually decreased for August, while the Bureau’s residential data has been slowing since February 2013.  

Investing Ideas Newsletter    - van

OZM 

We view multi-strategy hedge fund products as more likely to generate positive returns moving into the later stages of this current bull market versus plain vanilla equity or fixed income portfolios.As the bull run in both bonds and stocks (fueled by an accommodating U.S. central bank) ages, the ability to reduce volatility in a portfolio by adding non-correlated assets and also short exposure should once again bring leading hedge fund products to the top of the table from a performance standpoint.

 

While hedge fund strategies have lagged broader benchmark returns including the S&P 500 over the past several years, across cycle over the past 20 years, leading hedge funds have produced much higher returns and lower volatility than benchmarks.

 

For example, since its inception in 1994, Och Ziff has had a compound annual growth rate in its investment performance of 13.4%. That's nearly 400 basis points better than the S&P 500 with compounded returns of 9.6%.

Investing Ideas Newsletter    - ozm

Furthermore, returns have been more stable at OZM over this 20-year period with a standard deviation of just 5.3%, almost 1/3 of the variation of returns in the equity market with standard deviation of 15.2% over the same time period.

 

Simply put, leading hedge fund strategies over a measurable time period create higher returns with less potential variation and thus are extremely valuable vehicles. OZM shares with this positive historical track record remain on our Investing Ideas list as a beneficiary of more volatile markets which we see going forward.  

RH 

In the week following Restoration Hardware's 2Q14 earnings release, the key questions we’re getting from investors focus around the possibility of a revenue ramp in 2H.  It’s important to note that we’re looking at an 800 p ramp in ‘deferred revenue’ on the company’s balance sheet, which also synchs with a 35% increase in inventory headed into the third quarter. That’s not to mention a delay in the company’s marketing efforts that should push sales into 3Q.

 

All in, we’re comfortable with our 24% 3Q top line growth rate, versus the Street at 22%. We remain meaningfully higher for the year.

 

Let’s also keep this in context with our view that revenue will ramp through 2018 to about $5bn, vs. a sub-$2bn level today. That’s something that should put a 1-2% shift in revenue between quarters into perspective. 

 

* * * * * * * * * * 

 

Click on each title below to unlock the content.

 

Fund Flows: Trending, Not Mending

Our research shows that despite substantial losses in the U.S. equity fund category over the past 5 months which total $48 billion, the average draw down in U.S. stock funds since 2007 has averaged 40 weeks with over $113 billion lost. In other words, trends could continue on their downward slope. 

Investing Ideas Newsletter    - 889

 

Are You Positioned Defensively Enough (For Quad #4)?

The slowdown in both growth and inflation domestically requires investors to adopt a particularly defensive asset allocation.

Investing Ideas Newsletter    - defense

 

FDX: Moving to Roughly Indifferent

We have ‘liked’ FedEx shares since late 2012, gradually reducing our affinity as the shares have moved higher (although a bit too quickly).  With recent gains, we will move to ‘roughly indifferent’. 

Investing Ideas Newsletter    - fedex


Commodities: Weekly Quant

Commodities: Weekly Quant - chart1 Divergences

Commodities: Weekly Quant - chart2 Deltas

Commodities: Weekly Quant - chart3 USD Correls

Commodities: Weekly Quant - chart4 S P Correls

Commodities: Weekly Quant - chart5 volume

Commodities: Weekly Quant - chart6 implied vol

Commodities: Weekly Quant - chart7 cftc sentiment

Commodities: Weekly Quant - chart8 1mth correls

Commodities: Weekly Quant - chart9 3mth correrls

Commodities: Weekly Quant - chart10 6mth correls

Commodities: Weekly Quant - chart11 1yr correls

Commodities: Weekly Quant - chart12 3yr correls

 

Ben Ryan

Analyst


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

The Week Ahead

The Economic Data calendar for the week of the 22nd of September through the 26th of September is full of critical releases and events.  Attached below is a snapshot of some of the headline numbers that we will be focused on.

 

The Week Ahead - 09.19.14 Week Ahead


The Best of This Week From Hedgeye

Takeaway: Here's a quick look at some of the top videos, cartoons, market insights and more from Hedgeye this past week.

HEDGEYE TV

Why We Removed BofA From Our Best Ideas List (Plus 3 New Ideas) | $BAC $COF $OZM $LM

Hedgeye Financials co-heads Josh Steiner and Jonathan Castelyn discuss why they took Bank of America off their Best Ideas list on Thursday and offer up three other long ideas.

 

Q&A: McCullough Answers Questions on Gas Prices and the Fed

Hedgeye CEO Keith McCullough answers two critical questions from institutional subscribers.

 

McCullough: The Return of Deflation?

Hedgeye CEO Keith McCullough explains during Thursday’s institutional call why we might be heading into Quadrant 4 of his model. That’s when both growth and inflation slow. Here’s how to position yourself.

 

CARTOON

Lovey-Dovey

The Best of This Week From Hedgeye - Yellen Dove 9.17.14

On the spectrum of dovish vs. hawkish (versus expectations), this Fed statement was as dovish as it gets says CEO Keith McCullough.

 

Angels & Demons

The Best of This Week From Hedgeye - Equities devil  bonds angel 9.16.14

47% of Nasdaq stocks and 41% of stocks in the Russell 2000 are crashing from their 12-month peak. The long bond? It's up +12% YTD.

 

CHART

 #VOLATILITYASYMMETRY Remains

The Best of This Week From Hedgeye - COD volatilityasymmetry 9.15.14

In rate of change terms, the +10.1% week-over-week move in front month US Equity volatility (VIX) was peanuts compared to the % move in volatility in foreign currency and fixed income. That’s what happens when the Fed suppresses volatility to all time lows. The bubble peaks.

 

If we’re right and we’re set up for one of the most asymmetric moves in volatility ever (see our Q3 Macro Theme deck titled #VolatilityAsymmetry), Americans may be looking back at late 2007 a lot faster than they think.

 

Has Central Planning Reached Its Crescendo?

The Best of This Week From Hedgeye - COD centralplanning 9.18.14

 

Cracks Remain Across Europe

The Best of This Week From Hedgeye - COD crackseurope 9.19.14

As the ugly equation of declining growth + high unemployment + low and deflating inflation comes home to roost, the ECB’s newest response is to lever up its balance sheet (ECB President Mario Draghi has indicated the willingness to increase it by €1Trillion) and extend QE as the “elixir” to inflect weak and declining fundamentals across the region. 

 

POLL OF THE DAY 

Alibaba Bubble?

On Monday, we asked our viewers about the significance of the Alibaba IPO . 

 

The Fed

On Tuesday, as the Fed kicked off a two-day meeting, we asked our viewers about their expectations from that meeting. Here's what they told us.


INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID

Takeaway: Indian officials continue to enact policies that are structurally positive for the country’s GIP fundamentals.

India (EPI) Is Up +31% YTD vs. Only +8.7% For the SPY… For the Right Reasons

As you are probably well aware, we LOVE Indian equities. Per our July 7th note titled, #WINNING: INDIA’S STRUCTURAL GIP IMPROVEMENT CONTINUES:

 

“In five years of writing research notes on India’s budget, this is the first one that has a takeaway that isn’t extremely negative; in fact, it’s overwhelmingly positive. India’s new “management team” is flat-out killing it. We’ve said this before and we’ll say it again: if we could LBO entire countries, India would be our primary acquisition target!”

 

It should be noted that we turned bullish on India a full five months before we turned broadly positive on emerging markets (after having authored the bearish thesis in early 2013) because we were fortunate enough to anticipate India would begin to showcase the two things that’d make us bullish on any economy:

 

  1. Implement sustainable monetary and fiscal policy, which, on balance, tends to be pro-growth and anti-inflation;
  2. Introduce investor-friendly regulations, at the margins, effectively promoting free(r) markets in the process.

 

In the prose below, we highlight the key initiatives Indian policymakers have introduced recently that are in support of the aforementioned catalysts.

 

Secular Tailwind: Sustainable Monetary & Fiscal Policy

The seed for our bullish bias on Indian equities was planted back in September of last year when new RBI Governor Raghuram Rajan hiked interest rates. Since then, the RBI has hiked its benchmark repo and reverse repo rates a cumulative +50bps, which has aided a +10.8% recovery in the Indian rupee off its all-time low of 68.82 per USD.

 

In addition to hiking rates, “Dr. Raj” has introduced a number of supportive measures on the guidance and regulatory front that have been profoundly helpful in assuring international investors of the safety and sustainability of Indian financial assets:

 

  • Prioritizing Inflation Over Growth: Throughout his tenure as central bank governor, Dr. Rajan has resisted calls from investors and economists to help support Indian growth via dovish monetary policy, instead opting to aid growth the old-fashioned way – i.e. through quashing inflation. In his latest guidance, Dr. Rajan remarked, “Inflation is coming down and this is consistent with our forecast and I am glad. Macro indicators are improving but still have some way to go before we can declare we are out of the woods and claim victory on inflation, and that is only a matter time… The RBI in no way will hold rates high any longer than necessary... Growth will be most benefited if we disinflate the economy and we don’t have to fight this fight again. Let’s fight the anti-inflation fight once and let’s win. That will create the best conditions for sustainable growth.”
  • Growing FX Reserves; Tightening the Current Account Deficit: Since bottoming in August of 2013, India’s FX reserves have increased +15.5% to $317B as of the week ended September 5th; as a ratio to imports, India’s reserve coverage has ticked up nearly two full points since then to 7.7x . Moreover, India’s current account deficit has tightened from -5.4% of GDP in 2Q13 to -1.9% as of the latest reading (1Q14) on the heels of the RBI’s gold import restrictions. Both are incredibly positive for India in the since that it significantly de-risks the Indian rupee in the eyes of an international investment community that is [inappropriately] focused on the timing of a rate-hike cycle in the US.  
  • Cleaning Up Bad Debt: With nonperforming loans officially running at 4% of total assets (versus ~1% for China and ~0.9% for South Korea), the RBI is appropriately incentivizing Indian lenders to clean up their balance sheets in order to make headway for additional loan growth to support an economic recovery in the coming quarters. Per CARE Ratings Ltd., a sample of 39 financial institutions including State Bank of India and ICICI Bank have sold 100B INR ($1.6B) of non-performing assets in the fiscal year ending March 2014.

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - CPI

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - FX RESERVES

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - CURRENT ACCOUNT BALANCE

 

Not surprisingly, consensus expectations for Indian inflation have been steadily falling over the past few months amid such policies:

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - INFLATION

 

Secular Tailwind: Investor-Friendly Regulations

Not to be outdone, recently elected Prime Minister Narendra Modi has been busy working deals and cutting red tape in an effort to make good on his plan to hit $1T in investment by 2017. Such efforts have helped perpetuate a record $18.7B inflow into Indian bonds this year, after an unprecedented $8B outflow in 2013.

 

The latest news on this front comes in the form of $53B in loans and investment pledges from China and Japan this month. Specifically, Chinese Premier Xi Jinping has just pledged $20B in investment over the next five years to help India narrow its largest trade deficit with any single country ($34.4B on imports of Chinese heavy machinery, telecom equipment and durable goods alone as of 2013). Japanese prime minister Shinzo Abe also promised $33B in loans and investment earlier this month – investments that are sure to be part of the GPIF asset allocation overhaul, which is coming down the pike in Japan.

 

Securing pledges for investment is one thing; actually putting the money to work has been and continues to be a decidedly different activity in India given the country’s well-documented issues with bloated bureaucracy and corruption.

 

For example, former Prime Minister Monmohan Singh actually had to form a committee in June of last year to help unclog 463 blocked investments totaling some 22T INR ($362B). Since then, the committee – officially dubbed the Project Monitoring Group – has approved up 176 investments worth 6.5T INR, but only 60 of those have actually begun construction, effectively highlighting India’s ongoing struggle with bureaucracy.

 

Corruption is not exactly a non-issue either. Per the World Economic Forum’s 2013-14 Global Competitiveness Report, “inefficient government bureaucracy” and “corruption” are the #2 and #3 most frequently cited responses in response to the “most problematic factors for doing business” prompt at 17.5% and 17.3%, respectively:

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - MPFFDB

 

Not surprisingly, India ranks rather poorly in key fixed investment-related categories such as (rank of 148 economies):

 

  • Diversion of public funds (98th)
  • Public trust in politicians (115th)
  • Irregular payments and bribes (110th)
  • Burden of government regulations (104th)
  • Quality of overall infrastructure (85th)
  • Quality of electricity supply (111th)
  • Total tax rate, % of profits (128th)
  • Number of procedures to start of business (129th)

 

In light of this, we are extremely encouraged to see Prime Minster Modi aggressively seek to cut red tape and promote foreign investment. Under his stewardship, the Project Monitoring Group has accelerated its efforts to unclog India’s investment pipeline. Per PMG head Anil Swarup:

 

“The pace at which things are happening is faster than what we saw in the past. In the previous government, our job was just to see that the clearances would happen and we would assume that it was translating to work on the ground. The present government has asked us to do the leg-work and make sure that it is.”

 

While just a start, efforts like this are in line with his decision to raise foreign investment caps on defense and railways and we’re excited to see that Modi is living up to his reputation as a pro-business, pro-growth leader during the early days of his administration. Moreover, we anticipate that such deregulatory efforts are likely to continue.

 

Not surprisingly, consensus expectations for Indian growth have been steadily trending higher over the past few months amid such policies:

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - GROWTH

 

India Has Cyclical Tailwinds As Well

Generally speaking in emerging market investing, “reform” is a buzzword that perpetuates capital inflows, which is exactly what we’ve seen in India over the past year or so. Specifically, outstanding foreign investment in Indian equities has increased +9.7% in the YTD to $160B, while outstanding foreign investment in Indian debt capital markets has increased +10% in the YTD to $44.4B.

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - FLOWS

 

With the tailwind of “reform” remaining at our backs, we are excited to notify you that the Indian economy is likely headed into Quad #1 on our GIP model in the coming quarter. Easy growth compares, difficult CPI compares and annualized currency strength all contribute to this forecast.

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - INDIA

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - FX

 

This would be a inflection from the 3rd quarter slowdown we called for back in May when we booked what effectively equates to a sizeable gain (we don’t run money) in the WisdomTree India Earnings Fund (EPI) ETF: +21.6% vs. a +4.6% gain for the MSCI All-Country World Index. Since then, Indian growth has taken a hit:

 

  • Both Industrial Production and Manufacturing Production are slowing sequentially and negatively diverging from their respective trailing 3M, 6M and 12M trends.
  • Commercial Credit growth is slowing sequentially and negatively diverging from its trailing 3M trend.  
  • FDI is negatively diverging from its trailing 3M trend.
  • India’s Composite PMI is slowing sequentially and negatively diverging from its trailing 3M trend.  
  • Both Exports and Imports are slowing sequentially and negatively diverging from their respective trailing 3M trends.

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - India High Frequency GIP Monitor

 

INDIA: DOING EVERYTHING POSSIBLE TO GET YOU PAID - COMPOSITE PMI

 

Investment Conclusion: Remain Overweight Indian Equities

Please note that we rotated back into India on June 3rd, post the election consternation (or lack thereof); the EPI has appreciated +2.6% since then, besting the MSCI All-Country World Index’s +1.1% advance by 150bps.

 

All told, Indian officials continue to enact policies that are structurally positive for the country’s GIP fundamentals. In the context of these secular tailwinds and cyclical ones as well, we think India (EPI) will continue to deliver investors a positive absolute return over the intermediate-to-long term.

 

Indeed, the EPI poised to finally break out of the $22-$23.50 trading range it has traversed since June amid the aforementioned slowdown in economic growth.

 

India remains our favorite way to play the long side of EM equity exposure – an asset class that both our Tactical Asset Class Rotation Model (TACRM) and global GIP fundamental analysis is signaling as having legs to the upside.

 

Have yourself a fantastic weekend and Go Seahawks!

 

DD

 

Darius Dale

Associate: Macro Team


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