CONCLUSION: When it comes to spurring growth and protecting its currency, we are of the view that India “can’t have its cake and eat it too” at the current juncture. The benchmark SENSEX Index remains in a Bearish Formation – a clear quantitative signal to us that the recent spate of oft-conflicting policy maneuvers is likely to have a muted effect on turning around the Indian economy and the country’s poor investment climate over the intermediate term.
The phrase “[insert proper noun] wants to have its cake and eat it too” doesn’t really make sense to me. As a former offensive lineman, I generally enjoyed eating all the cake I could get my hands on. That being said, I believe the saying refers to an individual or entity’s desire to pursue an outcome that is conflict with another one of his/her/its wishes.
In the case of India, a country we have generally remained fundamentally bearish on across asset classes (stocks/rupee/rupee-denominated debt) for much of the past 19 months, the aforementioned phrase is quite appropriate. The Reserve Bank of India, in the midst of battling what we’d consider a full-fledged currency crisis (a peak-to-present decline > 20% over the LTM), is being forced to chose between fighting inflation – which is 270bps above their +4.5 YoY unofficial target (APR) and above it every month since OCT ’09 – or protecting growth, which has slowed to an 11-quarter low of +6.1% YoY in 4Q12 and looks to continue that trend when 1Q GDP is reported on Wednesday.
Rather than biting the bullet and hiking rates to protect the purchasing power of their citizenry, which is what many developing nations have been forced to do historically during periods of international stress (usually accompanied by USD strength), India has chosen the route of easing and tightening at the same time (more on this later). Their policy confusion has been rather unsupportive for the rupee, which has fallen to an all-time low vs. the USD as recently as MAY 23.
As we penned in our APR 17 note titled “IS INDIA OUT OF BULLETS?”, the country’s twin deficits, which have widened in recent years, are a real risk to the nation’s currency in times of heighted global volatility due to the typical slowdown in cross-border capital flows to developing nations like India. Coincidentally, inflows into India’s equity and bond markets peaked in the YTD right around the time we started getting loud about our expectations for a breakout in cross-asset volatility over the intermediate term (mid-MAR).
Per the aforementioned note: “No doubt, a further Deflating of the Inflation will eventually be supportive of the Indian economy; that said, however, we think India’s intermediate-term growth outlook, as well as the country’s financial markets are particularly at risk in an a higher-vol. environment over the intermediate term due to its widening current account and fiscal gap. India’s bloated fiscal deficit is of particular importance given that any slowing of capital inflows or outright capital outflows ultimately translates to a crowding-out of private sector funding.” With money supply (M3) growth at a ~7yr low, we’re seeing this phenomenon show up in the data in real-time.
Regarding the point we made about them easing and tightening at the same time, below is a list of the recent measures Indian policymakers have taken in order to combat either currency deprecation pressures (via fiscal and/or monetary tightening/capital controls) or economic growth headwinds (via fiscal and/or monetary easing/stimulus), which, if done at the same time, can seem a bit oxymoronic, or of the “having one’s cake and eating it too” variety:
- In MAR, the central government introduced an import duty on gold and platinum bars and coins, which facilitated a -33% YoY decline in gold and silver imports in APR;
- Raised interest rates on foreign currency deposits by as much as 300bps in addition to easing restrictions on foreign exchange loans for Indian exporters;
- Reduced the amount banks can hold in FX derivatives contracts to < $100M or 15% of the total such agreements (whichever is lower);
- Reduced the amount of overseas income Indian corporates can hold in foreign currency-denominated assets to 50% from 100%;
- Sold $5.4B of FX reserves (USD) to the market over the past 3-4 weeks, taking their total reserves down to $290B (-6% YoY); and
- Late last week, the central government allowed the State-run refiners to increase gasoline prices by +11% in a bid to combat fiscal deficit pressures stemming from the bloated subsidy bill (12.7% of total expenditures).
Interestingly, to point #5 above, providing USD liquidity to India’s FX market can be helpful for the exchange rate, but only because it tightens monetary conditions by curbing supply of Indian rupees in the domestic market. As such, their options here are limited given the Indian banking system’s persistent liquidity deficit (having borrowed nearly a trillion rupees from the central bank on average via reverse repo transactions a – form of monetary easing – over the last five days).
To point #6, we’ve crunched the numbers on the deficit below; the conclusion is short and simple: while the +11% increase can be taken by market participants as a signal that they are willing to cut further, it accomplishes very little in the direction of moving the needle on the fiscal deficit:
- In FY12, the subsidy bill on energy-related expenses was 59.1% of the total… holding that flat, we get to 1.123T rupees for FY12;
- Reducing that by -11% leaves us with 999.45B rupees for on energy-related subsidy expenses for FY13E;
- That takes our total planned subsidy expense 1.77T rupees or 11.9% of FY13E expenditures;
- The -123.5B rupees in savings is a mere 0.8% of the total planned expenditures and just 2.4% of the budgeted deficit;
- All in, the maneuver shaves a whopping -12bps off of India’s FY13E deficit/GDP ratio (assuming all other revenues and expenditures meet their targets).
All told, the math doesn’t lie. When it comes to spurring growth and protecting its currency, we are of the view that India “can’t have its cake and eat it too” at the current juncture. As the chart below highlights, the benchmark SENSEX Index remains in a Bearish Formation – a clear quantitative signal to us that the recent spate of oft-conflicting policy maneuvers is likely to have a muted effect on turning around the Indian economy and the country’s poor investment climate over the intermediate term.
POSITIONS: Long Healthcare (XLV) and Apple (AAPL); Short Industrials (XLI) and Basic Materials (XLB)
In my note titled “Net Long” at 1140AM EST on Friday, I explained the immediate-term upside scenario. With 1316 TRADE line support intact, we’re looking at finding an immediate-term TRADE overbought signal between 1.
Across my risk management durations, the lines that matter to me most right now are:
- Intermediate-term TREND resistance = 1369
- Immediate-term TRADE resistance = 1337
- Immediate-term TRADE support = 1316
With month-end approaching (Thursday) and the Employment Report (Friday) right after that, I don’t think trading the risk of this immediate-term range is going to be easy. Nothing in this business should be.
We currently have 9 LONGS, 6 SHORTS.
Keep moving out there,
Keith R. McCullough
Chief Executive Officer
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Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor". If you'd like to receive the work of the Financials team or request a trial please email .
* American and European bank swaps mostly tightened in the latest week. Notably, French and German banks saw their swaps fall WoW along with the US Global banks.
If you’d like to discuss recent developments in Europe, from the political to financial to social, please let me know and we can set up a call.
European Financials CDS Monitor – Bank swaps were tighter in Europe last week for 28 of the 39 reference entities we track. French and German banks tightened across the board. The median tightening was 1.6%.
Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread widened by 2 bps to 41 bps.
ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system. An increase in this metric shows that banks are borrowing from the ECB. In other words, the deposit facility measures one element of the ECB response to the crisis. The latest overnight reading is €741.86B.
Security Market Program – For an eleventh straight week the ECB's secondary sovereign bond purchasing program, the Securities Market Program (SMP), purchased no sovereign paper for the latest week ended 5/25, to take the total program to €212 Billion.
This note was originally published at 8am on May 15, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“There is, so I believe, in the essence of everything, something that we cannot call learning. There is, my friend, only a knowledge - that is everywhere.”
Last week I was on vacation and had some time to turn off the crackberry (or iCrackberry in my case) and do some reading. Most of my reading was centered on my day job as Director of Research at Hedgeye, but I also had a chance to read some fiction, including Hermann Hesse’s classic, “Siddhartha.”
For those of you that haven’t read Hesse’s novel, it is the classic example of a man’s search for meaning and identity. In the story, the protagonist, Siddhartha, lives in the time of the Buddha and is in search of enlightenment. On this path, he forsakes his family as a teen and leaves a comfortable lifestyle to the sparse life of an ascetic that is characterized by abstaining from worldly pleasures.
Siddhartha then has an awakening of sorts and leaves the ascetics to become a trader (in this day and age he would clearly have been trading CDS), and also takes on a lover. Siddhartha then again turns his back on the materialistic world to once again return to the ascetics. Eventually Siddhartha realizes that that his “understanding” is enhanced by the collection of his experiences.
From my purview, this short novel is the classic existential angst and search for identity story. In people, this often occurs years immediately following college, but also manifests itself in the “midlife crisis.” Nation states also struggle in the search for identity. In the United States this struggle has recently been on the social side of the equation as both Republicans and Democrats have taken up the gay marriage debate with fervor, but in Europe the search for identity continues along the economic path.
This morning's GDP numbers were released for the majority of the Eurozone. In the Chart of the Day, we’ve highlighted the y-o-y GDP growth rates for the EU-27. While the architects of the euro may have envisioned a scenario where economic progress is shared across the region, the reality has proven to be much different. Clearly, Germany has been, and continues to be, the key beneficiary of the common currency. This will only continue with the euro trading below the 1.30 line versus the U.S. dollar.
In aggregate, the EU27 grew 0.0% from Q4 2011 and 0.1% from Q1 2012. This was largely driven by Germany, which grew at 0.5% sequentially and 1.2% y-o-y. Germany has benefitted from strength in its industrial sector, in particular solid results from the automakers. As a result, exports have been a meaningful tailwind for Germany.
On the disappointing end of the GDP report were France, Italy and Spain. France’s growth effectively evaporated on a sequential basis to 0.0%, and Italy was -0.9% sequentially while Spain was down -0.3% sequentially. Clearly, Europe is seeing the impact of austerity in short-term GDP growth numbers. The open ended question remains how tolerable austerity remains, especially as Germany’s economy continues to dramatically outperform its neighbors.
To answer that question, we probably have to look no further than Francois Hollande’s first action as leader of France. Specifically, immediately after being sworn in today Hollande is flying to Germany to discuss a growth pact with Angela Merkel. While Merkel has been adamant that no new sovereign debt will be issued to support growth, she too is feeling the pressure to implement policies that are, at least in perception, more pro-growth by her political opposition in Germany. The economic identity crisis in Europe continues.
The European sovereign debt markets are clearly signaling their confusion around the lack of economic identity. While they had seemingly been reacting better to certain austerity policies, many periphery yields are now trading back near all-time highs. The key market we watch, of course, is the Spanish 10-year yield which is now solidly above the rhetorically critical 6% line at 6.25% this morning.
With France’s political identity resolved, at least temporarily, Greece is now in focus on the political front. My colleague Matt Hedrick highlighted this on Friday when he noted:
“This week saw each of the three main Greek parties (New Democracy, Syriza, and Pasok) try to form a coalition with each another, only to come up short each time. There’s new hope from some that Pasok leader Evangelos Venizelos can put together a unity government given a shift in stance on the part of Democratic Left leader Fotis Kouvelis, who has broken ranks with Syriza, which it had backed earlier in the week. (Syriza is thoroughly against the mandates of austerity, and may be the most divisive partner in a coalition build).”
Clearly, the search for political identity in Greece is going to be protracted.
Changing gears for a minute, I wanted to highlight a recent note from Howard Penney and Rory Green on our restaurants team titled, “The (Coffee) Prince”. As they wrote:
“For Howard Schultz, it is all about winning. Even when he doesn’t want to communicate it, he does. The word “Machiavellian” has come to represent, for many people, any human behavior that is cynical and self-interested. While Schultz seems to have a strong social conscience – and this is meant as a compliment – we can’t help but believe that the single-serve strategy being employed by Starbucks seems to rhyme with The Prince, Machiavelli’s most famous book. An appearance by Mr. Schultz on CNBC yesterday illustrates this perfectly.”
Their general point, and email firstname.lastname@example.org if you want to trial their research and read the entire note, is that the identity, or search for identity, of corporate leaders can very much impact financial results.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
* American and European bank swaps mostly tightened in the latest week. Notably, French and German banks saw their swaps fall WoW along with the US Global banks.
* We are including a new Asia Financials CDS table this week, which includes major banks and brokers from China, Japan and India. The credit profile of Asia's financials was mixed over the last week, with 6 of the 12 reference entities we track tighter.
* Sovereign CDS mostly widened WoW. While much of the focus these days is on Spain and its banks, it's worth noting that Italy continues to press higher right alongside Spain. Ireland is also moving higher.
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 0 of 13 improved / 2 out of 13 worsened / 11 of 13 unchanged
• Intermediate-term(WoW): Negative / 1 of 13 improved / 8 out of 13 worsened / 4 of 13 unchanged
• Long-term(WoW): Positive / 4 of 13 improved / 3 out of 13 worsened / 6 of 13 unchanged
1. US Financials CDS Monitor – Swaps tightened for 20 of 27 major domestic financial company reference entities last week.
Tightened the most WoW: JPM, MTG, RDN
Widened the most WoW: AXP, UNM, ACE
Widened the least MoM: C, UNM, TRV
Widened the most MoM: WFC, AXP, RDN
2. European Financial CDS - Bank swaps were tighter in Europe last week for 28 of the 39 reference entities we track. French and German banks tightened across the board. The median tightening was 1.6%.
3. Asian Financial CDS - Bank swaps were tighter in Asia last week for 6 of the 12 reference entities we track. The median tightening was 1.7%.
4. European Sovereign CDS – European Sovereign Swaps mostly widened over last week. French sovereign swaps tightened by 7.2% (-16 bps to 205 ) and Italian sovereign swaps widened by 0.7% (+4 bps to 520).
5. High Yield (YTM) Monitor – High Yield rates fell 1 basis point WoW, ending at 7.64 versus 7.65 the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 5.71 points last week, ending at 1646.
7. TED Spread Monitor – The TED spread fell less than a basis point last week, ending at 38.3 this week versus last week’s print of 38.8.
8. Journal of Commerce Commodity Price Index – The JOC index fell 0.4 points, ending the week at -11.4 versus -11.1 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread widened by 2 bps to 41 bps.
10. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system. An increase in this metric shows that banks are borrowing from the ECB. In other words, the deposit facility measures one element of the ECB response to the crisis.
11. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1. Last week spreads widened, ending the week at 168 bps versus 167 bps the prior week.
12. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production. Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion. Last week the index fell -107 points, ending the week at 1034 versus 1141 the prior week.
13. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 2-10 spread widened to 145 bps, 3 bps wider than a week ago.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 2.8% upside to TRADE resistance and 2.6% downside to TRADE support.
Margin Debt - April: +0.93 standard deviations
We publish NYSE Margin Debt every month when it’s released. NYSE Margin debt hit its post-2007 peak in April of 2011 at $320.7 billion. The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1. While this may sound complicated, the message is really quite simple. First, when margin debt gets to 1.5 standard deviations or greater, as it did last April, it has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period. We flagged this for the first time back in May 2011. The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. In other words, the last few months’ change in margin debt is the best predictor of the change we’ll see in the next few months. We would need to see it approach -0.5 to -1.0 standard deviations before the trend runs its course. There’s plenty of room for short/intermediate term reversals within this broader secular move. Overall, however, this setup represents a long-term headwind for the market. One limitation of this series is that it is reported on a lag.
The chart shows data through April.
Joshua Steiner, CFA
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