Jun 12, 2024
• Global economy faces headwinds.
• India’s growth remains resilient despite global challenges.
• Indian bonds are likely to be range-bound as the RBI counterbalances bond inclusion cheer.
• Better value in large-cap relative to mid and small-cap stocks in the medium term.
Goldilocks to Stagflation
Over the past several months, the U.S. economic commentary has been oscillating between “Goldilocks” and “Stagflation”. Earlier last month, the U.S. Bureau of Economic Analysis released advance estimates of GDP growth for the first quarter at 1.6%, but their more recently released estimates pegs GDP growth at a lower 1.3%. On the other hand, while housing inflation is now expectedly cooling, the other components of core inflation (also termed as “super core inflation”) are accelerating.
Contribution of all items to U.S. CPI (% point y/y)
Source: Bureau of Labor Statistics
Consequently, “stagflation” has been mentioned more in the last few days than “Goldilocks”. The latest jobs report adds to the muddling. Headline numbers are better than expected, but as you look under the hood, employers are reporting 272,000 new hires while households are reporting over 4 lakh fewer jobs. While the Fed and the trading community focus more on the non-farm payroll data, the household survey is a good indicator because workers are counted once even if they hold more than one job. The unemployment rate rose to 4%, the highest since November 2021 but still historically low.
Interest rate expectations have accordingly been fluctuating, with markets now expecting only one rate cut and about a 40% chance of a second one.
While this may have brought cheer to savers who get to enjoy higher yields a little longer, the IMF issued a dire warning. USD 9 trillion worth of government debt is set to mature in the next year and will have to be refinanced at higher rates. Interest costs have already exceeded the nation’s military budget. The fiscal strain that this places on the U.S. economy should be heeded, warned the IMF.
The European Central Bank (ECB), however, is not waiting for rate cues from the U.S. Fed. Eurozone inflation is expected to be closer to 2% through the end of 2025. There is a notable recovery in flash PMIs even if the region continues to lag the global manufacturing recovery. To support this recovery, the ECB began its rate cut cycle with a quarter-point cut last week. Markets expect 2-3 rate cuts this year.
China, too, has some green shoots emerging. While debt and demographic issues continue to affect domestic demand, exports show a sharp improvement, with orders from developing countries seeing the biggest increase. U.S. and EU trade tensions, meanwhile, continue to persist. The EU is expected to announce anti-subsidy tariffs on electric vehicles made in China. Exports of battery-powered passenger cars to the EU have grown nearly tenfold in just four years, reaching almost half a million in 2023. But these headwinds are factored into Chinese equities, which trade at close-to-historic valuation discounts and are attracting opportunistic investors.
Chinese manufacturing new orders
Source: The Daily Shot
Overall, global equities as represented by the MSCI World Index recorded a marginal decline of 0.2% for the month of May. Despite an optimistic start, concerns over inflation and geopolitical tensions weighed on investor sentiment, resulting in a slight retreat in global equities. The S&P 500 has been leading the gains this year, rallying another 1.5% in May 2024. The rally was supported by corporate earnings, with 87% of S&P 500 companies surpassing earnings estimates according to FactSet. Japanese equities have posted a robust gain of more than 15% this calendar year.
Source: Bloomberg, Sanctum Wealth
Above returns are price returns in local currency terms
India Update and Outlook
Modi 3.0 was just sworn in after what was initially thought to be a boring election but turned out to be a potboiler. While this is a coalition, the incumbent Bharatiya Janata Party continues to be the anchor, even though it has lost its single-party majority. This is significant for the continuity of economic policies. We expect the central theme of development and inclusion to be carried forward by this coalition government, with an emphasis on inclusion. To achieve this, there will be continued thrust on infrastructure and manufacturing, as well as an enhanced focus on affordable housing. All these sectors aid job creation and are hence important. Additionally, we expect more steps to address rural stress.
Source: Bloomberg, Sanctum Wealth
The above returns are price returns
India’s Q4 FY24 GDP numbers came in at a better-than-expected 7.2% year-on- year. Industry grew by 8.4%, with manufacturing at 8.9% year-on-year and construction at 8.7% year-on- year. Services, however, dipped to 6.7%. Agriculture came in weak at 0.6%. Yet, the overall GDP growth for the full year is an impressive 8.2%. The GDP growth estimate for FY25 has been raised to 7.2% from 7%. If this materializes, it will be the fourth consecutive year that the economy has expanded at a rate of over 7%. PMI readings, GST collections, and GVA point to robust growth. However, private consumption continues to remain an area of concern.
The fiscal deficit was lower than expected at 5.6%, compared to the budgeted 5.8%. Additionally, the RBI gave the government a large dividend of Rs 2 lakh crores. These factors give the government a bit more latitude to expand its welfare policy, which is an important lever for alleviating rural stress.
Indian fiscal deficit came in lower than expected
Source: Bloomberg, Sanctum Wealth
Core inflation in India has been moderating even as food inflation continues to be volatile. The impact of the heat wave on food prices will subside with the early onset of the monsoon. The monsoon season in India for 2024 is expected to bring above-normal rainfall, with the Indian Meteorological Department (IMD) predicting total monsoon rainfall to be about 106% of the long-period average (LPA) across the country. The Monsoon Core Zone, crucial for rain-fed agriculture, is also likely to receive above-normal rainfall. For equity investors, a favorable monsoon and expectations of government support to alleviate rural stress are creating opportunities for thematic investing. The link to our recent thematic report on this is included here.
The monetary policy was in line with expectations, and rates remained unchanged. However, the decision was not unanimous, as two members voted to cut rates.
The exit polls and actual election results created huge swings in domestic equities. Markets had priced in continuity and stable policymaking but corrected sharply as clarity waned and then moved higher as clarity re-emerged. There is no immediate trigger for equities to move higher, so markets may remain rangebound but with some volatility as ministerial allocations are declared.
Outlook
Equities: Stocks of companies that were expected to benefit from government reform surged prior to the election. Many of these are now excessively priced, and we anticipate a market rotation away from them towards companies with greater earnings visibility and reasonable valuations. As mentioned earlier, rural consumption is also emerging as a significant theme. We remain constructive on the infrastructure and manufacturing sectors, but valuations are not inexpensive. Therefore, stock picking will prove to be key for generating returns.
Fixed income: The benchmark 10-year yield has been trading in a narrow range for over a year now. From 6.98% a year ago, it has marginally increased to 7.02%. Notably, the lack of duration hasn’t adversely affected investors. Looking at the short term, the 10-year yield has eased nearly ten basis points in the past month, and we anticipate it to continue drifting down gently. While a robust economy allows the RBI to refrain from rushing into rate cuts, inclusion in the global bond index would likely exert downward pressure on yields. Therefore, we encourage investors to gradually increase duration.