Over the last couple of weeks we have seen concerns from the Eurozone reduce and the news flow from that part of the world has become less and less negative. Most the countries in the Eurozone that have had issues related to their ability to borrow and replace their earlier borrowings have been able to do so successfully. We have seen the spreads over Bunds for most of these countries also stabilize and narrow. All this coincided with the bottoming out of the Euro against the USD, although the GBP had bottomed out much earlier. The reduction in the negative sentiment has led to a blockbuster rally in the Euro vis a vis the USD where the value of the Euro has moved upto 1.30 from 1.20 in a period of a few weeks.
The entire event has also coincided with steadily worsening numbers in general with regards to the US economic growth and we have seen most of the data points related to industrial growth, consumer confidence, leading indicators etc fall off and the only positive thing that we have seen is that filings for unemployment benefits have been steadily reducing with reducing jobless claims. The housing market has also started to slacken with the home buying tax credits lapsing a couple of months back. This has been accompanied by falling CPI and PPI which in turn has revived fears of deflation. The FED minutes released last week also talked about downside risks to growth.
Corporate results of companies in the US have also in general been good in terms of profitability but lower than expectations in terms of topline. This could also in part have been due to the extremely strong dollar last quarter which would have reduced revenues in dollars as converted from local currencies for US MNC’s. All these factors saw the markets sell off sharply at the end of the last week. The results from financials have been good in terms of profits and improvement in balance sheet parameters but topline growth has been lagging expectations.
On the other hand the results season that started in India last week started off slow with Infosys and HDFC just about delivering, however it picked up during the week with most of the companies that reported over the last three days bettering expectations in general. The results coming out of the small number of mid cap companies that have reported till date has also been encouraging. Where deflation is a threat in the West in India it is more of rising input cost and capacity concerns on growth.
Rising inflation forced RBI to act a few days back in terms of tightening policy rates and the industrial production numbers for the month of May also showed a decline over expectations. The tight liquidity conditions that have persisted over the last two months would also be having an impact on growth. I think going forward RBI needs to be careful in the way it tightens as domestic liquidity is tight and foreign flows are not high enough to provide enough liquidity today. Also inflation is likely to fall off sharply over the next few months as the base effect plays out and also due to the fact that commodity prices across the board have been falling over the last three to four months. As the monsoon plays out and expectations of good rains actually turn out to be true over the next couple of months we will also see food inflation fall off sharply as inflationary expectation on the food side subside.
The concerns on China have shifted from overheating concerns to concerns on a slowdown in two months flat. I am amazed that most people are not satisfied with a 10% growth in a country that has grown consistently at 10% plus over the last two decades. How long can an economy sustain a 10% kind of growth? There is only one way to go with this kind of growth and that is down. However in my view this is not necessarily negative as it reduces inflationary pressures and allows policy to be more accommodative going forward.
As such with such a multitude of news flow floating around which way will the markets move is something to be analyzed closely. In my mind the USD carry trade on emerging economies is very much on. However with the sharp rally that we have seen over the last 20-30 days we could see some sort of short term sell off as a follow through of what’s happening in the US. The Chinese markets look like as if they have either already bottomed out or in the process of bottoming out as valuations have become attractive and overheating concerns have subsided. The US government Bonds and German Bunds also seem to be forming extremely negative technical formation which leads me to believe that we could see a shift out of bonds to risky assets over the second half of the year.
The entire event has also coincided with steadily worsening numbers in general with regards to the US economic growth and we have seen most of the data points related to industrial growth, consumer confidence, leading indicators etc fall off and the only positive thing that we have seen is that filings for unemployment benefits have been steadily reducing with reducing jobless claims. The housing market has also started to slacken with the home buying tax credits lapsing a couple of months back. This has been accompanied by falling CPI and PPI which in turn has revived fears of deflation. The FED minutes released last week also talked about downside risks to growth.
Corporate results of companies in the US have also in general been good in terms of profitability but lower than expectations in terms of topline. This could also in part have been due to the extremely strong dollar last quarter which would have reduced revenues in dollars as converted from local currencies for US MNC’s. All these factors saw the markets sell off sharply at the end of the last week. The results from financials have been good in terms of profits and improvement in balance sheet parameters but topline growth has been lagging expectations.
On the other hand the results season that started in India last week started off slow with Infosys and HDFC just about delivering, however it picked up during the week with most of the companies that reported over the last three days bettering expectations in general. The results coming out of the small number of mid cap companies that have reported till date has also been encouraging. Where deflation is a threat in the West in India it is more of rising input cost and capacity concerns on growth.
Rising inflation forced RBI to act a few days back in terms of tightening policy rates and the industrial production numbers for the month of May also showed a decline over expectations. The tight liquidity conditions that have persisted over the last two months would also be having an impact on growth. I think going forward RBI needs to be careful in the way it tightens as domestic liquidity is tight and foreign flows are not high enough to provide enough liquidity today. Also inflation is likely to fall off sharply over the next few months as the base effect plays out and also due to the fact that commodity prices across the board have been falling over the last three to four months. As the monsoon plays out and expectations of good rains actually turn out to be true over the next couple of months we will also see food inflation fall off sharply as inflationary expectation on the food side subside.
The concerns on China have shifted from overheating concerns to concerns on a slowdown in two months flat. I am amazed that most people are not satisfied with a 10% growth in a country that has grown consistently at 10% plus over the last two decades. How long can an economy sustain a 10% kind of growth? There is only one way to go with this kind of growth and that is down. However in my view this is not necessarily negative as it reduces inflationary pressures and allows policy to be more accommodative going forward.
As such with such a multitude of news flow floating around which way will the markets move is something to be analyzed closely. In my mind the USD carry trade on emerging economies is very much on. However with the sharp rally that we have seen over the last 20-30 days we could see some sort of short term sell off as a follow through of what’s happening in the US. The Chinese markets look like as if they have either already bottomed out or in the process of bottoming out as valuations have become attractive and overheating concerns have subsided. The US government Bonds and German Bunds also seem to be forming extremely negative technical formation which leads me to believe that we could see a shift out of bonds to risky assets over the second half of the year.
The next week is extremely heavy in terms of results and as such the short term movements of the markets will also be influenced by the results on a daily basis. We have also seen interest coming back in the mid cap segment of the markets as investors become more convinced about long term growth prospects. The other area of some concern is the steadily increasing leveraged trades in the domestic markets in the Futures & Options segment where outstanding have risen to high levels and as such the markets in the near term are more susceptible to sell offs due to global events. However on an overall basis taking into account all the news flows I would still argue that even if we have a sharp sell off it will be very short term in nature and will create the ground for a bigger rise subsequently. Specific investment ideas will continue to play out wherever results beat expectations as the expectation from the mid caps are still muted.
Overall still play for the BULL.