We have had a unique start of sorts to the new year 2016 where the cautious optimism of last year end has given way to pessimism and despair mainly due to the occurrences in China and the two instances of down circuit filter of 7% each in the Chinese Markets. People have also been spooked by the “HUGE” 1% downtick in the Chinese Yuan. Incidentally 1% daily swings are very common even with currencies like the Japanese Yen and the Euro. Let’s look at some issues one by one and then see what lies ahead.
CHINA- It is a given that the Chinese economy which sustained high growth rates of 9-10% mainly due to huge investments in fixed assets (which ran at the rate of 20% growth for years) is going to keep on slowing down. Given the huge Debt:GDP ratio of China at 280% as a whole it is unlikely that there is going to be a growth uptick anytime in the next 10 years. My view is that China will slowly come down to a growth of 4% over the next 10 years although it will still sustain 6-7% in the near future. There is no case to be worried on Yuan fall of 3-5% every year when currencies like that of Brazil have fallen nearly 35% in a year. However consumption growth will continue to be strong with growing prosperity as incomes increase and hence it will be a dichotomy of sorts.
The big debate of China is of “Hard Landing” i.e. a drastic and sudden slowdown of growth and maybe some sort of crisis. This is highly unlikely in my view. There are several positives in China.
– The household sector is a big net saver with savings rate of 40%. Unlike Western economies the Chinese have not lived beyond their means and will as such remain strong consumers for a long time to come. Chinese households save around 30% of their monthly income and consumption as a part of GDP is just 35% versus 75% plus for USA
– The Fiscal Position of the Chinese Government is very strong. Sovereign Debt to GDP remains extremely benign at just around 40%. This gives enough levers to the government to step in and support any major crisis in Government enterprises as well as Banks or the Property segment.
– Despite a rundown of nearly $ 80-100 billion every month for the last several months the foreign exchange reserves are still at $ 3.3 Trillion which is much higher than what they actually require. As the Yuan becomes freer floating and the onshore and offshore rates converge the pace of decline will slow down.
In a nutshell I do not believe that a big crisis is going to be triggered by China.
US and European- US and Euro zone growth data as well as employment data continues to be encouraging and indicates sustained expansion. Moreover sustained low commodity prices create a situation where the inflation uptick gets further pushed back. As such we are likely to be in a lower interest rate environment longer than what was thought a year back. A shallow US rate increase cycle as well as continued money printing by the ECB and BOJ means that liquidity will be adequate at least for the next 2-3 years. As such the view that there is going to be a huge liquidity withdrawal from Emerging Markets is farfetched. It is just an extrapolation of what happened in 2015 rather than an actual view.
We have seen a decent time wise and value wise correction in most equity markets. For example the DOW is at the same level now where it was two years back. The same is the case with European Markets. Most of the froth is out now. Equity bull markets will never end at the beginning of a rate hike cycle in any case.
INDIA
The most interesting part about the story for 2016 is the extreme pessimism with which it has started versus that bloated optimism of 2015. I was extremely cautious at the beginning of 2015 and am Bullish today.
The same brokerages that could see the “Mirage” of growth a year back are unable to see actual recovery today. The most interesting ones are two specific ones. UBS had an index target of 9500 for Dec 2015 in Jan 2015. Now they are forecasting 8200 by Dec 2016. Similarly the other ultra bull Ambit has come down from 36000 to a flat market. The same is the case with most armchair forecasters. As a contrarian it further reinforces the BULL CASE for me.
Several things are likely to go right for India
The full advantage of commodity weakness- The Indian economy is likely to see the full benefit of commodity weakness this year. We have an $ 80-90 billion swing advantage in savings just due to the fall in crude prices. It is true that nearly $ 40 billion of this has not reached the final consumer due to tax increases by the government. However the economy as a whole has got the benefit and this will play out in the form of growth uptick in this year and maybe for a few more years. It gives leeway to the government to further invest in capital expenditure. Similarly other major imports like Coal, Edible Oils etc also are giving a good advantage to us today.
Pay commission boost- The implementation of the Pay Commission recommendations will give an immediate boost to consumption. We are likely to see greater spend on Consumer Durables, Housing, renovations, holidays etc. The boost will be significant as it goes to the middle class where the probability of additional spend is high.
Infrastructure investments- We are already seeing a significant uptick in investments on the infrastructure side especially roads and a start of a potentially significant uptick in railways. Urban and Rural infrastructure spends are also likely to pick up going forward. Government projects like Swacch Bharat as well as the UDAY scheme of the power ministry will continue to boost investment in these segments. A successful implementation of SEB reforms will go a long way in boosting capital spends. Government capital expenditure data also continues to be strong.
Full advantage of lower interest rates yet to be seen- As banks were slow to pass on rate cuts to consumers the full advantage of the same is yet to be seen. We should see the impact of the same in both improvements in corporate results as well as uptick in consumer growth this year.
Monsoons- After the worst EL NINO in several years or decades the global weather forecasters are predicting an end to the phenomenon this year with a 50% probability of Neutral conditions and a 40% LA NINA chance. Moreover historical analysis of the last 150 years also indicates a normal to surplus monsoon after two bad years. With food inflation already having plateaued along with benign inflation in other CPI components a normal monsoon will do two things. Firstly it will contribute towards keeping inflation low and also boost rural consumption which was subdued this year. The probability that we will have a benign inflation environment which will lead to lower interest rates is looks higher today.
Corporate earnings growth estimates have turned pessimistic- From projecting a 15-20% earnings growth most forecasters are predicting that they cannot see much of earnings uptick today. This pessimism is good as it increases the probability of positive surprises and also creates a situation where the expectations have become so low today those small positive surprises can create a good price uptick. Most forecasts ignore an economic upturn, greater consumption, lower interest rates, operating leverage etc.
IN CONCLUSION
In conclusion I am of the strong opinion that, as at the beginning of 2015 it was important to ignore the hugely positive noise today is the time to ignore the extremely negative noise. Whenever we have sharp market falls the Doom and Gloom forecasters dominate television screens. Yes there will be volatility in the markets but the outlook is positive from a valuation as well as growth perspective. There is no way that the global equity bull market has ended as of now.
Many Large Established blue chip companies today are trading at 52 week low levels and at prices which are very cheap even assuming zero growth. Who can ever forecast the bottom or top, however those who are contrarian will make money in these companies for sure if they hold for the next one year. Although overall mid cap company growth outlook is improving valuations on an overall basis for that segment of the markets will adjust as large caps start performing again.
Looking at the markets everyday might make you pessimistic but the reality is likely to be different as we will see in Jan 2017.