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Alpha Edge, July 2016 - Something's gotta give

June was once again a roller coaster of a month for equity markets with two key events - US fed meeting and Brexit. The Fed meeting was as expected - a non-event.  Fed played the wait and watch policy influenced by the Brexit vote that was yet to happen. On June 24 we saw a historic moment, when for the first time in six decades a country voted to opt out of the EU. And the result was a ‘Redemption day’ where the world pressed the panic mode as the result of the vote was stunning and unexpected. However a near six sigma event fizzled out in its severity as world markets started anticipating a continuation of a soft central bank policy. This is one reason why markets brushed aside a critical event to rally as if nothing had happened. This dependency on central bank’s support may be dangerous as is by each episode of monetary easing that is leading to diminishing results, soon to approach zero impact. But that day may be sometime away.

 

Moving to the macro-economic picture, a big global red flag is a China slowdown and what-if they depreciate their currency massively. As a manufacturing hub to the world, they have done a lot in the last eight years to compensate for the near lack of perceptible growth momentum to the world it was serving. Their choice of tools have caused credit to explode to unproductive assets, making interest servicing difficult to those who borrowed. As a sideshow this created bubbles in real estate and then in stock markets. Sensing trouble, global investors are pulling out of China in a big way. If China recovery is delayed further, China may be forced to devalue and probably by a big quantum. Asian currencies as a result can turn volatile and upset many equations. Especially if it coincides with the 25 billion dollar FCNR outflow from India around September.

 

Back home we saw disappointing IIP numbers and a delayed start to the monsoon which recently picked up, bridging the rainfall deficit gap considerably. On another note, Mr. Rajan’s decision to not opt for a second term set alarm bells ringing. Strangely, the markets quickly brushed aside the doubts about continuity of the big monetary battles of taming inflation & cleaning up of the NPA problems of banks and rallied hard. Going forward all eyes would be on the monsoon session of the parliament where the expectations would be of passage of the GST bill. Earnings wise, Q4 of FY16 saw much better numbers signaling a recovery, but the numbers would whittle down if banks & Oil refiners were taken in to account. News papers` headlines conveyed a selective picture. We do feel that the trends are signaling for earnings recovery this year. Our concern is that it may not be broad based. Recovery could be limited to few sectors aided by Consumer-led themes continuing to drive earnings on the back of the Seventh Pay Commission payouts and possibly good monsoons. These two are the pillars of all hopes of a continued rally in markets.

 

 We believe something’s going to give in soon. Either broad based earnings have to pick up - evidence yet to surface, or stock prices correct reasonably – recent counter intuitive rally has us scratching our heads, or interest rates fall in India – which we doubt will be significant for another quarter or so, despite global rates scraping the bottom. In light of this, we strongly recommend fund strategies with flexibility to move across, both in Equity & Debt. Until one of the three gives in, focusing on absolute returns than beating the markets, is a desired virtue, in a world where economic theory is being turned upside down, negative interests rates et al.,

 

 

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