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Alpha Edge, December 2016 - Unintended consequences

What a month it has been..and why not? Global markets went into a tizzy as investors fled to safe-haven assets and the Mexican peso plunged to record lows and we saw US 10 year firming up as Donald Trump goes on to be the next president of the United States. Markets were betting on a win for Hillary Clinton, who was widely seen as the “business as usual” candidate. Trump’s win sparked fears of a new era of protectionist policies.

The general expectations across the globe of a Donald Trump victory was that it will lead to chaos and will send equity markets crashing. So what changed? Post the election win, analysts seem to change their mind and favorably assess whether his (Trump’s) mix of policies could still spur a fragile global economic recovery thanks to Mr. Trump’s promises of increased government spending, cutting of taxes and easing financial regulations. One needs to see if it will outweigh his external anti-trade rhetoric and protectionist posturing. Trumps domestic expansionary polices that are growth oriented and likely inflationary may be viewed as wresting the baton from the fiscal policy, that has kept US afloat so far after the great recession.

Hence, post the initial frenzy, markets globally changed course and what followed was that the Dow and other indices in developed markets hit record highs during the month. Just as all this was unfolding, Indian markets too mirrored its global peers, however it was only for a short period. Indian markets had to deal with another blow called the “Demonetisation”.

Yes, Indian markets not only had to deal with the surprise of US election win but also struggle to grapple with the sudden announcement of 84% of cash in the system invalidated. This is a big deal. What followed was chaotic with both analysts and economists scrambling to understand and interpret the impact that it could have. Well, we believe when something of this scale happens it is difficult to gauge the exact impact that it could have on the GDP or the earning. However one thing is emerging clear. There is an impact and it will be negative in the short term hopefully not into the medium term depending on how quickly Government increases cash liquidity in an economy. Most of the consumer spend happens in cash that’s 84% invalid for now and to replace that cash back in to the system, will take months. Until then, there would be restrictions on cash withdrawal which in turn means less spending comfort. Consumer spending was what was driving earnings and GDP growth till now with investments take-off nowhere in sight. However, beyond the uncertainty on consumption in the short term, significant changes are likely to occur. The top few being that the organized players benefit at the expense of the unorganized, improvement in the liquidity with. We will have banks with enough liquidity which would help interest rates soften further, we may even see reduction in tax rates as less money would be locked under mattresses and more taxes paid with people seeing increased risk in hoarding cash.  

With the uncertainty around and a rising interest rate scenario globally, we may see FII’s continue with their withdrawal spree which could put pressure on the equity markets that’s adjusting to the sluggish growth in earnings (which will now take much longer to recover) and high valuations. Hence, until we deal with the “Unintended consequences” of such a bold move by Indian PM, we will continue to see pain in the economy. 

 

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