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State of Fear

Nov 7, 2016


On Sep 12th, 2016, we wrote that indices were richly valued and forward returns on the index were likely to be muted (see “Global Turmoil and High Valuations” Sep 12 2016, Nifty 50: 8866).

This week we discuss the current investment scenario, implications of the U.S. elections, our past experience with similar events, review where we are in the business cycle domestically and globally, review our technical models, and update our investment outlook.

Investing in Times of Fear & Uncertainty

“Nothing is so firmly believed as that which is least known.”

― Michael Crichton, State of Fear

The markets are on risk-off, investors panicking because markets hate uncertainty. The end of the week witnessed the recognition that Donald Trump could be sitting in the White House and we had an ugly sell-off. Anything can happen, so it is important to consider the facts and historical precedent.

The U.S. Bond Market Is Not Signalling Any Imminent Signs of Stress in the Economy

The U.S. Bond Market Is Not Signalling Any Imminent Signs of Stress in the Economy

Fear Increases Viewership

The media is on overdrive, spreading fear and uncertainty. There is one thing the media in the U.S. does particularly well – whether it is a hurricane, a snow storm, terrorism, or financial markets uncertainty – and that is create and perpetuate fear. Fear brings eyeballs and ratings. But when was the last time the financial media got things right? So in times of uncertainty, the hype is the last thing we choose to listen to.

Let us consider some facts were Mr. Trump to win.

Republican Wins Lead to Handsome Market Returns

In almost every case back to 1880, equity markets in the U.S. have risen on news that Republicans win elections and fall when Democrats win. This time around as well, a Republican win is likely to lead to massive tax cuts, and markets love lower taxes.

Protectionist Policy Against China is Unlikely

We in fact welcome the U.S. taking on China for protectionism. China has benefitted from lop-sided agreements for decades. However, the Chinese happen to own massive amounts of U.S. debt, so we are skeptical that this will happen. If it did, however, we would surmise that it would naturally coincide with a further strategy tilt towards India.

Exports have been a major driver of the U.S. economy. They need us, as much as we need them. Moreover, Mr. Trump’s rhetoric in the third debate was decidedly pro-trade. So we are a little less panicked than most on this issue.

Bring Jobs Back to the U.S.

Most of you that have followed U.S. elections know this rhetoric creeps up every four years. Usually there is limited follow through. We would ask though, does the U.S. want textile manufacturing jobs at Bangladesh wages or BPO jobs at Hyderabad wages? Any alternative at U.S. wage rates would mean lower profits for U.S. corporates and the fact is that U.S. policy is driven by corporate lobbyists, so we’re sceptical on this front as well.

Spending, Debt and Taxes

Mr Trump has raised the possibility of massive tax cuts as well as restructuring U.S. debt in the manner of a failed real estate developer. Perhaps this is just campaign rhetoric. Again, a massive tax cut is a massive positive for the markets. We would point to the 1980s and the 2000s as two examples.

In contrast, the spending and tax measures (cuts for some, increases for others) advocated by Hilary Clinton would boost public debt by $200 billion, to 86 per cent of GDP, over the next decade.

The question we are asking is this: Since when did the U.S. become concerned about taking on additional debt, particularly when this debt would be stimulative for the economy. Mr. Trump will likely use a tough position on debt. Again, how far he succeeds remains to be seen. Our view is that tougher constraints on the Fed would be welcomed by global institutional investors.

Geo-political & Terrorism Issues

Mr. Trump has taken a hard stance on terrorism. From our vantage point, that aligns India on terrorism policy with the U.S. The recent sting operation that India staged is evidence that the Modi government is moving on similar lines.

Currency Manipulators

Trump wants to go after “currency manipulators”. Again, this list would seem to indicate China and not India. However, this would again appear to be campaign rhetoric and we expect currency and exchange rate policy will be driven by Wall Street and not Washington.

We will wrap up by stating it is highly unlikely the Republicans get control of both Houses, it is never easy to implement massive reforms, a repeal of Obamacare will be a market friendly event, and massive tax cuts are good for markets.

Indian Economy

Our investment outlook is data driven. After a lull in the summer, the data in India seems to be improving and that to us is a predictable and reliable driver of market returns.

India’s Manufacturing PMI Hits a 22 Month High & Private Sector Activity a 4 Year High

Manufacturing sector growth in India hit a 22-month high in October, driven by a sharp and accelerated increase in new orders, purchasing activity and output. The Nikkei Markit India Manufacturing Purchasing Managers’ Index (PMI) rose to 54.4 in Oct-16 vs. 52.1 in Sep-16. Survey data indicated that this placed pressure on firms’ capacity as backlogs of work rose further, but employment levels were unchanged over the month.

Subsequently, the Nikkei India Composite PMI Output Index rose from 52.4 in September to 55.4in October. This pointed to a marked pace of expansion in private sector activity that was the quickest in nearly four years. Boosting growth of services output was a pick-up in new orders, which expanded at a solid pace that was faster than in September. According to panellists, the upturn was supported by greater client requests and improved demand conditions.

PMI Data Indicate that Private Sector Activity Was Quickest in Four Years in October

PMI Data Indicate that Private Sector Activity Was Quickest in Four Years in October

Credit Growth Remains Strong, Rural Growth Showing a Marked Uptick, up +13.6%

Alongside strengthening manufacturing and services activity, credit growth has moved up for agriculture and allied activities (yellow line in chart below), up +13.6%. Personal loans are up 18.1%. Non-food bank credit is keeping track with GDP growth at roughly 8%. Services sector credit growth is up a healthy 12.1%. The only sector missing from the party is industry credit. In light of strong demand trends for capital, we surmise the consumer, the rural sector and the services economy are showing improving fundamentals.

Personal Loans Strong +18.1%, Agricultural Credit Activity Accelerating Higher, +13.6%

Personal Loans Strong +18.1%, Agricultural Credit Activity Accelerating Higher, +13.6%

Strong Money Supply Growth Also Helping to Spur the Economy

Strong Money Supply Growth Also Helping to Spur the Economy

Earnings Scorecard

With earnings season underway, and roughly 179 companies out of our universe of CNX 500 reporting, the numbers are reasonable but not stellar. Earnings growth, adjusted for Axis Bank’s huge miss and Idea Cellular’s huge loss, are up 13.4% year over year. Not bad. This is lower than the prior quarter’s adjusted 14.8% growth, but there is many more companies to report and we are only one third of the way through earnings season.

The number for the NSE 100 which is large cap dominated, is currently at 11.9%, suggesting that earnings growth is coming from the lower cap quintiles of the market.

MidCap Earnings Revisions Are Showing Upward Momentum While Large Caps Remain Dormant

MidCap Earnings Revisions Are Showing Upward Momentum While Large Caps Remain Dormant

With 179 Stocks Reporting, Adjusted Earnings are Up 13.4% YoY

With 179 Stocks Reporting, Adjusted Earnings are Up 13.4% YoY

Global Economy

Good News – Growth Is Picking Up in China and the U.S.

The Caixin China Composite PMI indicated the fastest expansion in Chinese business activity since early 2013 during October. It was predominantly supported by growth in manufacturing output, but the services sector also picked up from the previous month.

Caixin China Output PMI Strongest Since 2013         U.S. Services PMI Strongest in 11 Months

China Output PMI Strongest Since 2013 U.S. Services PMI Strongest in 11 Months

U.S. GDP:U.S. Q3CY16 gross domestic product was up 2.9%, vs 2.5% expectations driven by strong exports.

U.S. Markit PMI:U.S. Markit Services PMI for October came in at 54.8, vs. 52.3 in September highlighting the strongest pace of growth in the services sector in 11 months. However, the U.S. ISM non-manufacturing PMI dropped to 54.8 in October vs. 57.1 in the prior month. October data pointed to a relatively strong month for the U.S. service sector, with business activity and incoming new work rising at the fastest rates since November 2015. Survey respondents attributed the recovery in growth momentum to improving domestic economic conditions and greater consumer spending in particular.


The selloff last week led to the index closing at 8434 levels down by 2.23% for the week. The Nifty has broken the critical and psychological level of 8500 and closed below it. As mentioned earlier the bearish head and shoulders pattern has also given a breakdown pattern and the index closed below the neckline level.

Momentum indicators have entered into bearish range with price also breaking previous swing lows around 8500 level, conforming the break down. The pattern is giving a target around 8040 on the downside for the Nifty. In between support is seen at 8150 levels which is the 38.2% retracement of the whole rise from Mar’16 of 6826 to Sep’16 high of 8969. FIIs turned sellers for the month of October for the first time since Feb’16 with a net out flow of Rs 6168cr.

On the derivatives front, Nifty Future witnessed unwinding of long positions. But in the last trading session there was 1.82% increase in open interest indicating a build-up of short positions. Also Nifty Put options saw the highest open interest shifting from 8400 strike to 8200 suggesting market participants expect lower levels. Nifty options put call ratio is also below one level at 0.93 which is negative. INDIA VIX is currently at the 16.85 level coming off its lows of 13 and likely to head higher.

Going forward, if the Nifty sustains below 8500 levels, then market is likely to test 8150 initially and then 8050 levels on the downside. On the upside, any pullback is likely to be capped between 8550-8615 zone.

China Output PMI Strongest Since 2013 U.S. Services PMI Strongest in 11 Months


In a piece titled “Global Turmoil and High Valuations” on Sep 12th, 2016, with the Nifty 50 near its highs, we wrote that indices were richly valued and forward returns were likely to be muted on the index. Since then, the market is down some 5% while most stocks are down much more.

Today, with the world wringing its hands in fear, we are letting the data drive our investment positioning and looking to add to portfolios as the sell-off continues. We see nothing in the data that suggests alarm. On the other hand, we see hyperbole, misinformation and fear mongering, typical of the media prior to major events.

In the event Mr. Trump wins, we are talking about a shrewd, successful businessman taking over the helm of the world’s largest economy. In the event Mrs. Clinton wins, we are talking about a shrewd, seasoned politician taking over. It is never as bad – or as good – as the media would have you believe. Meanwhile our domestic economy looks to be improving, alongside improving fundamentals in China and the U.S.

The time to protect portfolios was September 12th, or even last week. While the market looks to have had a horrible week, these are usually times of opportunity. When fear is high, the opportunity set is more attractive. We advise clients to stay invested, add to positions, hold on to the knowledge that India is the fastest growing and one of the strongest economies in the world, and not let the fear mongers sway us. Let us keep in mind the long view and keep fear away from our portfolio decisions.

In the event of further selloff, once the dust settles, capital will seek yield and growth.