Mar 21, 2016

Market Update – On the Global Economic Scenario and the Indian Budget- 21/3/2016

The equity and debt markets have found some stability at the current levels. This is after the extreme bout of volatility witnessed in the months of January and February.

The general global macro consensus is that China is slowing down, along with Europe and Japan. The US is showing some sprouts of economic revival but the Fed cannot formulate policy in isolation and will have to keep tab of the global economic scenario.

After the global financial crisis of 2008-09, most governments in the world eased up on liquidity hoping that this would lead to a revival in the investment as well as consumer credit cycles. What happened instead is most of this money landed in the hands of speculators and financial firms chasing high-returns (on the quick).

China launched a massive fiscal expansion program in the wake of the Financial Crisis. This meant that credit was easy and the world’s largest exporter went in to over-drive in trying to corner the global market for goods and commodities. Other G20 countries also created conditions for a global credit glut thereby creating a massive rally in commodities (including Oil and Gold). Speculators also bought in to this frenzy creating an even larger commodity bubble.

What we are witnessing now is that the world has finally realized not enough people are buying these goods and commodities. So, even at super-low interest rates, many firms around the world are struggling to repay their debts because of ‘lack of demand’.    

This is difficult terrain for the global economy to navigate and we expect that in the absence of any other ideas monetary and fiscal expansion will continue. This means that debt will continue to remain cheap. However, this time money may not pour in to commodities. We believe that some of this money will make its way in to ‘emerging markets’.

In this context it is good the Government has decided to focus on macro-economic stability in this year’s budget. This allows us to attract global capital. We will (over-all) be beneficiaries of the commodity bear market. This has created room for India to be extremely attractive to foreign capital.

India’s primary concern is that we are capital starved. Coming on the back of a high interest rate regime as well as the huge burden of NPA’s, banks will find it difficult to bring down interest rates quickly. What we could instead witness is an expansion of the corporate debt market with significant foreign investor interest. The finance minister has already indicated that he would like to focus and develop India’s corporate bond market.  This should be an interesting space for investors in the coming years.

We also believe that there will be a slow-down (correction) in the domestic business environment. This is on account of both global and local factors. Credit (at present) is hard to come by for Indian businesses. The global slow-down will also affect demand. While over-all regulation and governance has improved, credit- growth is still low indicating a lack of business and consumer confidence. Government spending on infrastructure has been increased. We expect that it will take at least a few years for the ‘trickle-down’ effect of these initiatives to come to fruition.

A stable macro-economic environment also creates room for the RBI to reduce rates. This could create a major fillip for the economy. The debt markets will be the most interesting to watch and will give us good long-term asset allocation indicators.

The equity market is currently trading at 18.85 time trail. This is slightly higher than its long term averages. The market (Sensex) has rebounded quite smartly from 23,000 to about 25,000 today. For our long-term asset allocation we will continue to remain under-allocated to equities.

The 10 year G-Sec has had a tremendous rally post the budget (benefitting from the finance minister’s commitment to rein in the fiscal deficit and the over-all budget’s commitment to macro-economic stability). From 8% in February, yields are now close to 7.5%. Duration plays would have benefitted from the rise in prices of bonds. The macro-economic environment has also created conditions for a slight over-allocation to bonds. We recommend this strategy for our investors.