Simultaneous rise in these 3 asset classes is BIG trouble
BNP Paribas Mutual Fund
WF: It looks like the stage is being set up for the perfect storm! Looking internationally first, how do you read the situation in the EU, the US decision to commence a trade war with the rest of the world and the rise of US treasury yields beyond 3%? What implications does this have on global markets in general and Indian markets in particular?
Ritesh: Trade and tariff barriers are never good for markets. Having said that, I believe Europe and China would bear the brunt of this battle, not so much the US. The European situation is particularly precarious because, in spite of all ECB support, the European economy is still very weak with almost flat bank lending. When Greece was in trouble, it could be bailed out because of the small size of its economy but Italy is a behemoth because of its size and its high debt/GDP. It was actually ridiculous that Italy bond yields traded lower than US bond yields simply because of ECB bond buying. Markets don’t like uncertainty and concerns over Italy and Deutsche Bank is reflecting on European equity markets. Another worry for markets could be rise in the US bond yields which make them attractive in comparison to the rest of the world. For any reason (due to FED quantitative tapering, rise of FED rates or widening US fiscal deficit), if the US 10 year bond yields sustainably breaks out above 3% then capital from the rest of the world can shift back to the US and would lead to disproportionate rise in Emerging Market bond yields including India. I am not much concerned about the impact of trade war on Indian equity markets simply because India is largely a domestic oriented market. What I am worried about is rising crude prices and sticky core inflation; because at some point in time it will lead to stagflation in India which will negatively affect corporate profitability and equity markets.
WF: Indian macros seem to be deteriorating even as some fund managers prefer to focus on the micros of stocks they own. How do you read the Indian macro situation and how do you see this impacting Indian debt and equity markets going forward?
Ritesh: Oh yes no doubt, the culprit is rising oil prices and very low agricultural commodity prices along with rising government spending and lower corporate capex. Rising global oil prices, if passed on as it is now, is the best thing for Indian macros because it shifts the burden from the government deficit to the consumer leading to lower demand for crude without compromising on government finances. So watch out for any compromise of sharing burden with PSU which will be negative for markets. Lower agricultural prices will actually be inflationary because the government has already committed to a safety net and that entails higher outlay. At this stage in the economic cycle, the corporate capex should have started rising and the government spending should have come down but I don’t see this happening so I will be keeping a tab on this over the next few months to determine whether we are on the third day of five day cricket match or fifth day.
WF: Does the 9 year old global equity bull market appear fragile now? Are we now close to the end of this cycle or does the bull market still have some more way to go? What signs would denote topping out of this cycle?
Ritesh: I can see the cycle topping for almost all major economies except US simply because the US small caps (Russell 2000 Index) has broken out to a new high and this supports my theory that capital is moving back to the US. This also means that the periphery economies (economies with deteriorating macros) are very vulnerable to any shift in capital flows. I am not getting into the fundamentals but simply dipping into the capital flow model. The US has shared its GDP with the rest of the world since the last 30 odd years of petrodollar system and now with them being energy independent and a big exporter of oil they don’t see the need to carry the burden of the world. Hence they are withdrawing from the world and are going to take back their capital so the economies which are dependent on global trade or dollar funding to run their economies are in deep trouble. The final sign for me would be when all the three asset classes in unison will be rising, the US dollar, US bond yields and US equity markets and we are already seeing some initial signs of it.
WF: What is your strategy now in the fixed income space – on duration funds as well as accrual based funds?
Ritesh: We are not into accrual space but I think we will see spreads widening for lower rated corporate bonds as liquidity tightens. Indian G-Sec yield curve shouldn’t be this flat in this kind of nominal GDP so instead of duration we prefer liquid government bonds more from a tactical purpose rather than owning for long term because I believe rates are headed higher this calendar year.
WF: Where do you see the best opportunities in Indian fixed income now and what product categories appear the best bets now?
Ritesh: The ideal opportunity is in short term bond/ FMP/Roll down types of product. Investment in accrual should be on hold till the time the spread widens further. Instead of accrual an investor may look for retail bond issues which have started giving more attractive yields.
WF: What is your equity strategy now? Which themes and sectors do you see value in now and which ones appear overvalued?
Ritesh: We continue to position our portfolio around the broad themes, Formalisation, Financialisation, Pollution Clampdown in China, Doubling of farm income and Fiscal spending which we started out this calendar year with some minor changes.
We remain overweight financials, especially private-sector retail banks where they are gaining market share from PSU banks and insurance companies benefitting from low penetration. We are positive on the recovery in consumption and are participating through staples, selected discretionary consumer companies ranging from auto and media to retail and the leisure industry. Our overweight in industrials is a pure bottom-up play as we believe the macroeconomic recovery is still underway and are hence participating in this via selected industrial companies.
We remain underweight energy and healthcare and have reduced underweight in information technology sector. We added technology companies that have managed to see benefits of better execution at their end and some marginal tailwinds in demand outlook from their key end user segments.
WF: Which product categories within equity and hybrid funds appear the best bets for investors now?
Ritesh: I think from a three years perspective multicap funds with a large cap bias is an ideal category to be in. Balance funds will retain its charm but expectation needs to be toned down. Fixed income has started becoming attractive from a three to five years perspective but I will hold on till year end and till then arbitrage is the next ideal category.
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