Over the past several months, we have witnessed two interesting phenomena in India. The first is the considerable shift in India’s micro indicators; the second is the outsize role of a few stocks in driving the stock market. Both of these offer insights on why selectivity is essential in investing in India’s equity market.
In recent years, India enjoyed good macro conditions primarily led by subdued inflation, lower interest rates and commodity prices (especially for crude oil), a manageable current account, and an appreciating currency. Despite the positive macro backdrop, the micro – or the health of many Indian companies – had room for improvement, with many companies suffering from high leverage and low demand for their products. Challenging micro aside, the equity market (represented by the MSCI India Index) rose nearly 39% in 2017. This surge was largely fueled by domestic as well as foreign flows chasing good macro but ignoring the deteriorating micro environment.
Fast forward to 2018, and the macro has faced pressure largely from the depreciating currency and higher commodity prices, while the micro environment has improved considerably. Indian companies are moving forward, and demand is coming back.
US tariffs on an additional US$16 billion of Chinese goods just went into effect, completing the $50 billion of tariffs announced in April. The tariffs focus on industrial machinery and avoid many consumer-grade products like computers, smartphones, and apparel. China has reciprocated in kind with tariffs on $16 billion worth of US imports including fuel, autos, and steel products. So what’s next? We see three key events worth watching for the rest of the year:
In pre-crisis days, market participants understood that central bankers had their hands on the short-term end of the yield curve and knew how to react when rates were dialed down to boost a sluggish economy or up to cool an overheated one.
In response to the financial crisis, mission creep set in. Leading central banks moved into the long end of the curve, where rates traditionally had been determined solely by market forces. Yesteryear’s yield curve, therefore, was a transparent comparison between the market’s view of the economy down the road versus the Federal Reserve’s. When the 10-year Treasury rate fell below the two-year rate, creating an inverted yield curve, recession typically followed 18 months later – a report card suggesting that the market had superior forecasting powers. Today’s yield curve may have morphed into a kind of financial funhouse, where the rates we see are distorted images of market-determined rates.