Global Macro Strategy second half 2011: Inflation outlook

In the previous post we postulated some of the main factors which can dominate the second half of 2011.
The factors are:

1. QE3 or not?
2. Interest rates outlook for Emerging economies.
3. Will Fed hike the rates in 2H 2011?
4. The persistent European problem.
5. High levels of household debt and
6. Double dip or not....


Lets have a discussion about how each one of the above will affect the undercurrents of the markets.


As of now Fed has said that they are not doing any QE3 and I am sure they will not start any other money printing  program by the name of QE3. The Fed is already buying the bonds from the proceeds of maturing securities. 
That amount is not much and is staggered so the impact will be minimal.


The dual target of Fed being Inflation and unemployment cannot be met through the QE program now. While launching the QE2 there were fears of Deflation which is why the Fed started the money press. Now the CPI is rising so much that the US has released crude from the Strategic Petroleum Reserves. 


About employment the Fed cannot do much as it grows with the GDP. Unless there is growth in real economy the will not be much employment. To grow an economy one needs policy and incentives which is job of an administration, any reserve bank cannot do much in that space. 


So we feel that there will not be any QE3 program unless the inflation gets tamed.


It is expected that Fed will start raising rates in 2nd Half 2011 but as of now there are no indication in that direction. In the last Monetary Policy assessment Ben said that he is looking for an extended period of low interest rates. It is through the low rates that the Fed can keep giving the stimulus to the economy. Although it is debatable as Japanese low rates have not stimulated their economy in any way. 
I feel that unless there is a pickup in GDP to above 3% for two quarters Fed will not raise rates.


The ECB meanwhile has given indications of raising rates again as there target is to control inflation rather than unemployment. 
Given the worries on sovereign scenario for many European countries it does not make a case for any steep increase in interest rates but another 25 bps cannot be ruled out as the German and France industry is in good shape.


The scenario is very different in the Emerging economies as some of them has already raised the rates as the fight against inflation is intensifying. India, Brazil, South Africa, Taiwan all have raised rates minimun of 3-4 times in past 1 year.


There are now talks from China and India that the interest rate rise might be over as Inflation is showing signs of peaking. I think that with crude down to $90 levels there can be for sure some cooling off signs in inflation. 
Vietnam has actually reduced their rates this weekend as the growth suffered a lot. 


What we can see is less raise in interest rate rise from here.


In short there is for sure signs of abating inflation as there is no QE from US and crude below $90 levels.
This can reduce pressure on Emerging economies not steepen the rates which can improve their GDP growth in next 3-4 months.


The developing countries on the other hand will raise rates esp ECB as they feel the inflation heat.


All this can reverse the money to EM stock markets which fled earlier this year on inflation outlook.


Rest in next part

India Macro Strategy Part 1: Factors to consider

India has under performed for the first half of 2011. The performance was one of the lowest among the emerging markets inline with Egypt, Vietnam and Brazil. While Egypt and Vietnam has there own specific internal issues Brazil is in same set as of India. The problems plaguing India are Inflation, Investment slowdown, Inaction by policy makers.

We have been bullish on consumption stocks namely the FMCG for the first half. The rationale was to be in defensive sector as the first mid cycle slowdown hits the global economy.

Before forming strategy lets outline the major factors to consider:

1. QE3 or not?
2. Interest rates outlook for Emerging economies.
3. Will Fed hike the rates in 2H 2011?
4. The persistent European problem.
5. High levels of household debt and
6. Double dip or not....

All of the above issues were there in Jan 2011 and we are still having the same issues. Structurally noting has changed expect that QE2 has ended and fed has not indicating of any further QE measures at least by in name,

The same set of problems are still in the global economy.

Coming to India the main issues we need to consider are:

1. Inflation.... will this Genie ever get into the bottle
2. Investment slow down across the sectors.
3. Inaction by Govt. on policy formulation.
4. GDP Growth concerns

The policy inaction on number of fronts has been the main concern for the India. Recent corruption scandals has impacted the county's image a big way. FDI like Posco has been in limbo for a long long time.

These are the factors we will consider to arrive at strategy for this half.
We will explore in detail each of the above factors in next post.

Macro Inflation Indicator Brazil's Bikini Wax

Today I read a beautiful article about how inflation is hurting people in their very social life. Link
The simplicity measuring inflation is these ways is far far better than putting all the surveys and collecting prices.

Summary: Brazil has one of the most beautiful beaches with year long summer so waxing far common. But the cost of waxing has increased a lot and is putting a lot of pressure on wages.

The country is facing very similiar prioblems like India and the central Bank over there has increased rates a lot and is also using currency as a tool to fight the inflation.

The stock markets looks very and has followed more or less same path.

Macro event trade: Wheat and Rice to gain

There is a drought condition in North China which is a major Wheat and Rice growing area. The drought is said to be worst in last 50 years. The first alert for the drought came in Feb 2011 when the rains were totally dry season.  What makes it worse is that China is world’s largest producer of Wheat.

The drought has come at the time of sowing season with very less of sowing season remaining now.

Since China has the world’s highest population it has many mouths to feed. This combined with the affluence of Chinese the per capita wheat consumption of China has increased a lot.

The wheat rallied to new highs in Feb and fell to supp[ort levels after that to 700 levels.

The commodity is trading in a range as of now but any further supply disruption can take it to new highs.

There are news of Ukraine starting wheat exports which can calm the markets for short term as of now.

But one can keep this commodity on the watch list for some time.

Strategy What happens when QE2 ends Part 1

The QE2 has been supporting markets a lot when it started in Nov 2010. The global markets made a fresh after that. The program is going to end in June 2011 and probably that's why the global markets  are changing their trends.

 In next few posts I will try to explore how to benefit from the upcoming macro event.

First lets see define the timelines

QE1 Start :  Jan 2009        QE1 End : Mar 2010

Ben Speech on QE2 Aug 2010  --> Indication on starting another round of QE.

QE2 Start : Nov 2010   QE2 End: June 2011

Everyone knows that the QE1 ended a bear phase and started bull run and most of global markets made highs in Jan 2010.

Most of the markets struggled during the QE1 end to start of QE2 period.

Attached is the chart with SPX and EEM with timelines.

The above chart clearly shows all the trend for US and Emerging markets.

Worth noticing is the markets show jitters 1 month before end of QE as it is unwinding of trades based on QE.

And I feel that the recent free fall in commodities was more or less attributed to end of QE2.
The increase of margins just added fuel to fire. The effect is clearly visible on CRB index charts.

So there is increased probability that when Fed withdraws the "Helicopter Printing Press"   (Visually)  then we can see a range market for quite some time.

India Sectoral Trend Weekly 6 May

The last two weeks have been tumultuous for the equity markets.

With the straight fall there has been a lot of change in the weekly sectoral trend for the markets.
The main points are:

1. The # of sectors on Sell / Lev Sell mode is 10 with CNX IT Sector in Lev Sell mode for last 2 weeks.

2. Nifty was in Neutral mode as of Friday 6th May.

3. The trend for 11 sectors is Neutral which is quite high indicating the ongoing sideways movement in many indices.

4. Broader market indices like BSE 500, BSE Small Cap, BSE Mid cap and  Nifty CNX 100 are in Neutral zone.

5. The cyclical index Metal, Realty, Cap Goods and IT are in bearish mode while the defensive sectors are in Neutral mode.

The above points clearly shows that the trend is towards accumulating the consumption stocks rather than being in Growth or High beta stocks.

This is inline with the earlier Macro call of Monsoon trade. See Post here.

The weekly color table:

India Sectoral Trend Weekly 21 Apr

Indian sectoral indices while remaining mostly in buy mode are showing signs of sideways move.

The indices average move last week was just 0.4% and prior week was -0.5% while the Nifty move 1.1% last week and -0.5% prior week.
The average move of last 2 weeks for broader market indices like BSE 500 is at 0.3%, Small cap at 0.6% and Nifty Mid cap was flat.

This shows that while that there was some traction in Nifty there is no clear sectoral leadership as of now which can take markets to new highs.

The weekly color is as follows:

The IT is still maintaining the Neutral color after the Infy's results shows broader strength is still present in the index.

The Auto and FMCG indices are clear winners and this could be a good monsoon macro trade.

Socioeconomics: The Cup that counts

India winning the ICC world cup is a moment that will be cherished and remembered for a long time to come.

This event will leave a big impact on the Indians and for sure can change the dynamics of sports in India and subcontinent. The Bhupathi Paes winning the finals and becoming top seeded in doubles was all lost in the news.



The hope that was materialized will provide new confidence to Indians and this for sure will reflect in the equity markets in times to come. As of now it would be difficult to quantify the impact.

The frenzy will continue to IPL and for sure the Media sector will all be flaring up.

The equity market did cheered with close above 5900 levels. Was it the Cup effect? It seems so.
The FII ownership at 18% (as of Dec 2010) is quite low and we Indians cheered to the news.

Japan: The macro effect. The effect is yet to be seen

First of all my sympathy for Japanese people and I pray to God that the situation does not worsen from here and the recovery for them to be strong.

Now what does the event reflects in numbers.
The major things are Future of Nuclear Power industry, Japanese debt, the GDP growth and the effect on their exports and the financial impact of the event.


I am pretty sure that the whole world will have to rethink of their push of Nuclear energy. Some protests have already been reported in Germany, UK and India. The major nuclear power equipment suppliers are GE, Areva, Westing house to name a few and state owned company of Russia. The Uranium suppliers from Canada and Australia can also be impacted.

The Japanese have the highest debt per capita of $ 44,722 as of Jan end. The only good thing is that about 75% of that internal debt. But that sure can limit to finance the recovery. The Govt was alrady under pressure to reduce the debt and is now faced to raise more. The BoJ has already doubled the massive quantitaive easing program to $ 120 bn.

Third the demographics of Japan is completely changed from the WW II and is now much more older. This sure can be a bit of dampener if they do not immigration some workers from Asia.

The Kobe earthquake effect was of 2.5% of the GDP. They counrty took about 2-3 months to recover from the shock itself leave the recovery.

Here is the chart of the Index at that time.

The equity market recovered after 4 months later.

I am also more worried if any Barrings bank like event this time as the index has plunged 6% in a uptrend.

The large picture macro buy would be Steel companies in China and Infra stocks in Japan. More about that later on.

Dow theory update: Rally is under threat

The last Dow update was just a week earlier where the outlook was bullish when the Dow Transports made a new high negating the effect of crude which was a sign of caution.

Now the Transports have broken the previous swing lows and has closed below the 50 DMA. The volumes were also more than average this time. What is worth mentioning is that the decline has persisted for 2 days and both days were more about 1% decline.

The RSI and  Macd was already on bearish divergence sell signal.  Chart.

The current effect is due to Middle east disturbance which is escalating day by day and can have wider geopolitical risks. The biggest is the crude shock. The last one was in 1971 which we have to study in detail to know the effect. Will post the results about that later.

Dow Theory another Bullish confirmation

The Transports Index made a new closing high y'day. Last time we observed the Transport index was at 50 DMA while the Industrial was at new high. The main observation was that it was due to high crude effect. Post here.

Now with Tran index closing at new highs it is bullish confirmation as per Dow theory principle.

Way to go Dow.

Now since US indices is in bull phase what could be the implications for emerging markets esp Indian markets.

This is a whole macro trade here. My call is to confirm the earlier buy of companies exporting to US/Europe. That call was in mid Dec. Link here.

The IT sector coupled with Gems exporting and a few commodities centric sector can do well based on this macro play.

Germany's DAX: Whats happening here and why?

DAX is one of the most bullish index in the world right now. (Kospi is another one.)
The index being in thick of Europe woes is making new 2 year highs and has recovered nearly 70% of the fall.

And all this when the Europe's currency worries are topic of every fortnight at least.

So lets dissect whats behind this particular index which is powering it to new highs.

Lets start by analyzing the German economy. The exports account for 1/3rd of the total national output with the country being the second largest exporter last year. Facts from wikipedia.

Now if we look that exports being so high of the output then lets see if the exporting sectors growing.
The main sectors that have Industrials and Consumer Durables both of which are export sectors.
These sectors constitute about 40% of the index. 
The main items being exported are automobiles, machinery which are needed throughout of the world when the world GDP is growing.
Thats one piece of puzzle.
Now comes the best part. While everyone is shorting Euro on rise it makes DAX move up. Why????
Simple rule this weakens their currency and exporters get the benefit form this. wow....

Next thing is that financials just form 15% of the index so very less of the subprime effect here.
Going further there is falling unemployment. How come?
Well the exports are rising and the factories require people. Its not China that they have oversupply of workers.
 So the people now consume more and that powers the economy.

So we have a rising index with the help of exports which benefits from falling currency and inturn raises domestic consumption without much of the financial leverage as evident in West.
Its that simple.

If we look at other countries which closely resembles this model are South Korea and Taiwan. Well check those indices.