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.

Emerging Markets ETF

Emerging markets are generally regarded as the risker trade then the SPX. They are generally leading indicator of the change in the risk perceptions around the world.

The EEM etf is a good way to track the performance and perception about the emerging markets.

This etf has been in range for some time after breaking out from the resistance of 48 but then it reverted back to channel just when the commodity selloff started. This was also partially attributed to the QE2 end when risk reduction started globally.

The ETF now is holding the grounds quite well as it held the last range support of 45 and now has formed a falling wedge kind of pattern from where the breakout is happening.  The bullish breakout is confirmed above the 48 levels as it will be then above the range high.

Worth noting is the change in slope of relative performance w.r.t SPX.

Does this indicate the change in perception to risk especially when the US indices are falling?
As the emerging markets have both growth and domestic consumption not depend on US economy.

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.

Dow Theory update: New high in Dow Industrials

The US index Dow Jones Industrial made a new 2011 high after the Transport index made a new high on 31st March.

This validates the bullish stand. The dip in mid March did triggered a sell signal when the 50 SMA was broken.
But the recent swing low above 50 SMA was a buy signal. The above average volumes on breakout is a good sign.

The Transport index in remains in bullish trend.

The daily macd is though in sell mode but it has started turning to bullish mode.

Nifty and SPX in X O view

The Emerging market ETF EEM has broken out of the consolidation. Read the post here.
The etf is relatively bullish than SPX which is a major turn in the assets allocation globally.

Lets see how Nifty is performing relatively.
First Nifty vs EEM in a relative chart:

The ratio has been in range for quite some time and has is at the resistance trendline.
The 50 SMA is getting flat which is a good sign.

This shows that India is still underperformer in emerging markets.

Now hows the Nifty vs SPX. Well that's showing bullishness.

There is first breakout from the double top of X's which is highlighted. Though it is still below the bearish trendline but the ratio has rising bottoms.

So overall Nifty is for sure signs of bullishness but the months of under performance still lingers and that itself can be good trigger for buying by funds.

Dow Theory update: New high in Transorpts

Just a small update that y'day Transport index hit a new high for the Year 2011.
The Industrial is still below the 2011 high of 12392.

This coupled with the new highs in US Small Cap index Russell 2000 shows that the US indices are on a bullish trajectory.

US Small cap makes new high: Bullish indication

US Small cap index Russell 200 has made a new high for the year 2011.
This is a significant development as the major index SPX and Indu are still below their yearly highs.
The small cap index is generally regarded as leading index and its turning up is shows investors confidence in the markets.

Attached is the chart:

US Indices and Commodities vs 50 DMA

The US indices y'day closed below the 50 DMA after 130 days. Here are the charts

 

The commodities meanwhile are still above the 50 DMA. The Base metal index has broken the 50 DMA.

Is all this sign of QE ending?

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.

Dow Theory: Sign of caution or Crude effect

The latest signal from Dow theory is of caution. The last sign was of bullishness when Indu was at 11250 levels. Post here.

Now the Transports has broken the 50 DMA and has last swing high below 50 DMA while the Industrials INDU is trading above the 50 DMA. Chart:

While this could be the effect of crude as Transport companies use crude as their primary input and is there main cost. If crude stays above 90 levels then for sure it could have some effect on the Industrial index also as crude is used in every aspect of life which could for sure increase the inflation. More discussion can lead to debate here.So lets see charts.

The second way we can look at this is that divergence can be a buying point for Transports as Industrials is still at new highs. For that lets see how the broader US indices are telling us.

Not much of signs of caution in Midcap and smallcap indices.

Crude has moved to new highs though failed to cross the resistance there. The structure is still bullish of crude.

This all could be attributed to Egypt effect which lead to fresh highs in commodities. Reuters commodities index CRB broke to fresh weekly highs. Link here.