India

Aspectos destacados Estamos elevando la calificación de las acciones indias de infraponderadas a neutrales dentro de una cartera de renta variable de mercados emergentes (EM). Sin embargo, las perspectivas para el rendimiento absoluto de los precios de las acciones indias siguen siendo pesimistas. Es probable que los rendimientos de los bonos locales aumenten debido a un déficit presupuestario en expansión. Los rendimientos de los bonos más altos y el crecimiento todavía deprimido anularán el efecto positivo puntual de los recortes del impuesto de sociedades sobre los precios de las acciones. Tema principal La medida extraordinaria e inesperada se adoptó porque el crecimiento de la economía india ha disminuido drásticamente. El gobierno indio recurrió la semana pasada a una inesperada y sustancial reducción del impuesto de sociedades. El gobierno redujo el tipo impositivo efectivo del impuesto de sociedades del 35% a alrededor del 25%. ¿Cuáles son las implicaciones de inversión de este drástico cambio de política? ¿Por qué la medida extraordinaria? La medida extraordinaria e inesperada se adoptó porque el crecimiento de la economía india ha disminuido drásticamente: El gasto discrecional de los hogares se está contrayendo (Gráfico I-1). Las medidas del gasto de capital de las empresas son extremadamente débiles y, en muchos casos, también están contrayéndose (Gráfico I-2). Chart I-1 India: El gasto discrecional de los hogares se está contrayendo India: el gasto discrecional de los hogares se está contrayendo India: el gasto discrecional de los hogares se está contrayendo Chart I-2 India: El gasto de capital está estancado India: El gasto de capital está estancado India: El gasto de capital está estancado Las ganancias por acción de las 500 principales empresas indias cotizadas han caído un 8% respecto al año pasado en términos de moneda local (Gráfico I-3). Las medidas subyacentes de la inflación son bajas (Gráfico I-4). Chart I-3 India: Las ganancias corporativas indias se están contrayendo Las ganancias corporativas indias se están contrayendo. Las ganancias corporativas indias se están contrayendo. Chart I-4 La inflación está extremadamente contenida La inflación está extremadamente contenida La inflación está extremadamente contenida El banco central ha estado recortando las tasas de interés, pero los costos de endeudamiento en términos reales siguen siendo elevados. La razón es que la inflación ha caído, elevando las tasas de préstamo en términos reales (ajustadas por inflación) (Gráfico I-5). Además, los costes de endeudamiento corporativo (rendimientos de bonos corporativos BBB en moneda local) están por encima del crecimiento del PIB nominal (Gráfico I-6). Esto implica que los costes de endeudamiento no se encuentran en niveles propicios para desembolsos de inversión de capital por parte de las empresas. La decisión del gobierno de reducir drásticamente el impuesto de sociedades es la decisión de política adecuada en el entorno actual. Los responsables políticos esperan que las empresas, a su vez, inviertan y que se desencadene un ciclo económico virtuoso. Chart I-5 Las tasas reales son altas y están subiendo Las tasas reales son altas y están subiendo Las tasas reales son altas y están subiendo Chart I-6 Las tasas de endeudamiento son altas en relación con el crecimiento nominal Las tasas de endeudamiento son altas en relación con el crecimiento nominal Las tasas de endeudamiento son altas en relación con el crecimiento nominal Chart I-7 Préstamos bancarios comerciales: público vs. privado Préstamos de Bancos Comerciales: Público Vs. Privado Préstamos de Bancos Comerciales: Público Vs. Privado Por último, los prestamistas todavía están lamiéndose las heridas por los préstamos morosos. Los bancos públicos han llevado a cabo recortes, las compañías financieras no bancarias están actualmente reduciendo sus balances y los bancos privados podrían ser los siguientes en reducir su ritmo de originación de crédito (Gráfico I-7). Al darse cuenta de que una reducción gradual de las tasas de política del banco central probablemente no impulsará el crecimiento a corto plazo, las autoridades han recurrido a la política fiscal para estimular. India es un país con escasa inversión y el gasto de capital es la clave de su potencial de crecimiento a largo plazo. Por lo tanto, la decisión del gobierno de reducir drásticamente el impuesto de sociedades es la medida de política adecuada en el entorno actual. Los responsables políticos esperan que las empresas a su vez inviertan y que se desencadene un ciclo económico virtuoso.  Una pregunta pertinente para los inversores, sin embargo, es si estas medidas de política fijarán un suelo para los precios de las acciones ahora o si existe una mejor oportunidad de compra más adelante. Los rendimientos de los bonos locales son clave para los precios de las acciones Si los rendimientos de los bonos locales gubernamentales y corporativos aumentan significativamente en respuesta a este estímulo fiscal, los precios de las acciones tendrán dificultades. Chart I-8 Los altos costes de endeudamiento son negativos para los precios de las acciones Los altos costos de endeudamiento son negativos para los precios de las acciones. Los altos costos de endeudamiento son negativos para los precios de las acciones. Si los rendimientos de los bonos domésticos aumentan significativamente en respuesta a este estímulo fiscal, los precios de las acciones tendrán dificultades. En contraste, si los rendimientos locales se mantienen cerca de los niveles actuales, los precios de las acciones se comportarán bien, especialmente en relación con el referente de EM (Gráfico I-8). Críticamente, los precios de las acciones son mucho más sensibles a las tasas de interés y a las expectativas de crecimiento a largo plazo que a los beneficios o dividendos del próximo año.1 La reducción de los impuestos corporativos es un evento puntual que impulsará las ganancias y posiblemente los dividendos el próximo año, pero solo el próximo año. Si las tasas de interés suben o las expectativas de crecimiento nominal a largo plazo se moderan, un aumento puntual en los beneficios corporativos no será suficiente para justificar valoraciones de acciones más altas. Por el contrario, tasas de interés más altas o expectativas de crecimiento nominal más bajas anularán el efecto positivo del aumento puntual de los beneficios corporativos el próximo año. Como resultado, el valor razonable de las acciones disminuirá, no aumentará. Conclusión: Los rendimientos de los bonos en moneda local y las expectativas de crecimiento a largo plazo son mucho más importantes para la valoración de las acciones que el aumento puntual de las ganancias corporativas. Perspectivas para los bonos locales ¿Por qué aumentarían bruscamente los rendimientos de los bonos locales en medio de un crecimiento débil persistente y una inflación muy baja? La razón principal es un déficit fiscal que se está ampliando con fuerza, lo que obliga a aumentar la emisión de bonos gubernamentales. El déficit presupuestario global del gobierno central fue del 3,7% del PIB previo al último recorte del impuesto de sociedades. Sumado a los gobiernos estatales, el déficit fiscal agregado ronda el 6% del PIB. En el futuro, el déficit presupuestario central superará considerablemente el pronóstico del gobierno del 3,3% del PIB para este año fiscal. Además de las reducciones del impuesto corporativo, el crecimiento de los ingresos públicos se ha desplomado y seguirá cayendo al menos hasta el final del ejercicio fiscal actual – marzo de 2020 – debido al crecimiento nominal muy lento. Chart I-9 India: Creación de dinero frente al déficit fiscal India: Creación de dinero frente al déficit fiscal India: Creación de dinero frente al déficit fiscal Si la creación de dinero amplio por parte de los bancos comerciales se queda corta frente al déficit fiscal agregado (equivalente a la emisión neta de bonos del gobierno), los rendimientos de los bonos estarán bajo presión al alza. Gráfico I-9 muestra que a medida que el déficit fiscal agregado se dispara, el aumento incremental de la oferta monetaria amplia podría no ser suficiente para absorber el déficit en expansión.  Salvo por las grandes compras de bonos por parte de los bancos, esto implicaría que hay menos financiación disponible tanto para los sectores público como privado. Esto empujaría los rendimientos de los bonos al alza. Aumentan las probabilidades de que la nueva emisión de bonos no sea fácilmente absorbida por el mercado. Con el 28% de los depósitos, las tenencias de bonos gubernamentales por parte de los bancos ya están muy por encima del mínimo legal del 18.75%. Las tenencias de bonos gubernamentales por parte de extranjeros también se han disparado desde 2014. Es probable que el apetito de los inversores extranjeros por los bonos del gobierno indio sea débil en los próximos meses por las siguientes razones: Un aumento pronunciado de la relación deuda pública/PIB desde su actual nivel elevado del 67%. La depreciación de las monedas de los mercados emergentes probablemente provocará salidas de capital extranjero de los mercados de renta fija de EM, lo que erosionará la demanda internacional de bonos en moneda local indios. Los bancos representan el 42% de las tenencias de bonos gubernamentales, las compañías de seguros el 23%, y los fondos mutuos y los extranjeros el 3% cada uno. En conjunto, actualmente representan el 71% de los bonos gubernamentales en circulación. Por lo tanto, los bancos son clave para financiar tanto al sector público como al privado. Chart I-10 Tenencia del RBI de bonos gubernamentales Tenencia del RBI de bonos gubernamentales Tenencia del RBI de bonos gubernamentales Un riesgo para el escenario de rendimientos más altos es que el banco central de India acelere aún más sus compras en curso de bonos gubernamentales (Gráfico I-10). En tal caso, los rendimientos de los bonos se verán limitados. Sin embargo, esto implicaría expansión cuantitativa o monetización de la deuda pública. Esto último llevará a la depreciación de la moneda y desencadenará la fuga de capitales. Conclusión: Es probable que los rendimientos de los bonos gubernamentales indios aumenten. Esto elevará los rendimientos de los bonos corporativos en moneda local y, a su vez, pesará sobre las valoraciones de las acciones. Conclusiones de inversión Las perspectivas para el rendimiento absoluto de los precios de las acciones indias siguen siendo pesimistas (Gráfico I-11, panel superior). No obstante, estamos aprovechando el bajo rendimiento de los últimos meses para mejorar la calificación de esta bolsa de infraponderada a neutral dentro de una cartera de renta variable de mercados emergentes (EM) (Gráfico I-11, panel inferior). Las probabilidades de que las acciones superen al índice de referencia de EM han aumentado debido a los recortes del impuesto corporativo, pero no son lo suficientemente altas como para justificar una asignación con sobrepeso. Chart I-11 Precios de las acciones indias: Perfiles de rendimiento absoluto y relativo Precios de las Acciones de la India: Perfiles de Rendimiento Absoluto y Relativo Precios de las Acciones de la India: Perfiles de Rendimiento Absoluto y Relativo Chart I-12 Nuestra posición larga en software indio / corta en acciones de EM Nuestra posición larga en software indio / corta en acciones de mercados emergentes Nuestra posición larga en software indio / corta en acciones de mercados emergentes Como ocurre con otras monedas de EM, la rupia es vulnerable a una corrección en los próximos meses. Históricamente, los inversores extranjeros en India han inyectado de forma acumulada 148.000 millones de dólares en acciones y fondos de inversión. Por lo tanto, las decepciones acumuladas por parte de los inversores extranjeros respecto a la trayectoria de crecimiento de India y a los déficits fiscales podrían desencadenar un período de salidas de capital. Una moneda más débil y nuestro tema de favorecer apuestas de crecimiento en mercados desarrollados frente a los emergentes siguen justificando una posición larga en acciones de software indias / corta en el índice general de acciones de EM. Iniciamos esta posición el 21 de diciembre de 2016 y ha generado ganancias considerables (Gráfico I-12). Los inversores de renta fija deberían seguir apostando por el steepening de la curva de rendimientos, recibiendo swaps a 1 año y pagando swaps a 10 años.   Arthur Budaghyan Jefe de Estrategia de Mercados Emergentes arthurb@bcaresearch.com Ayman Kawtharani, Editor/Estratega ayman@bcaresearch.com   Notas al pie 1      La razón es que tanto tasas de interés como tasa de crecimiento a largo plazo de las ganancias están presentes en el denominador de cualquier modelo de descuento de flujos de caja (Precio de la acción = Dividendo esperado / (Tasa de interés – Tasa de crecimiento a largo plazo de las ganancias)). Por lo tanto, tienen el potencial de afectar los precios de las acciones de forma exponencial, mientras que los dividendos/beneficios están presentes en el numerador, por lo que su impacto sobre los precios de las acciones es lineal.

Destacados Estamos aprovechando la reclasificación de las acciones indias de infraponderadas a neutrales dentro de una cartera de renta variable de mercados emergentes (EM). No obstante, las perspectivas para el rendimiento absoluto de los precios de las acciones indias siguen siendo negativas. Es probable que los rendimientos de los bonos locales aumenten debido al ensanchamiento del déficit presupuestario. Rendimientos de los bonos más altos y un crecimiento todavía deprimido anularán el efecto positivo puntual de las reducciones del impuesto corporativo en los precios de las acciones. Análisis La medida extraordinaria e inesperada se adoptó porque el crecimiento de la economía india se ha desacelerado drásticamente. El gobierno indio recurrió la semana pasada a una inesperada y amplia reducción del impuesto sobre la renta corporativa. El gobierno redujo la tasa efectiva del impuesto corporativo del 35% a alrededor del 25%. ¿Cuáles son las implicaciones de inversión de este drástico cambio de política? ¿Por qué la medida extraordinaria? La medida extraordinaria e inesperada se adoptó porque el crecimiento de la economía india se ha desacelerado drásticamente: El gasto discrecional de los hogares se está reduciendo (Gráfico I-1). Las medidas del gasto de capital por parte de las empresas son extremadamente débiles y, en muchos casos, también se están contraendo (Gráfico I-2). Gráfico I-1 India: El gasto discrecional de los hogares se está contrayendo India: el gasto discrecional de los hogares se está contrayendo India: el gasto discrecional de los hogares se está contrayendo Gráfico I-2 India: El gasto de capital está estancado India: El gasto de capital está estancado India: El gasto de capital está estancado Las ganancias por acción de las 500 principales empresas indias cotizadas han caído un 8% respecto al año pasado en términos de moneda local (Gráfico I-3). Las medidas subyacentes de la inflación son bajas (Gráfico I-4). Gráfico I-3 Las ganancias corporativas indias se están contrayendo Las ganancias corporativas indias se están contrayendo. Las ganancias corporativas indias se están contrayendo. Gráfico I-4 La inflación está extremadamente contenida La inflación está extremadamente contenida La inflación está extremadamente contenida El banco central ha estado recortando las tasas de interés, pero los costos de endeudamiento en términos reales siguen siendo elevados. La razón es que la inflación ha disminuido, lo que eleva las tasas de préstamo en términos reales (ajustadas por inflación) (Gráfico I-5). Además, los costos de endeudamiento corporativo (rendimientos de bonos corporativos BBB en moneda local) están por encima del crecimiento del PIB nominal (Gráfico I-6). Esto implica que los costos de endeudamiento no se encuentran en niveles propicios para los desembolsos de inversión de capital por parte de las empresas. La decisión del gobierno de reducir drásticamente los impuestos sobre la renta corporativa es la decisión de política adecuada en el entorno actual. Los responsables de la política esperan que las empresas, a su vez, inviertan y se desencadene un ciclo económico virtuoso. Gráfico I-5 Las tasas reales son altas y están aumentando Las tasas reales son altas y están subiendo Las tasas reales son altas y están subiendo Gráfico I-6 Los tipos de endeudamiento son altos en relación con el crecimiento nominal Las tasas de endeudamiento son altas en relación con el crecimiento nominal Las tasas de endeudamiento son altas en relación con el crecimiento nominal Gráfico I-7 Préstamos de bancos comerciales: públicos vs. privados Préstamos de Bancos Comerciales: Público Vs. Privado Préstamos de Bancos Comerciales: Público Vs. Privado Por último, los prestamistas aún están lamiéndose las heridas por los préstamos incobrables. Los bancos públicos han sufrido recortes, las empresas financieras no bancarias están reduciendo actualmente sus balances y los bancos privados podrían ser los siguientes en reducir su ritmo de originación de crédito (Gráfico I-7). Al comprender que la reducción gradual de las tasas de política del banco central probablemente no impulsará el crecimiento en el corto plazo, las autoridades han recurrido a la política fiscal para estimular. India es un país con inversión insuficiente y el gasto de capital es clave para su potencial de crecimiento a largo plazo. Por lo tanto, la decisión del gobierno de reducir drásticamente los impuestos sobre la renta corporativa es la decisión de política adecuada en el entorno actual. Los responsables de la política esperan que las empresas, a su vez, inviertan y se desencadene un ciclo económico virtuoso.  Una cuestión pertinente para los inversores, sin embargo, es si estas medidas políticas establecerán ahora un suelo para los precios de las acciones o si se presentará una mejor oportunidad de compra más adelante. Los rendimientos de los bonos locales son la clave de los precios de las acciones Si los rendimientos de los bonos gubernamentales y corporativos en moneda local aumentan considerablemente en respuesta a este estímulo fiscal, los precios de las acciones tendrán dificultades. Gráfico I-8 Los altos costos de endeudamiento son negativos para los precios de las acciones Los altos costos de endeudamiento son negativos para los precios de las acciones. Los altos costos de endeudamiento son negativos para los precios de las acciones. Si los rendimientos de los bonos domésticos aumentan considerablemente en respuesta a este estímulo fiscal, los precios de las acciones tendrán dificultades. En cambio, si los rendimientos de los bonos locales se mantienen cerca de los niveles actuales, los precios de las acciones se comportarán bien, especialmente en relación con el índice de referencia de mercados emergentes (EM) (Gráfico I-8). Críticamente, los precios de las acciones son mucho más sensibles a las tasas de interés y a las expectativas de crecimiento a largo plazo que a los beneficios o dividendos del próximo año.1 La reducción de los impuestos corporativos es un evento puntual que incrementará las ganancias y posiblemente los dividendos el próximo año, pero solo el próximo año. Si las tasas de interés aumentan o las expectativas de crecimiento nominal a largo plazo se moderan, un aumento puntual de las ganancias corporativas no será suficiente para justificar valoraciones accionarias más altas. Por el contrario, tasas de interés más altas o expectativas de crecimiento nominal más bajas abrumarán el efecto positivo del aumento puntual de las ganancias corporativas el próximo año. Como resultado, el valor justo de las acciones disminuirá, no aumentará. Conclusión: Los rendimientos de los bonos en moneda local y las expectativas de crecimiento a largo plazo son mucho más importantes para las valoraciones de las acciones que el aumento puntual de las ganancias corporativas. Perspectivas de los bonos domésticos ¿Por qué aumentarían de manera abrupta los rendimientos de los bonos locales en medio de un crecimiento débil persistente y una inflación muy baja? La razón principal es un fuerte ensanchamiento del déficit fiscal, lo que obliga a incrementar la emisión de bonos gubernamentales. El déficit fiscal global del gobierno central era del 3,7% del PIB antes de la última reducción del impuesto corporativo. Sumado a los gobiernos estatales, el déficit fiscal agregado ronda el 6% del PIB. De cara al futuro, el déficit presupuestario central excederá considerablemente la previsión gubernamental del 3,3% del PIB para este ejercicio fiscal. Además de las reducciones del impuesto corporativo, el crecimiento de los ingresos del gobierno se ha desplomado y seguirá cayendo al menos hasta el final del ejercicio fiscal actual – marzo de 2020 – debido al crecimiento nominal muy débil. Gráfico I-9 India: Creación de dinero frente al déficit fiscal India: Creación de dinero frente al déficit fiscal India: Creación de dinero frente al déficit fiscal Si la creación de dinero amplio por parte de los bancos comerciales no cubre el déficit fiscal agregado (que equivale a la emisión neta de bonos del gobierno), los rendimientos de los bonos estarán sujetos a presión al alza. Gráfico I-9 muestra que, a medida que el déficit fiscal agregado se dispara, el aumento incremental de la oferta monetaria amplia podría no ser suficiente para absorber el déficit creciente.  Salvo grandes compras de bonos por parte de los bancos, esto implicaría que habrá menos financiación disponible tanto para el sector público como para el privado. Esto empujaría los rendimientos de los bonos al alza. Aumentan las probabilidades de que la nueva emisión de bonos no sea fácilmente absorbida por el mercado. Con el 28% de los depósitos, las tenencias de bonos gubernamentales por parte de los bancos ya están muy por encima del mínimo legal del 18,75%. Las tenencias de bonos gubernamentales por parte de extranjeros también se han disparado desde 2014. La apetencia de los inversores extranjeros por los bonos gubernamentales indios probablemente será débil en los próximos meses por las siguientes razones: Un aumento pronunciado de la relación deuda pública/PIB desde su actual nivel elevado del 67%. La depreciación de las monedas de mercados emergentes (EM) probablemente desencadenará salidas de capital extranjero de los mercados de renta fija de EM, lo que reducirá la demanda internacional de bonos indios denominados en moneda local. Los bancos representan el 42% de las tenencias de bonos gubernamentales, las compañías de seguros el 23% y los fondos mutuos y los extranjeros el 3% cada uno. En conjunto, actualmente representan el 71% de los bonos gubernamentales en circulación. Por lo tanto, los bancos son clave para financiar tanto al sector público como al privado. Gráfico I-10 Participación del RBI en los bonos gubernamentales Tenencia del RBI de bonos gubernamentales Tenencia del RBI de bonos gubernamentales Un riesgo para el escenario de rendimientos de bonos más altos es que el banco central de India acelere aún más sus compras en curso de bonos gubernamentales (Gráfico I-10). En tal caso, los rendimientos de los bonos se verían limitados. Sin embargo, esto implicaría una expansión cuantitativa o la monetización de la deuda pública. Esto último conduciría a la depreciación de la moneda y provocaría la fuga de capitales. Conclusión: Las probabilidades son de que los rendimientos de los bonos del gobierno indio aumenten. Esto elevará los rendimientos de los bonos corporativos en moneda local y, a su vez, pesará sobre las valoraciones de las acciones. Conclusiones de inversión Las perspectivas para el rendimiento absoluto de los precios de las acciones indias siguen siendo negativas (Gráfico I-11, panel superior). Sin embargo, estamos aprovechando la subrentabilidad de los últimos meses para mejorar la calificación de esta bolsa de infraponderada a neutral dentro de una cartera de renta variable de mercados emergentes (EM) (Gráfico I-11, panel inferior). Las probabilidades de que las acciones superen al índice de referencia de EM han aumentado debido a las reducciones del impuesto corporativo, pero no son lo suficientemente altas como para justificar una asignación en sobreponderación. Gráfico I-11 Precios de las acciones indias: perfiles de rendimiento absoluto y relativo Precios de las Acciones de la India: Perfiles de Rendimiento Absoluto y Relativo Precios de las Acciones de la India: Perfiles de Rendimiento Absoluto y Relativo Gráfico I-12 Nuestra posición larga en software indio / corta en acciones de EM Nuestra posición larga en software indio / corta en acciones de mercados emergentes Nuestra posición larga en software indio / corta en acciones de mercados emergentes Como ocurre con otras monedas de mercados emergentes (EM), la rupia es vulnerable a un retroceso en los próximos meses. Históricamente, los inversores extranjeros en India han inyectado de forma acumulada 148.000 millones de dólares en fondos de renta variable y de inversión. Por lo tanto, las decepciones acumuladas por parte de los inversores extranjeros respecto a la trayectoria de crecimiento de India y a los déficits fiscales podrían desencadenar un periodo de salidas de capital. Una moneda más débil y nuestro tema de favorecer apuestas de crecimiento de mercados desarrollados (DM) frente a mercados emergentes (EM) siguen justificando una posición larga en acciones de software indias / corta en el índice de renta variable general de EM. Iniciamos esta posición el 21 de diciembre de 2016 y ha producido ganancias considerables (Gráfico I-12). Los inversores en renta fija deberían seguir apostando por un pronunciado diferencial en la curva de rendimientos, recibiendo swaps a 1 año y pagando a 10 años.   Arthur Budaghyan Jefe de Estrategia de Mercados Emergentes arthurb@bcaresearch.com Ayman Kawtharani, Editor/Estratega ayman@bcaresearch.com   Notas 1      La razón es que tanto las tasas de interés como la tasa de crecimiento a largo plazo de las ganancias están presentes en el denominador de cualquier modelo de descuento de flujos de caja (Precio de la acción = Dividendos esperados / (Tasa de interés – Tasa de crecimiento a largo plazo de las ganancias)). Por lo tanto, tienen el potencial de afectar los precios de las acciones de forma exponencial, mientras que los dividendos/beneficios están presentes en el numerador, por lo que su impacto en los precios de las acciones es lineal. Recomendaciones de acciones Recomendaciones sobre divisas, crédito y renta fija

Chart II-1Indian Stocks Failed To Break Major Resistance Levels Indian stocks have failed to break out above their highs, in both local currency and U.S. dollar terms, and have rolled over decisively (Chart II-1, top panel). Relative to the EM equity benchmark, Indian share prices have recently been underperforming despite collapsing oil prices and plunging U.S. interest rates. Furthermore, this bourse’s relative performance against the global equity index in common currency terms has bounced lower from a major structural technical resistance (Chart II-1, bottom panel). India’s recent underwhelming equity dynamics have transpired despite ongoing monetary policy easing by the country's central bank. In a nutshell, the roots of this poor equity performance trace back to lackluster profitability, rich equity valuations and overcrowded positioning. We recommend investors continue avoiding Indian equities for now as more downside is likely. Domestic Growth/Corporate Earnings Slump Indian domestic demand growth has been nosediving with no clear end in sight: Sales of passenger cars, two-wheelers, three-wheelers, tractors as well as medium & heavy commercial trucks are all contracting at double-digit rates (Chart II-2). Similarly, real gross fixed capital formation growth has decelerated, the number of capex projects underway are falling, capital goods imports and production are contracting and cement production growth has plummeted (Chart II-3). Some cracks are also appearing in India’s real estate sector. Chart II-4 shows nationwide housing price growth is decelerating in nominal terms and deflating in real (inflation-adjusted) terms. Chart II-2Domestic Demand Is Very Weak Chart II-3Capex And Infrastructure Are Heading South Chart II-4House Prices Are Contracting In Real Terms Typically, share prices become extremely sensitive to business cycles slowdowns when valuations are elevated. This is currently the case for the Indian bourse. In fact, India’s latest corporate earnings season was lackluster and many companies across various sectors have warned about slowing growth. More visibility on an ameliorating profit outlook as well as lower valuation multiples are needed for share prices to reach a sustainable bottom. India Is Joining The “Kick The Can Down Road” Club Banks have been the star performers within the Indian bourse with non-financials generating underwhelming returns. This warrants particular attention to bank stocks’ fundamentals and valuations. Recent media reports have been highlighting that India’s NPL cycle has finally turned for the better – marking an end to the country’s bad asset cycle that started in 2013. However, scratching below the surface, the recent reduction in India’s NPLs ratio has not occurred due to organic improvement in India’s corporate borrowers’ ability to service debt. For instance, the EBITDA-to-interest expense ratio for the country’s non-financial publically-listed companies has not improved at all (Chart II-5). Chart II-5Poor Debt Servicing Ability Among Indian Corporate Borrowers Rather, what seems to be driving the NPLs ratio lower is a regulatory forbearance: The new Governor of the RBI – Shaktikanta Das – issued a new circular on NPL recognition in June. It essentially provides commercial banks with much more flexibility in the way they can deal with their bad assets and permits them to delay their NPL recognition. The central bank also allowed India’s manufacturing and infrastructure corporates in default to borrow via the External Commercial Borrowing route in order to pay down their domestic loans under a one-off settlement. Furthermore, the RBI permitted commercial banks to restructure loans of micro-, small-, and medium-sized businesses before they turn bad - allowing banks to delay the proper recognition of such types of loans as well. Finally, the RBI reduced the risk weight of consumer credit from 125% to 100% in its monetary policy meeting yesterday. The objective of this measure is to accelerate consumer credit growth even though the latter has been booming in the past ten years. All in all, these regulatory measures reverse banks and corporate sector restructuring efforts and thereby are negative from a structural perspective. In the past, we were positive on the Indian banking system structurally because the central bank was promoting critical reforms.   Under the new leadership of the RBI, India is now joining the “kick the can down the road” club. This warrants somewhat lower equity multiples for banks than before. Financials Stocks Are Still Expensive Despite the selloff, Indian bank stocks are not yet cheap. For Indian public banks we focused our analysis on the State Bank of India (SBI) as it is the largest and only public bank that has performed reasonably well. This bank presently trades at a price-to-book value (PBV) ratio of 1.15.  Our analysis shows that at a more realistic 12% NPL ratio4 and assuming a 30% recovery ratio, 25% of its equity would be impaired. This would move its adjusted PBV ratio to 1.5. Assuming a fair-value PBV ratio of 1.3, the SBI appears to be overvalued by 15-17%. As to private banks,5 they are also expensive. For instance, if their NPLs rise to 6% from around 3% currently, they would seem overvalued by at least 12% (Table II-1). The analysis assumes a generous recovery ratio of 50% and a very high fair-value PBV ratio of 3.3.  Chart II-6Major Asset-Liability Mismatches In Non-Bank Finance Sector Finally, a comment on non-bank financial companies (NBFCs) is warranted. Their liquidity situation is extremely grim. Chart II-6 shows that our proxy for liquidity, measured as short-term investments (including cash) minus short-term borrowing for the 11 large NBFCs we assessed,6 is in a deep negative territory. In other words, these companies have a substantial maturity mismatch. Remarkably, these non-bank organizations grew their assets at a 20% annual compounded growth rate since 2009. Odds are they have misallocated capital to a large extent and their NPL ratio is probably in the double-digits. According to the RBI, non-bank financials’ gross NPLs ratio stood at 6.6% as of March 2019. By comparison the NPLs ratio of Indian banks peaked at 11.2%. Meanwhile, their valuations are not cheap at all. For instance, the NBFCs included in the MSCI India equity index carry a PBV ratio of 3.5 for consumer finance focused companies and a PBV ratio of 3 for thrift & mortgage finance focused companies. Bottom Line: Share prices of banks and non-bank financials are far from being cheap and remain at risk of further decline. Chart II-7Ominous Signals From The Indian Broader Equity Market Investment Recommendations In absolute U.S. dollar terms, Indian stocks have meaningful downside. This is confirmed by some precarious technical signals: the equal-weighted stocks index has dropped by 28% from its top in January 2018 and small-cap stocks are breaking down (Chart II-7). Finally, while the RBI cut rates yesterday, share prices still closed lower. In terms of our relative strategy, we continue to recommend that dedicated EM equity investors keep underweighting Indian stocks for now, but our conviction level is lower than it was in May. The basis is that ongoing fiscal and monetary easing, coupled with very low U.S. bonds yields and oil prices, might help Indian equities to outpace their EM peers at some point. For now, we will wait for a better entry point to upgrade. Our strongest conviction is that Indian stocks will underperform the global equity index in common currency terms (please see Chart II-1 on page 11). As for the currency, lingering problems in the NBFC sector will force the RBI to keep liquidity in the banking system abundant. Excessive liquidity expansion amid the ongoing selloff in EM currencies will hurt the rupee. Fixed-income investors should play a yield curve steepening trade as lower short rates and rupee deprecation could generate a yield curve steepening. Ayman Kawtharani, Editor/Strategist ayman@bcaresearch.com Footnotes 4      Instead of the 7.5% ratio it reported last week. 5      We analyzed the six largest private banks: HDFC Bank, ICICI Bank, Axis Bank, Yes Bank, IDFC First Bank and Kotak Mahindra Bank 6      Six of which are listed in the MSCI India equity index and account for 12% of MSCI total market cap.

Analysis on India is available below. Highlights Moderate RMB depreciation is consistent with the economic as well as political objectives of Chinese authorities. Yet, this is bad news for EM currencies and risk assets. As EM currencies depreciate, driven by a weaker RMB and lower commodities prices, foreign investors will head for the exit and EM risk assets will plummet. Meanwhile, there are tell-tale signs of an incipient EM breakdown. We continue to recommend shorting a basket of the following EM currencies versus the U.S. dollar: ZAR, CLP, COP, IDR, MYR, PHP and KRW. We also remain structurally short the RMB. Feature In our May 23 report titled The RMB: Depreciation Time? , we argued that the odds of an RMB depreciation were rising and that the currency would likely depreciate by some 6-8% versus the dollar. We contended that this would be bad news not only for EM currencies but also for all EM risk assets. EM fundamentals have been poor – both exports and cyclical domestic sectors have been contracting for some time. We illustrated the weak domestic demand conditions experienced by the majority of developing economies in our recent report, Domestic Demand In Individual EM Countries. Nevertheless, many investors have been ignoring the growing evidence of deteriorating growth conditions. The recent breakdown in the CNY/USD cross has reminded investors of the 2015 episode, when global risk assets – particularly in EM – tumbled following the yuan’s depreciation. We expect the RMB to depreciate by another 5-6% or so. We expect the RMB to depreciate by another 5-6% or so (Chart I-1). This will likely trigger a full-scale breakdown in EM risk assets. With respect to investor positioning, sentiment on EM was buoyant up until last week. Chart I-2 shows that asset managers’ and leveraged funds’ net long positions in EM equity index futures and high-beta liquid currencies futures was elevated as of Friday August 2. Chart I-1More Downside In RMB Chart I-2Investor Sentiment On EM Was Positive As Of Last Week With negative news proliferating on many fronts – the U.S.-China confrontation, slumping global trade, shrinking EM profits, tumbling commodities prices and RMB depreciation – the risk of a portfolio capital exodus from EM is rising, and a liquidation phase is highly probable. Implications Of RMB Depreciation It is impossible to know whether the recent RMB depreciation was market-driven or engineered by the PBoC. Our best guess is that the latest RMB depreciation was driven by both market pressures as well as the authorities’ increased tolerance of a weaker RMB.  The mainland economy requires a weaker currency to counteract accumulating deflationary pressures from deteriorating domestic and foreign demand, as well as to offset rising U.S. import tariffs. The Chinese leadership likely regards RMB depreciation as an economic and political response to U.S. import tariffs. That said, the Chinese authorities have significant latitude to control the exchange rate, not only via selling the central bank’s foreign currency reserves and tightening capital controls but also by utilizing foreign currency forward swaps. Therefore, the RMB depreciation will run further but will unlikely spiral out of control. Regardless of the cause of the depreciation, a weaker RMB will affect the rest of the world in general and EM in particular. Regardless of the cause of the depreciation, a weaker RMB will affect the rest of the world in general and EM in particular via the following two channels: Escalating competitive devaluation: The RMB is causing a breakdown in other Asian currencies, especially those exposed to manufacturing exports (Chart I-3). Critically, falling export prices herald currency depreciation not only in China but also in other Asian economies such as Korea, Singapore and Taiwan (Chart I-4). Chart I-3Breakdown In Emerging Asian Currencies Chart I-4Lower Export Prices Warrant Currency Depreciation Less Chinese imports = a drag on global trade: An RMB devaluation reduces Chinese importers’ purchasing power in U.S. dollar terms. The same amount of credit and fiscal stimulus in yuan when converted into U.S. dollars can be used to procure less goods and commodities. In brief, the gap between mainland imports in yuan and in dollars will widen (Chart I-5). Chart I-5Chinese Imports In Dollars Will Continue Shrinking Chinese imports in dollar terms will continue contracting. Many EM and some DM currencies will be negatively affected, since China is a major source of demand for these economies. Bottom Line: Moderate RMB depreciation is consistent with the economic as well as political objectives of Chinese authorities. Yet, this is bad news for EM currencies and risk assets. An EM Breakdown Is In The Making There are a number of financial markets and individual share prices that have been forewarning of potential breakdowns in EM/China plays and global pro-cyclical assets. In particular: Having failed to break above its 200-day moving average, the Risk-On vs. Safe-Haven currency ratio1 has dropped below its three-year moving average (Chart I-6, top panel). This indicator has had a very high correlation with EM stocks and global materials equities. Hence, its breakdown heralds a gap down in EM share prices as well as global materials stocks (Chart I-6, middle and bottom panels). Chart I-6Beware Of Breakdowns The rationale for using the 400-day (18-month), 800-day (three-year) and other long-term moving averages is similar to why investors utilize the 200-day (nine-month) moving average. When a market fails to punch below or above any of its long-term moving averages, odds are that it will make a new high or low, respectively. We discussed these technical indicators and have offered empirical examples of how these signals have historically worked in principal markets such as the S&P 500 and U.S. bond yields in our past reports.   Base metals (including copper) and oil prices as well as global steel stocks have broken below their three-year moving averages (Chart I-7). Commodities prices have been exhibiting a very bearish chart formation, and will likely plunge further. BCA’s Emerging Markets Strategy team remains bearish on commodities prices, even though BCA’s house view is bullish. The primary basis for this divergence in view has been and remains the Chinese growth outlook. Chart I-7Commodities Are In A Trouble Spot Chart I-8Canary In A Coal Mine For Commodities Share price of Glencore – a major player in the commodities space – has plunged below its three-year moving average, which has served as a support a couple of times in recent years2 (Chart I-8). Crucially, this stock has exhibited a head-and-shoulders formation, and has nose-dived below its neckline. Kennametal (KMT) – a high-beta U.S. industrial stock – leads the U.S. manufacturing cycles and has formed a similar configuration as Glencore’s (Chart I-9). This raises the odds that the U.S. manufacturing PMI will drop below the 50 line. Finally, the relative performance of S&P 500 global cyclical stocks versus global defensives3 has resumed its downtrend after failing to break above its 200-day moving average (Chart I-10). This foreshadows a poor global growth outlook and serves as a downbeat signal for global cyclical plays. Chart I-9Canary In A Coal Mine For U.S. Industrials Chart I-10A Message From S&P 500 Industry Groups Does all of the above imply that the global growth slowdown is already priced into global financial markets? Not necessarily. These breakdowns have occurred on the fringes of markets. As the average investor heeds to these signals and as these breakdowns move from the periphery to the center, there will be more damage to global risk assets in general and EM in particular. Importantly, there are cyclical segments of global and EM financial markets that have not adjusted and remain vulnerable. For example, global semiconductor stocks and global industrial share prices remain elevated despite the enduring global manufacturing recession (Chart I-11). Chart I-11Mind The Gaps The wide gap between share prices and revenues of these cyclical sectors implies that investors have been pricing an imminent business cycle recovery. Odds are that the current global manufacturing downturn will last longer or that a bottoming-out phase will be more extended than in 2012 and 2015. We have elaborated on the rationale for a more extended downturn in our past reports, and our conclusions still stand: A lack of aggressive stimulus in China, a lower propensity to spend among Chinese households and companies, as well as the ongoing trade war will continue to dampen business sentiment worldwide. Consequently, the current gap between share prices of these cyclical sectors and their underlying revenues will likely be closed via lower stock prices. As to non-cyclical equity sectors, they are less vulnerable to a profit downturn but their valuations are very expensive, and investor positioning is heavy. Further, EM local currency bonds as well as EM sovereign and corporate credit markets have been buoyant because of falling U.S. interest rates. Yet EM currencies are at risk from both RMB devaluation and falling commodities prices. EM currency depreciation will in turn undermine returns on EM local currency bonds and spur an investor exodus from high-yielding domestic bonds. Chart I-12Which Way These Gaps Will Close? Excess returns on EM sovereign and corporate credit have historically correlated with EM currencies and commodities prices as well as with equity returns (Chart I-12). Commodities prices, EM currencies and share prices are all poised to weaken further. It will be very surprising if sovereign and corporate spreads do not widen from their current tight levels. Bottom Line: There are a number of tell-tale signs of an incipient EM breakdown. As EM currencies depreciate driven by a weaker RMB and lower commodities prices, foreign investors will head for the exit and all EM risk assets will plummet. Investment Recommendations We are reiterating our negative stance on EM currencies and risk assets both in absolute terms and relative to their DM counterparts. Our recommended country overweights and underweights for EM equity, sovereign credit and local currency bond portfolios are always available at the end of our reports (please refer to pages 18 and 19 ). As to exchange rates, we continue to recommend shorting a basket of the following EM currencies versus the U.S. dollar: ZAR, CLP, COP, IDR, MYR, PHP and KRW. We also remain structurally short the RMB. In a nutshell, EM currency depreciation will -- for now -- overwhelm the positive impact of lower domestic interest rates on EM equities and in some cases will prevent developing nations’ central banks from reducing rates further. Finally, we recommended a long gold / short oil and copper trade on July 11 and this has panned out nicely (Chart I-13). Gold has made a structural breakout versus the rest of commodities complex and investors should hold into this position. We recommended a long gold / short oil and copper trade on July 11 and this has panned out nicely. Chart I-13A Structural Breakout In Gold Versus Oil And Copper Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Indian Stocks: Poor Profit Outlook Amid Rich Valuation Indian stocks have failed to break out above their highs, in both local currency and U.S. dollar terms, and have rolled over decisively (Chart 1, top panel). Chart II-1Indian Stocks Failed To Break Major Resistance Levels Relative to the EM equity benchmark, Indian share prices have recently been underperforming despite collapsing oil prices and plunging U.S. interest rates. Furthermore, this bourse’s relative performance against the global equity index in common currency terms has bounced lower from a major structural technical resistance (Chart II-1, bottom panel). India’s recent underwhelming equity dynamics have transpired despite ongoing monetary policy easing by the country's central bank. In a nutshell, the roots of this poor equity performance trace back to lackluster profitability, rich equity valuations and overcrowded positioning. We recommend investors continue avoiding Indian equities for now as more downside is likely. Domestic Growth/Corporate Earnings Slump Indian domestic demand growth has been nosediving with no clear end in sight: Sales of passenger cars, two-wheelers, three-wheelers, tractors as well as medium & heavy commercial trucks are all contracting at double-digit rates (Chart II-2). Similarly, real gross fixed capital formation growth has decelerated, the number of capex projects underway are falling, capital goods imports and production are contracting and cement production growth has plummeted (Chart II-3). Chart II-2Domestic Demand Is Very Weak Chart II-3Capex And Infrastructure Are Heading South Some cracks are also appearing in India’s real estate sector. Chart II-4 shows nationwide housing price growth is decelerating in nominal terms and deflating in real (inflation-adjusted) terms. Chart II-4House Prices Are Contracting In Real Terms Typically, share prices become extremely sensitive to business cycles slowdowns when valuations are elevated. This is currently the case for the Indian bourse. In fact, India’s latest corporate earnings season was lackluster and many companies across various sectors have warned about slowing growth. More visibility on an ameliorating profit outlook as well as lower valuation multiples are needed for share prices to reach a sustainable bottom. India Is Joining The “Kick The Can Down Road” Club Banks have been the star performers within the Indian bourse with non-financials generating underwhelming returns. This warrants particular attention to bank stocks’ fundamentals and valuations. Recent media reports have been highlighting that India’s NPL cycle has finally turned for the better – marking an end to the country’s bad asset cycle that started in 2013. Chart II-5Poor Debt Servicing Ability Among Indian Corporate Borrowers However, scratching below the surface, the recent reduction in India’s NPLs ratio has not occurred due to organic improvement in India’s corporate borrowers’ ability to service debt. For instance, the EBITDA-to-interest expense ratio for the country’s non-financial publically-listed companies has not improved at all (Chart II-5). Rather, what seems to be driving the NPLs ratio lower is a regulatory forbearance: The new Governor of the RBI – Shaktikanta Das – issued a new circular on NPL recognition in June. It essentially provides commercial banks with much more flexibility in the way they can deal with their bad assets and permits them to delay their NPL recognition. The central bank also allowed India’s manufacturing and infrastructure corporates in default to borrow via the External Commercial Borrowing route in order to pay down their domestic loans under a one-off settlement. Furthermore, the RBI permitted commercial banks to restructure loans of micro-, small-, and medium-sized businesses before they turn bad - allowing banks to delay the proper recognition of such types of loans as well. Finally, the RBI reduced the risk weight of consumer credit from 125% to 100% in its monetary policy meeting yesterday. The objective of this measure is to accelerate consumer credit growth even though the latter has been booming in the past ten years. All in all, these regulatory measures reverse banks and corporate sector restructuring efforts and thereby are negative from a structural perspective. In the past, we were positive on the Indian banking system structurally because the central bank was promoting critical reforms.   Under the new leadership of the RBI, India is now joining the “kick the can down the road” club. This warrants somewhat lower equity multiples for banks than before. Financials Stocks Are Still Expensive Despite the selloff, Indian bank stocks are not yet cheap. For Indian public banks we focused our analysis on the State Bank of India (SBI) as it is the largest and only public bank that has performed reasonably well. This bank presently trades at a price-to-book value (PBV) ratio of 1.15.  Our analysis shows that at a more realistic 12% NPL ratio4 and assuming a 30% recovery ratio, 25% of its equity would be impaired. This would move its adjusted PBV ratio to 1.5. Assuming a fair-value PBV ratio of 1.3, the SBI appears to be overvalued by 15-17%. As to private banks,5 they are also expensive. For instance, if their NPLs rise to 6% from around 3% currently, they would seem overvalued by at least 12% (Table II-1). The analysis assumes a generous recovery ratio of 50% and a very high fair-value PBV ratio of 3.3.  Finally, a comment on non-bank financial companies (NBFCs) is warranted. Their liquidity situation is extremely grim. Chart II-6 shows that our proxy for liquidity, measured as short-term investments (including cash) minus short-term borrowing for the 11 large NBFCs we assessed,6 is in a deep negative territory. In other words, these companies have a substantial maturity mismatch. Chart II-6Major Asset-Liability Mismatches In Non-Bank Finance Sector Remarkably, these non-bank organizations grew their assets at a 20% annual compounded growth rate since 2009. Odds are they have misallocated capital to a large extent and their NPL ratio is probably in the double-digits. According to the RBI, non-bank financials’ gross NPLs ratio stood at 6.6% as of March 2019. By comparison the NPLs ratio of Indian banks peaked at 11.2%. Meanwhile, their valuations are not cheap at all. For instance, the NBFCs included in the MSCI India equity index carry a PBV ratio of 3.5 for consumer finance focused companies and a PBV ratio of 3 for thrift & mortgage finance focused companies. Bottom Line: Share prices of banks and non-bank financials are far from being cheap and remain at risk of further decline. Investment Recommendations In absolute U.S. dollar terms, Indian stocks have meaningful downside. This is confirmed by some precarious technical signals: the equal-weighted stocks index has dropped by 28% from its top in January 2018 and small-cap stocks are breaking down (Chart II-7). Finally, while the RBI cut rates yesterday, share prices still closed lower. Chart II-7Ominous Signals From The Indian Broader Equity Market In terms of our relative strategy, we continue to recommend that dedicated EM equity investors keep underweighting Indian stocks for now, but our conviction level is lower than it was in May. The basis is that ongoing fiscal and monetary easing, coupled with very low U.S. bonds yields and oil prices, might help Indian equities to outpace their EM peers at some point. For now, we will wait for a better entry point to upgrade. Our strongest conviction is that Indian stocks will underperform the global equity index in common currency terms (please see Chart II-1 on page 11). As for the currency, lingering problems in the NBFC sector will force the RBI to keep liquidity in the banking system abundant. Excessive liquidity expansion amid the ongoing selloff in EM currencies will hurt the rupee. Fixed-income investors should play a yield curve steepening trade as lower short rates and rupee deprecation could generate a yield curve steepening. Ayman Kawtharani, Editor/Strategist ayman@bcaresearch.com Footnotes 1      Average of CAD, AUD, NZD, BRL, CLP & ZAR total return (including carry) indices relative to average of JPY & CHF total returns. 2      The drop occurred well before the latest negative profit report. 3      These indexes are based on U.S. S&P 500 industry groups and published by Goldman Sachs. The Bloomberg tickers for S&P 500's global cyclicals and global defensives indexes are GSSBGCYC and GSSBGDEF, respectively. 4      Instead of the 7.5% ratio it reported last week. 5      We analyzed the six largest private banks: HDFC Bank, ICICI Bank, Axis Bank, Yes Bank, IDFC First Bank and Kotak Mahindra Bank 6      Six of which are listed in the MSCI India equity index and account for 12% of MSCI total market cap. Equity Recommendations Fixed-Income, Credit And Currency Recommendations  

While the media has zeroed in on the newly announced tariffs on Mexico late last week, tariffs on Indian imports and the narrowly avoided Australia trade war front barely made the news. This heightened policy uncertainty has taken investors aback. Worrisomely, the recent May update of the “Baker, Bloom, and Davis” categorical trade policy uncertainty index surged, which bodes ill for the overall market (trade policy uncertainty shown inverted, top panel). Similarly, we updated the article count that mention “trade war” using Bloomberg data and the message is similar: the opening up of new trade war fronts will continue to weigh on the broad market (trade war article count shown inverted, bottom panel). Bottom Line: Refrain from trying to catch a falling knife, a tactically cautious equity market stance is still warranted.

India: How Sustainable Is A 2.0 Modi Rally? Prime Minister Narendra Modi, and his party – the Bharatiya Janata Party – have won a strong majority in the Indian general election this month. Indian stocks surged in the past month as evidence was emerging that Modi was in the lead. Chart II-1Facing Resistance? Yet this Modi 2.0 rally is unlikely to last for too long. First, as EM stocks continue selling off, Indian share prices will not defy gravity and will fall in absolute terms. Interestingly, the Indian stock market has hit its previous highs – levels at which it failed to break above in the past 12 years (Chart II-1, top panel). We expect this resistance line to hold this time around too. Likewise, we are still reluctant to upgrade this bourse on a relative basis as it has reached its previous highs. This level will likely prove to be a hindrance, at least for the time being (Chart II-1, bottom panel). The basis for betting against a break out in Indian equity prices in both absolute terms and relative to the EM benchmark over the next couple of months is because of the following: Domestic Growth Weakness: India’s domestic growth has been decelerating sharply. The top two panels of Chart II-2 illustrate that manufacturing and intermediate goods production as well as capital goods production growth are all either contracting or on the verge of shrinking. Similarly, domestic orders-to-inventories ratio for businesses is pointing to a further growth slump according to a survey conducted by Dun & Bradstreet (Chart II-2, bottom panel). Furthermore, sales growth of all types of vehicles are either contracting or have stalled (Chart II-3). Chart II-2Business Cycle Is Weak Chart II-3Domestic Demand Is Fragile Regarding the financial sector, Indian banks – encouraged by a more permissive and forbearing central bank on the recognition of non-performing loans – have recently lowered provisions to boost their earnings (Chart II-4). Share prices should not normally react to such accounting changes. Banks either do carry these NPLs or do not. Therefore, the stock price of a bank should not fluctuate much if a central bank is forcing it to recognize those NPLs or if the latter is relaxing recognition and provisioning standards. Chart II-4Less Provisions = More Paper Profit Chart II-5Very Weak Equity Breadth In brief, we are skeptical about the sustainability of the current rally in bank share prices based on the relaxation of some accounting rules. Unfavorable Technicals & Valuations: Technicals for India’s stock market are precarious. Participation in this rally has been very slim. Indian small cap stocks have not rallied much, lagging dramatically behind large-cap stocks (Chart II-5, top panel). Our proxy for market breadth – the ratio of equal-weighted stocks to market-cap weighted stocks – has also been deteriorating and is sending a very bearish signal for the overall stock market (Chart II-5, bottom panel). Finally, the Indian stock market is overbought and vulnerable to a general selloff in EM stocks. Namely, foreign investors have rushed into Indian equities as of late. This raises the risk of a pullout as foreign investors become disappointed by India’s dismal corporate earnings and outflows from EM funds leads them to pare their holdings. As for valuations, the Indian stock market is still quite expensive both in absolute and relative terms. Oil Prices: Although oil prices will likely drop,1 Indian stocks could still underperform the EM equity benchmark in the near term. Chart II-6India Versus EM & Oil Prices The rationale for this is that Indian equities have brushed off the rise in oil prices since the beginning of the year and outperformed the majority of other EM bourses (Chart II-6). By extension, Indian equities could ignore lower oil prices for a while and underperform the EM benchmark in the near term. Beyond near term underperformance, however, India will likely resume its outperformance. First, sustainably lower oil prices will begin to help the Indian stock market later this year. Second, the growth impact of ongoing fiscal and monetary easing will become visible toward the end of this year. Meanwhile, food prices are starting to pickup and this will support rural income and spending. Finally, the Indian economy is much less vulnerable to a slowdown in global trade because Indian exports make only 13% of the country's GDP. Bottom Line: We are maintaining our underweight stance in Indian equities for tactical considerations, but are putting this bourse on an upgrade watch-list. Ayman Kawtharani, Editor/Strategist ayman@bcaresearch.com     Footnotes 1 The view on commodities of BCA’s Emerging Markets Strategy service is different from BCA’s house view due to the difference on the view on the global business cycle and Chinese demand.

Please note that analysis on India is published below. Highlights This report reviews several financial market-based indicators and price signals from various corners of global markets that are pertinent to the global business cycle, and hence to EM risk assets. The overwhelming message from these indicators and price actions is that the global industrial cycle remains in the doldrums, and a recovery is not imminent. As such, global cyclical segments, commodities, and EM assets are all at risk of plunging. Beware of reigning complacency in EM sovereign and corporate credit markets. Various indicators point to wider EM credit spreads. Feature EM risk assets appear to be on the brink of a breakdown. This week we review various market-based indicators that are telegraphing a relapse in both EM risk assets and commodities. The relative performance of EM versus global stocks leads turning points in the global manufacturing cycle by about six months. As always, we monitor economic data extremely closely. However, one cannot rely solely on economic data to predict directional changes in financial markets. Turning points of economic indicators and data often lag those of financial markets. In fact, one can make reliable economic forecasts based on the performance of financial markets. For example, the relative performance of EM versus global stocks leads turning points in the global manufacturing cycle by about six months (Chart I-1). Chart I-1EM Stocks Signal No Improvement In Global Industrial Cycle Over the years, we have devised and tracked several market-based indicators that have a good track record of identifying trends in EM risk assets. In addition, we constantly monitor price signals from various corners of financial markets that are pertinent to the global business cycle, and hence to EM risk assets. The overwhelming message from these market-based indicators is that the global industrial cycle remains in the doldrums, and a recovery is not imminent. As such, global cyclical segments, commodities and EM are all at risk of plunging. Our Reflation Indicator Our Reflation Indicator is calculated as an equal-weighted average of the London Industrial Metals Price Index (LMEX), platinum prices and U.S. lumber prices. The LMEX index is used as a proxy for Chinese growth, while U.S. lumber prices reflect cyclical growth conditions in the American economy. We use platinum prices as a global reflation proxy; this semi-precious metal is sensitive to the global industrial cycle in addition to benefitting from easy U.S. dollar liquidity. The Reflation Indicator has failed to advance above its long-term moving average and has broken down. Chart I-2Our Reflation Indicator Presages No Reflation Chart I-2 illustrates that the Reflation Indicator has failed to advance above its long-term moving average and has broken down. Typically, such a technical profile is worrisome and is often followed by a significant drop. In addition, the Reflation Indicator rolled over at its previous highs last year, another bearish technical signal. Investors should heed signals from this indicator as it correlates well with EM share prices in U.S. dollar terms as well as EM sovereign and corporate credit spreads (Chart I-3). EM credit spreads are shown inverted in the middle and bottom panels. An examination of the individual components of the Reflation Indicator reveals the following: Industrial metals prices in general and copper prices in particular have formed a classic head-and-shoulders pattern (Chart I-4, top panel). As and when the neckline of this pattern is broken, a major downward gap is likely to ensue. Platinum prices have reverted from their key technical resistance levels (Chart I-4, middle panel). This constitutes a bearish technical configuration, and odds are that platinum prices will be in freefall. Finally, lumber prices have failed to punch above their 200-day moving average and have broken below their 3-year moving average (Chart I-4, bottom panel). Chart I-3Reflation Indicator And EM Chart I-4Beware Of Breakdowns In Commodities Prices These technical signals are in accordance with our qualitative assessment of global growth conditions. The global industrial cycle remains very weak, and a recovery is not yet imminent. Meanwhile, the U.S. is the least exposed to the ongoing global trade recession because manufacturing and exports each represent only about 12% of the U.S. economy. Remarkably, economic weakness in Asian export-dependent economies has so far been driven by retrenching demand in China – not the U.S. As Chart I-5 reveals, aggregate exports to China from Korea, Japan, Taiwan and Singapore were still contracting at a 9% pace in April from a year ago, while their shipments to the U.S. grew at a respectable 7% rate. Chart I-5Asian Exports To China And To U.S Chart I-6Global Steel And Energy Stocks Are Breaking Down Commodities: Hanging By A Thread? Some commodity-related markets are also exhibiting configurations that are consistent with a breakdown. Specifically: Global steel stocks as well as oil and gas share prices have formed a head-and-shoulders pattern, and are breaking below their necklines (Chart I-6). Such a technical configuration foreshadows major downside. Shares of Glencore – a major player in the commodities space – have dropped below their three-year moving average which has served as a support a couple of times in recent years (Chart I-7). Crucially, this stock has also exhibited a head-and-shoulders formation, and has nose-dived below its neckline. Kennametal (KMT) – a high-beta U.S. industrial stock – leads U.S. manufacturing cycles, and has formed a similar configuration to Glencore’s (Chart I-8). This raises the odds that the U.S. manufacturing PMI will drop below the 50 line. Chart I-7A Head-And-Shoulders Pattern In Glencore Stock... Chart I-8...And In Kennametal (High-Beta U.S. Industrial Stock) Finally, three-year forward oil prices are breaking below their three-year moving averages (Chart I-9). A drop below this technical support will probably mark a major downleg in crude prices. Bottom Line: Commodities and related equity sectors appear vulnerable to the downside. Meanwhile, the U.S. dollar is exhibiting a bullish technical pattern and will likely grind higher, as we discussed in last week’s report titled, The RMB: Depreciation Time? (Chart I-10). Chart I-9Forward Oil Prices Are Much Weaker Than Spot Chart I-10The U.S. Dollar Is Heading Higher EM Equities: A Make-It-Or-Break-It Moment Chart I-11EM Stock Indexes: Sitting On Edge Of A Cliff The MSCI EM Overall Equity Index is at an important technical support level (Chart I-11, top panel). If this support is violated, a major downleg will likely ensue. In addition to the above indicators, the following observations also suggest that this support level will be broken and that a gap-down phase will transpire. Both the EM small-cap and equal-weighted equity indexes have been unable to advance above their respective three-year moving averages and are now breaking down (Chart I-11, middle and bottom panels). This could be a precursor for the overall EM stock index to tumble through defense lines, and drop well below its December lows. Our Risk-On/Safe-Haven Currency ratio also points to lower EM share prices (Chart I-12). This indicator is constructed using relative total returns of commodity related (cyclical) currencies such as the AUD, NZD, CAD, BRL, CLP and ZAR against safe-haven currencies such as the JPY and CHF. Importantly, as with EM stocks, this market-based indicator has failed to break above highs reached over the past 10 years. This is in spite of negative interest rates in both Japan and Switzerland that have eroded the latter’s total returns in local currency terms. This ratio has also formed a head-and-shoulders pattern, and may be on the edge of breaking below its neckline. A move lower will spell trouble for EM financial markets. EM corporate profits are shrinking in U.S. dollar terms, and the pace of contraction will continue to deepen through the end of the year. The U.S.-China confrontation is not the only reason behind the EM selloff. In fact, the EM equity rebound early this year was not supported by improving profits. Not surprisingly, the EM equity rebound has quickly faded as investor sentiment deteriorated in response to rising trade tensions. Global semiconductor share prices have made a double top and are falling sharply. Importantly, prices for semiconductors (DRAM and NAND) have not recovered since early this year. The ongoing downdraft in the global semiconductor industry will continue to weigh on the emerging Asian Equity Index. Finally, the relative performance of emerging Asian equities versus DM ones has retreated from its major resistance level (Chart I-13). Odds are that it will break below its recent lows. Chart I-12Risk-On/Safe-Haven Currency Ratio And EM Equities Chart I-13Emerging Asian Stocks Versus Developed Markets Bottom Line: EM share prices are sitting on the edge of a cliff. Further weakness will likely lead to investor capitulation and a major selloff. EM Credit Markets: Reigning Complacency? One asset class in the EM space that has so far held up relatively well is sovereign and especially corporate credit. EM sovereign bonds’ excess returns correlate with EM currencies and industrial metals prices, as shown in Chart I-14. So far, material EM currency depreciation and a drop in industrial metals prices have generated only a mild selloff in EM sovereign credit. Lower commodities prices, EM currency depreciation and weaker global growth are all negatives for cash flows of both sovereign and corporate issuers. Excess returns on EM corporate bonds track the global business cycle closely (Chart I-15). The current divergence between EM corporates’ excess returns and the global manufacturing PMI is unprecedented. Chart I-14EM Sovereign Credit Market Is Complacent... Chart I-15...As Is EM Corporate Credit Market Our expectation that EM credit spreads will widen is not contingent on a massive default cycle unravelling across the EM credit space. However, lower commodities prices, EM currency depreciation and weaker global growth are all negatives for cash flows of both sovereign and corporate issuers. Chart I-16 illustrates that swings in cash flow from operations (CFO) among EM ex-financials and technology companies correlate with other global business cycle indicators such as Germany’s IFO manufacturing index. Chart I-16EM Corporate Cash Flow Fluctuates With Global Manufacturing Cycle Chart I-17EM Corporate Spreads Are Too Narrow Given Their Financial Health The lingering weakness in the global business cycle will likely lead to shrinking CFOs among EM companies, and hence warrants wider corporate credit spreads. Concerning valuations, EM corporate bonds are not cheap at all when their fundamentals are taken into account. Chart I-17 demonstrates two vital debt-servicing ratios for EM ex-financials and technology companies: interest expense-to-CFO and net debt-to-CFO. Both measures have improved only marginally in recent years, yet corporate spreads are not far from their all-time lows (Chart I-17, bottom panel). We are aware that with DM bond yields at very low levels - and in many cases even negative - the appeal of EM credit markets has risen. We are also cognizant that some investors are expecting to hold these bonds to maturity and earn a reasonable yield. Such a strategy has largely paid off in recent years. Nevertheless, if the selloff in EM financial markets escalates – as we expect – EM credit markets will be hit hard as well. To this end, it makes sense to step aside and wait for a better entry point. For dedicated fixed-income portfolios, we continue to recommend underweighting EM sovereign and corporate credit versus U.S. investment-grade credit. Finally, to identify relative value within EM sovereign credit spreads, we plot, each country’s foreign debt obligations as a share of annual exports on the X axis against sovereign spreads on the Y axis (Chart I-18). This scatter plot reveals that Russia and Mexico offer the best relative value in the EM sovereign space. As such, we are reiterating our high-conviction overweight position in these sovereign credit markets as well as in Hungary, Poland, Chile and Colombia. South Africa and Brazil appear attractive as well, but we are underweight these two sovereign credits. The basis for our pessimistic outlook is due to the unsustainable public debt dynamics in these two countries, as we discussed in our Special Report from April 23. Other underweights within the EM sovereign credit space include Indonesia, the Philippines, Malaysia, Turkey and Argentina.   Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com     India: How Sustainable Is A 2.0 Modi Rally? Prime Minister Narendra Modi, and his party – the Bharatiya Janata Party – have won a strong majority in the Indian general election this month. Indian stocks surged in the past month as evidence was emerging that Modi was in the lead. Chart II-1Facing Resistance? Yet this Modi 2.0 rally is unlikely to last for too long. First, as EM stocks continue selling off, Indian share prices will not defy gravity and will fall in absolute terms. Interestingly, the Indian stock market has hit its previous highs – levels at which it failed to break above in the past 12 years (Chart II-1, top panel). We expect this resistance line to hold this time around too. Likewise, we are still reluctant to upgrade this bourse on a relative basis as it has reached its previous highs. This level will likely prove to be a hindrance, at least for the time being (Chart II-1, bottom panel). The basis for betting against a break out in Indian equity prices in both absolute terms and relative to the EM benchmark over the next couple of months is because of the following: Domestic Growth Weakness: India’s domestic growth has been decelerating sharply. The top two panels of Chart II-2 illustrate that manufacturing and intermediate goods production as well as capital goods production growth are all either contracting or on the verge of shrinking. Similarly, domestic orders-to-inventories ratio for businesses is pointing to a further growth slump according to a survey conducted by Dun & Bradstreet (Chart II-2, bottom panel). Furthermore, sales growth of all types of vehicles are either contracting or have stalled (Chart II-3). Chart II-2Business Cycle Is Weak Chart II-3Domestic Demand Is Fragile Regarding the financial sector, Indian banks – encouraged by a more permissive and forbearing central bank on the recognition of non-performing loans – have recently lowered provisions to boost their earnings (Chart II-4). Share prices should not normally react to such accounting changes. Banks either do carry these NPLs or do not. Therefore, the stock price of a bank should not fluctuate much if a central bank is forcing it to recognize those NPLs or if the latter is relaxing recognition and provisioning standards. Chart II-4Less Provisions = More Paper Profit Chart II-5Very Weak Equity Breadth In brief, we are skeptical about the sustainability of the current rally in bank share prices based on the relaxation of some accounting rules. Unfavorable Technicals & Valuations: Technicals for India’s stock market are precarious. Participation in this rally has been very slim. Indian small cap stocks have not rallied much, lagging dramatically behind large-cap stocks (Chart II-5, top panel). Our proxy for market breadth – the ratio of equal-weighted stocks to market-cap weighted stocks – has also been deteriorating and is sending a very bearish signal for the overall stock market (Chart II-5, bottom panel). Finally, the Indian stock market is overbought and vulnerable to a general selloff in EM stocks. Namely, foreign investors have rushed into Indian equities as of late. This raises the risk of a pullout as foreign investors become disappointed by India’s dismal corporate earnings and outflows from EM funds leads them to pare their holdings. As for valuations, the Indian stock market is still quite expensive both in absolute and relative terms. Oil Prices: Although oil prices will likely drop,1 Indian stocks could still underperform the EM equity benchmark in the near term. Chart II-6India Versus EM & Oil Prices The rationale for this is that Indian equities have brushed off the rise in oil prices since the beginning of the year and outperformed the majority of other EM bourses (Chart II-6). By extension, Indian equities could ignore lower oil prices for a while and underperform the EM benchmark in the near term. Beyond near term underperformance, however, India will likely resume its outperformance. First, sustainably lower oil prices will begin to help the Indian stock market later this year. Second, the growth impact of ongoing fiscal and monetary easing will become visible toward the end of this year. Meanwhile, food prices are starting to pickup and this will support rural income and spending. Finally, the Indian economy is much less vulnerable to a slowdown in global trade because Indian exports make only 13% of the country's GDP. Bottom Line: We are maintaining our underweight stance in Indian equities for tactical considerations, but are putting this bourse on an upgrade watch-list. Ayman Kawtharani, Editor/Strategist ayman@bcaresearch.com     Footnotes   1 The view on commodities of BCA’s Emerging Markets Strategy service is different from BCA’s house view due to the difference on the view on the global business cycle and Chinese demand. Equity Recommendations Fixed-Income, Credit And Currency Recommendations