Inflation, not the pandemic, is the biggest worry for equity investors, according to DBS Group Research’s Taimur Baig, at a time a severe second wave of Covid-19 infections poses risks of fresh curbs.
“Investors should be cognizant of the fact that this [Covid-19] is by no means as dire as it was a year ago,” Baig, managing director and chief economist at the research house, said on BloombergQuint’s special series Navigating Through Uncertainty. “A year ago, investors knew very little about the disease, the world didn’t have the wherewithal and protocols associated with the optimal response to those who were affected by it, and we were a year away from a vaccine rollout.”
But as vaccines became available, besides hospitals’ protocol of how to deal with patients, Baig is confident the economic damage from lockdowns and cessation of activities will be far better dealt with this time.
“When we think about asset classes, we have to sort of keep that as a starting point that we will not revisit the complete lack of confidence and uncertainty and flight to safety that we saw in the first instance of Covid-19, when the dollar soared, and interest rates collapsed while credit spreads widened and there was a huge fear of a global liquidity crunch,” he said.
Instead, he said the market has issues related to the inflation outlook.
Balancing out inflationary signs against the Fed’s statements of not raising rates is a tall order for the market, according to Baig. Prices, at least over the last six months, do not offer a great deal of room for comfort about remaining benign, he said. In the next six to nine months, prices of rice, soybeans, certain semiconductor chips, and some energy products are heading only in the upward direction, he said.
The world, Baig said, has idiosyncratic supply-demand mismatches, which coupled with a surge in demand from all stimulus measures make it hard to see prices remaining benign. “Hence, the tug of war—if one sees the long-term inflation expectation markers and long-term interest rates have ticked up, but at the same time the central banks are asking investors to ignore all that because everything is transitory; [that] is a potential source of tension.”
Baig said there’s a lot of debt in this world. “A lot of companies and a lot of countries will come to the market for refinancing in the next six to nine to 12 months. For that refinancing to take place in an orderly manner, you need inflation and interest rates to be under wraps,” he said.
You also need liquidity to be ample. A sudden spurt of inflation would create debt refinancing-related difficulties. So that’s probably at the top of my concern right now.Taimur Baig, MD, DBS Group Research
He, however, doesn’t expect a sudden crash in the equity markets due to this spike in inflation. A crash is going to require seismic events, a huge setback on Covid, a huge setback on inflation, or a massive geopolitical tension, he said. Any of those three things are relatively unlikely in the horizon and, therefore, sort of the trigger for crash at least on the macro side is not there, Baig said.
Markets, according to him, can also tumble on account of fraud or systemic crash such as the collapse of mortgage-backed securities 13 years ago. But, Baig said, he has no ability to predict that. Baig said a collapse in expensive equity valuations would require a dramatic change in the rates outlook, it’s more likely that investors will get “more defensive” as opposed to forsaking the equity markets in the event of rising inflation.
The one issue, Baig said, maybe the pace with which the world goes from 1.7% on the 10-year U.S. bond yields to higher levels. If the world were to travel to 2.25-2.5 gradually over three quarters because growth and inflation forecasts are being revised upwards, it will not cause any issues and that the global economy can handle that, he said, adding that a quick move forward can be problematic though.
“If you were to say we take a look at a time machine but this time we go forward two years, and 10-year interest rate is 2.5-2.6, that is great, and the Fed did an amazing job of reflating the economy, the growth is good, but if we say that’s going to happen the next three months, we’re going to have some issues in the markets.”
India View
The current policy package in India, according to Baig, seems to be cognizant of the major changes that are taking place in the world. India, he said, is trying to seize the opportunity of an evolving global manufacturing landscape. The nation is aware that in the China-U.S. tussle there are certain angles that it can pursue, which can act to its benefit.
According to Baig, India is on the right side with respect to galvanising global interest and its policy signals are certainly being constructive or are being seen as constructive.
Also, Baig’s not worried about the corporate balance sheet either as there has been significant deleveraging. Besides, an excessive investment boom-bust seen in the last 20 years, particularly in the construction property sector, leaves Indian corporate on far better footing now than it has been in a long time.
That’s because India has never been a country where households are highly indebted, but recently debt has gone up and it hasn’t held up well against the macro headwinds of recent years. So, it’s in the interest of households, in the interest of the consumption outlook that the Reserve Bank of India succeeds in keeping inflation down and succeeds in keeping interest rates down, he said.
Watch the full interview with DBS Group Research’s Taimur Baig:
Edited excerpts:
...You started off the interaction saying that you don’t believe that the second wave or the third wave as countries may like to call, may not really hit the economy and thereby maybe businesses that hard. So do you reckon that weaknesses, if any that come in because of this reason, partially, could actually be buying opportunities because the liquidity safety net is alive and kicking?
TAIMUR BAIG: I think so. Look, I think we can say very safely that if today, there was a big order coming in from say a western company to produce iPhones or a huge order from H&M for garments, I think the owner of that manufacturing plant whether it is in Philippines or in India or Indonesia, they know the protocol to follow that even if there is a Covid resurgence taking place, how to keep the manufacturing plant going. This is the big difference between today and then. We were shutting everything down at that point, we’re not going to shut everything down, we know how to carry on agriculture, we know how to carry on manufacturing, even if everybody’s not vaccinated, even if there is a big surge of virus taking place. Which is why I think that this fear that around a resurgence in Covid virus and that is of course happening, there’s no denying that, that we’ll head back into the kinds of lockdown that we saw earlier, it’s unlikely and therefore, if indeed the markets are getting nervous and they are getting worried about the outlook which is justifiable, but it would then certainly open up some stream of in my view from the selloff because I do not see any of these developments being sustainable. We are winning the battle against Covid, we are vaccinating the world maybe a little slower than we would have wanted and certainly the variants are complicating the matter but even a century ago, the 1819 pandemic it went away at one point. There was a herd immunity, and it did go away. It seems like we’re in the middle of a nightmare that will never end. A year from now when you and I talk, we’ll talk about very different things.
What’s your view on India sitting from the perch that you are in, wherein you get a chance to look at various other geographies, various economies and then try and map India out there because what we did not get in the whole of 2020 was a large stimulus, but it eventually turned out to be okay, maybe. But the government to its credit has done some amazing stuff with tax rates over the last two years, the PLI schemes that have been announced, left, right, centre and what was being hailed as a really good budget almost unheard of in the last so many years. So, post all of this but amid the scare around the rising virus and the lack of stimulus, where does India stand vis-à-vis some of the other countries that are vying for capital and how would you rate the markets currently for somebody who’s looking at it not just six months out but maybe 18-24 months out?
TAIMUR BAIG: India always commands a great deal of goodwill from global investors. Even though returns have not kept up with that expectation, five years ago, 10 years ago, if you were to put in 10,000 market in the Sensex index, after adjusting for the rupees depreciation the returns are not great. You would have been much better off investing in S&P 500 than Sensex. Now sitting in India when you’re looking at the rupee return, it looks pretty good and there are certain Indian companies that have actually outpaced the exchange rate movement and they have delivered very good returns even for foreign investors, you think about like an HDFC Bank if the CDR has been a star source return over the last five-seven years in the U.S. But by and large I think the goodwill has stayed despite underwhelming return from the broad indices and the investors clutch onto every positive news out of India and are generous enough to discount, most of the negative news. Now, if you have years of paralysis on policy or years of uncertainty about tax regime, of course, that hurts investor sentiment, and it then manifests in people’s misgivings both in the capital markets as well as drug investment spaces. That’s inevitable but right now we are looking at investors who are in general favourably predisposed toward India and they’re looking at the manufacturing sector as a possible source of significant long-term growth. Going back to your narrative that if countries are thinking about China plus one, which countries can offer the scale that can even partially mimic what China has to offer and certainly Vietnam and India would be on the top of that list within Asia. So, we do hear from Japanese companies, Korean companies and Taiwanese companies, a lot of medium-and long-term plans about setting up manufacturing in India. They are hoping that the local governments and the centre would be good partners in going for that because these things are capital intensive, labour intensive and require long decisional period during which you need policy certainty, you need availability of labour and land and infrastructure. So, all of those things are hard. It’s far more than passing a law that’s ground level delivered in reality, but it can be done, we have seen east Asia do it for decades. It’s India’s turn now and to sum up that point, investors are looking at it favourably, they are hoping that this is the turn.
You looked at policy for a number of years in India specifically, do you sense that this time around is really different? I’m just using the budget and the PLI schemes as an example of the government finally waking up to the fact that let’s treat business as the highest priority because that will do everything else if economic growth comes in, all other pains would be forgiven?
TAIMUR BAIG: I think that we need to first take stock of the existing reality which is a tough one that it’s not just Covid, remember we came into this crisis already on a weak footing, the banking system was dysfunctional, growth was anemic already. So, when we start picking up the pieces from the slowdown and the loss of GDP of the last one to one and a half years well into 2022 or 2023 before all that loss ground is being made up for and going back to the trend that was seen in the middle part of last decade, that’ll take maybe another five years to go back. So, it’s a daunting task ahead and it is coming at a time when you have to have very progressive forward-looking thinking because the world is not static, it’s changing very dramatically. The trade regime, the way capitalists moving around the world, the outsized role of China, everything it has to be considered on a dynamic basis. So, I do think that the current policy package seems to be cognizant of those major changes that are taking place. India’s trying to seize on the opportunity of the evolving global manufacturing landscape. India is cognizant of the fact that in the China-U.S. tussle, there are certain angles that India can pursue which can act to its benefit and I think that, that is again being pursued. So, the economic aspect, the geopolitical aspect are almost intertwined these days. You can’t really separate the two. So, India is certainly on the right side with respect to galvanising global interest and its policy signals are certainly being constructive or are being seen as constructive.
You have a fairly decent view of how the top down or the bird’s eye view is. Just one more aspect—just looking at the way things are evolving within India, the RBI has been at the forefront of fighting the battle when it comes to almost everything really, they’ve done the heavy lifting of sorts, we just had a policy on Wednesday as well when the dovish stance seems to have been extended, thus far for the foreseeable future. How do you see the bottom-up story in India? Do you reckon that earnings growth would come back partially because of the low basis but also because of the efforts that the government has put in, two corporate India has de-leveraged heavily over the last three, four years during tough times and maybe that also aids the performance over the course of the next few?
TAIMUR BAIG: My worry is not about the corporate balance sheet. I agree with you that there has been significant amount of deleveraging and the sort of excessive investment boom-bust that we have seen in the last 20 years, particularly around the construction property sector I think is in a far better footing now than it has been in a long time. I worry a bit about the household balance sheet. India has never been a country where households are highly indebted, but debt has gone up, and it hasn’t held up well against the macro headwinds of recent years. So, it is in the interest of households, in the interest of the consumption outlook that RBI succeeds in keeping inflation down, succeeds in keeping interest rates down. I mean, mind you the last one year has not been great in terms of inflation outturn. The market has been forgiving, the global markets and nobody really cares if supply side related disruptions are putting you inflation up to 6-6.5%. This is not a time to get all very holy about the inflation outlook. I think the RBI has struck the right tone that the focus is on growth, not on inflation right now because with some of these upsides, the monetary policy can’t do anything about it. So going back to the issue of the ground reality and the outlook from the bottom up perspective, consumption ought to be well supported by the fact that interest rates are low and job creation will resume on the back of manufacturing resumption and some degree of normalisation of the economy in the second half of this year. As India gets into this whole supply chain business where Indian companies or foreign companies operating in India start making components that will then make a finished product using various other components producing in various other parts of Asia, India then becomes a part of this whole supply chain and the positive spill over whether it is technology transfer or know-how or corporate culture and the safety that comes from being part of a bigger manufacturing community, I think could be immense. So, I think that corporate India by virtue of having a leaner balance sheet and this tantalising prospect of a manufacturing rebound is in good shape. We need to keep an eye on the households.
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