Moneycontrol Pro Weekender | Keeping the faith

#Pro Weekender, ‘Gentle Jay’ in this FT piece, Another tack, Evergrande implosion, here, Evergrande’s future, housing more affordable for the masses, research paper, Chinese growth will slow, monsoon rains, recovery tracker, herd immunity tracker, a four balance sheet problem, Mahindra & Mahindra Financial Services, Manappuram’s, Eastern Window, our melt-up thesis on the markets, doubts about a capex-led recovery, HG Infra Engineering, Heidelberg Cement, Freshworks’ US listing, TCS, IFGL Refractories, Zee-Sony marriage, what investors could expect, tyre companies, Ceat’s, Sona BLW Precision Forgings, Tim Harford’s take

Dear Reader,

The markets this week demonstrated their faith in both Jerome Powell and the Communist Party of China. The Fed chief not only signalled that conditions were in place for the taper to begin soon, but added that he hoped to wrap it up by mid-2022. Surprisingly, the equity markets soared on the announcement, with the Sensex losing no time in scaling Mount 60K.

But if the party in the markets is so dependent on fresh supplies of liquidity, shouldn’t the prospect of lower supply make them quake? One answer to that question is that Jay Powell—‘Gentle Jay’ in this FT piece—is a master communicator, having prepared the markets for a taper slowly but surely. Another tack is to point to the fact that interest rates are not going to go up any time soon. After all, all that is happening is that fresh asset purchases are being wound down, but liquidity remains abundant. It’s not quantitative tightening.

Yet another view is that the markets were already jittery about the Evergrande implosion and Powell’s dismissal of any contagion from it came as a relief, along with the Chinese central bank’s injection of large dollops of liquidity to shore up their banking system.

Ultimately, what matters is growth. If growth comes back, the markets wouldn’t mind a reduction in liquidity. The latest Flash PMIs show the US Composite PMI fell to a 12-month low, mainly because of weakness in the services sector. The Flash PMIs for the Eurozone and the UK also fell. Indeed, the median projections at the recent Federal Open Markets Committee meeting also show lower growth projections, as well as higher inflation. The OECD too has toned down its projections of US growth.

What then explains the market’s optimism? Apart from the weight of money, which is a huge factor, the market is buying the central banks’ line that temporary supply disruptions are keeping inflation high and growth low. The waning of the Delta variant is yet another positive, which will revive growth in the services sector.

Much depends on inflation. The Bank of England said this week, ‘Against a backdrop of robust goods demand and continuing supply constraints, global inflationary pressures have remained strong and there are some signs that cost pressures may prove more persistent.’ Note that bond yields in the US have moved up, albeit only a bit. We checked how investors could play the high oil and gas prices here.

Evergrande’s future and the fate of China’s real estate sector is still a grey area. If Xi is serious about what he said about houses being for living in and not for speculation and if the slogan of ‘common prosperity’ is to have any meaning, he must make housing more affordable for the masses. As a research paper says of China, ‘We are in a highly uncertain regulatory environment and it is not yet clear what the equilibrium for China’s authoritarian regulatory governance will eventually be.’

At the very least, even if there is no market contagion, Chinese growth will slow. Whether that will be offset by higher growth in the rest of the world remains to be seen. The Biden administration’s fiscal push, in particular, holds promise. Perhaps the markets are applauding the handing over of the baton from monetary to fiscal policy.

India, thankfully, will only be minimally affected by a Chinese slowdown. The monsoon rains are once again back to near-normal levels. Our recovery tracker this week is middling, but there are a host of other indications that the Indian economy may have turned the corner.

Our herd immunity tracker suggests that the entire adult population could be vaccinated in the next four months. The twin balance sheet problem—Arvind Subramanian had expanded it to a four balance sheet problem—is largely behind us. This week, we recommended Mahindra & Mahindra Financial Services as a likely beneficiary of the reduction in non-performing assets. For the risk taker, Manappuram’s huge valuation discount to Muthoot makes it attractive.

The government has set up a bad bank, has taken the initiative in industrial policy via the Production-Linked Incentive (PLI) schemes and announced the National Monetization Pipeline. Why, even in geopolitics, the Modi-Biden meet will cement India’s position in the quad, as our Eastern Window points out. The upbeat mood was captured in our melt-up thesis on the markets.

To be sure, there are still some doubts about a capex-led recovery, as an RBI study points out. And much of the growth has already been captured in stock valuations. As a US research note from Jefferies warns, ‘moving slightly from very negative real rates to just modestly negative rates would certainly change the valuations of highly priced shares.’

The good news for India is that central government finances are in good shape, it has removed the spending curbs and is pushing capex. That should benefit stocks such as HG Infra Engineering. Cement companies should be key beneficiaries of infra spending and we analysed their prospects here. We pointed out that Heidelberg Cement has several growth levers in place.

Demand is outstripping supply in the IT sector, with commensurate increases in salaries. Freshworks’ US listing is a defining moment for the sector. We also looked at what sets TCS apart from the rest.

One of the factors leading to a revival of interest in real estate is the IT sector boom. The other, as pointed out by Jefferies’ Chris Wood, is increased affordability. Writes Wood: ‘The housing affordability ratio, measured as home loan payment as a percentage of income, has declined from 53% in FY12 to the record low of 27% in FY21 and is estimated at 28% this fiscal year.’ It’s no wonder then that the DLF stock is at a 12-year high.

While corporate capex may still be muted, household capital expenditure may therefore step in. And there are sectors such as steel that are planning capex, which should help the likes of IFGL Refractories.

The Zee-Sony marriage was a fairy tale one, with every analyst showering rose petals on it. We weighed in on what investors could expect after the dizzying run-up in the stock.

The road is becoming smoother for tyre companies, as rubber prices fall. We found Ceat’s prospects and valuations attractive.

While ESG is all the rage these days, it doesn’t mean that every company will find the space an attractive one. As a proxy play on EVs, we recommended Sona BLW Precision Forgings.

And lastly, in keeping with the prevailing bullish sentiment, here’s Tim Harford’s take on how a shock, such as the pandemic, can make both businesses as well as individuals stronger.

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