Infrastructure thematic
· Fed tightening expectations have picked up over the past week. If this is not a surprise to GREED & fear given the natural propensity for Fed governors to start talking hawkish after share prices have risen and credit spreads have come down, GREED & fear's fundamental view remains that American economic growth is tepid at best.
· The failure of American consumption to pick up over the past year and more in the manner expected can be explained not just by increased consumer caution but also by the increasing costs of two essentially non-discretionary items for most Americans. That is the soaring cost of medical care and the rising cost of rents.
· The US mortgage application index has still not really picked up convincingly during this economic recovery reflecting the continuing reality that banks view mortgage lending as a regulatory minefield. The mortgage industry also remains essentially socialised as a result of the continuing "conservatorship" status of Fannie Mae and Freddie Mac and the sharp surge in activity by the Federal Housing Administration since 2008.
· GREED & fear thinks it is only a matter of time before markets re-focus on the fundamental lack of growth momentum in the American economy, though there is the potential for a late cycle "suckers' punch" in terms of accelerating wage pressures.
· If the Fed really does start trying to raise rates, as opposed to just talking about it, expect the yield curve to flatten not steepen on the announcement. While the US yield curve has potentially been distorted by ultra-low and negative government yields in Europe and Japan, GREED & fearcan explain the shape of the US yield curve by the ongoing decline in nominal GDP growth and the related fact that velocity is running at a 60-year low.
· The continuing pressure on disposable incomes in America also explains why the election debate is going the way it is. GREED & fear still maintains the view that the chances of a substantial infrastructure stimulus are rising significantly whichever side wins the White House in November. This is a reason to buy US "smokestack" stocks which have already started to perform.
· More infrastructure stimulus is also increasingly likely in Japan given the prevailing view that the Japanese economy is weakening again. Still nominal compensation continues to rise in Japan reflecting a tightening labour market and a growing female participation rate. The increase in regular full-time workers also recently overtook the increase in part-time workers.
· There are, therefore, some fundamental positives to note in Japan, as the labour market responds to the natural pressures and demands created by a declining working-age population. But the problem is that this story has been overshadowed by the systemic risk raised by Kamikaze Kuroda's high beta monetary policy.
· There have been interesting political developments in India over the past week. The important point is less that the BJP did well but that the Congress did badly in all four key state elections held earlier this month. This leaves the BJP looking like the only major national party which also means that the odds still favour a Modi re-election in the general election in 2019, though the key political test will be the state election in the most populous state of Uttar Pradesh in April 2017.
· It is now the time for the Modi government to sort out the mess in the public-sector banks before the demands of the political election cycle take priority. Fortunately, all the evidence is that this is finally happening.
· It is likely that recapitalisation plans for the public-sector banks will be announced soon with the hope that the banks are cleaned up by March 2017. Such an outcome would be extremely constructive and would contrast significantly with the failure so far of China to address its rising systemic NPL risk proactively. Deleveraging is much more real in India than in China as reflected in the fact that credit growth is running in line with nominal GDP growth in India whereas in China it remains well above.
· GREED & fear views Modi as by far the most impressive political leader in the world today. But it is true that he has had a problem passing legislation because of obstruction by the Congress Party in the Upper House. Still this does not mean that nothing has happened on the legislative front.
· A landmark bankruptcy bill was passed in India on 11 May which is of huge long-term significance. Another recent development which has not received the attention it deserves was the passage of a bill in March introducing long overdue regulation of the residential property sector.
· The most important reform introduced by this bill is that developers will be forced to keep 70% of pre-sales cashflow in an escrow account until a project is completed. This is critical for confidence in an Indian housing market where many projects have been "stuck" in recent years, leaving would-be home buyers who have paid instalments on a property which has never been completed with no redress against the developer.
· The above reform should therefore create real barriers to entry for the residential property market since only developers with the necessary strong balance sheets will be able to sustain such a business model.
· In the hope that the relative doldrums in the residential property market in India are in the process of bottoming out GREED & fear will again introduce an Indian property stock in the Asia ex-Japan long-only portfolio. An investment in Prestige Estates will be reintroduced with an initial weighting of 3%. This will be paid for by shaving the existing investments in Reliance Industries, Bharti Infratel and Universal Robina by 1ppt each.
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