USFC January 2019 CIO Report

January 2019 USA and India Investment Outlook

CONTINUED SLOWING OF US ECONOMIC GROWTH

The US economy is growing; however, the pace of growth is slowing. We are clearly shifting to the downside of the business cycle in 2019. Slowing rise and/or contraction should be the expectation going forward for most markets and companies. The shift in the business cycle is consistent with leading-indicator input and our forecasts.

US FEDERAL GOVERNMENT SHUTDOWN

Government shutdowns in modern times arise from amendments made to the Antideficiency Act in 1982. There have been 14 federal government shutdowns since that time. We just completed, through a temporary reprieve, the third shutdown under President Trump and we expect another shutdown when the current temporary reopening expires in two weeks.

The shutdown is a misnomer, as significant portions of the government remain open and operational. The political pressure to reopen the government is mostly derived from the affected federal employees who do not receive paychecks. Political pressure to reopen the government comes primarily for a reasonable sympathy for these workers, not from any dramatic loss or danger.

What effect should we expect to the economy from the government shutdown? Using US Total Industrial Production monthly data as the benchmark for the economy during each of the post-1982 shutdowns, the economy always maintained its then-current business-cycle trend with no more deviation than would be expected for any given month

Standard & Poor’s wrote that the 2013 16-day shutdown “has taken $24 billion out of the economy” and decreased the economy’s rate of growth in the fourth quarter of 2013 by 0.6 percentage points. However, $24 billion equates to just 0.1% of 2013’s US economy of $16.7 trillion. So, unless the shutdown drags out for several months, we do not expect a meaningful impact to the overall economy.

OUR ECONOMIC OUTLOOK (USA)

US Industrial Production during the 12 months through November was up 4.0% from one year ago. US Total Manufacturing Production, the largest of the three major segments of the industrial economy, slowed in its pace of growth in the most recent month of data. Similarly, the pace of rise for US Electric and Gas Utilities Production (up 4.7%) has slowed in each of the past two months, albeit mildly.

Meanwhile, US Total Mining Production (up 12.5%) is growing at an accelerating pace but will enter a slowing growth trend early this year. Each component of the industrial economy is signaling that we are near the top of the business cycle.

Slowing growth, when it takes hold early this year, will persist through the first half of 2019. Activity will then decline into early 2020.

OUR INVESTMENT OUTLOOK (USA)

We see US real estate continuing as a superior investment for our offshore investors, as this asset class is an income producing hedge against inflation and a hedge against the increasing volatility of the equities markets. Texas will continue to benefit from the fallout from the 2017 Tax Act, as companies in high tax states are faced with significantly higher local taxes in 2018 and beyond and many make the choice to relocate to states with low or zero state income taxes.

A YEAR IN REVIEW (INDIA)

On the other side of the pond, Foreign Portfolio Investors (FPIs) withdrew US$ 14.2 billion from India in FY 2019 (1st April 2018 till 28th January 2019). Indian equity markets witnessed outflows of US$ 7.3 billion while debt markets witnessed outflows of US$ 6.9 billion, which indicates that no particular asset class was spared from the wrath of FPI outflows. While global ‘risk-off’ sentiments may be partly blamed as a reason for the outflows, much of the concern remains local in nature. Specifically, they have resulted from rising concerns of fiscal imbalance as well as concerns over ‘profitless’ growth of the Indian economy, which is already reeling under ‘jobless’ growth.

In November, the Indian fiscal deficit touched 115% of the budgeted numbers estimated for FY 2019. While the Indian government budgeted the FY 2019 fiscal deficit at INR 6.24 lakh crores, which was estimated to be 3.3% of Indian GDP, the number for April-November’18 actually stood at INR 7.16 lakh crores. While government expenses were on track, slower revenue from direct and indirect tax collections acted as the primary reason for the deficit number being way out of the radar.

Meanwhile, the Indian current account deficit widened to 2.7% of GDP for the first half of the financial year as compared to 1.8% in the same period during the last financial year. This was primarily due to a sharp spike in trade deficits which rose to US$ 50 billion (October 2017 to September 2018) as compared to US$ 32 billion (October 2016 to September 2017). While volatility in crude played its role in the rise in CAD, rise in electronics imports as well as slowdown in exports also contributed to this sharp spike.

Both the above factors have contributed to a sharp spike in Indian fixed income yields as well as had a cataclysmic effect on the value of the Indian rupee, which shed roughly 11% of its value in FY 2019 (1st April 2018 till 28th January 2019).

GROWTH WITHOUT JOBS AND PROFITABILITY: HOW LONG CAN IT RUN? (INDIA)

Indian equities, meanwhile, are grappling with a unique scenario where their profitability, compared to Indian GDP growth, has been falling alarmingly. In fact, according to a report from Motilal Oswal, a leading domestic brokerage house, India Inc’s profits as a share of GDP stood at a 15-year-low of 2.8% in 2018. The implication of this means that the corporate balance sheet is increasingly getting decoupled from the overall India macro story, spooking FPIs which led to the sharp outflows highlighted above.

OUR ECONOMIC OUTLOOK (INDIA)

Overall, with Indian general elections around the corner, we can expect India’s already strained fiscal scenario to persist owing to pre-election populist measures. This will likely keep the Indian rupee and bond yields under pressure, while Indian equities may not see active long-term flows especially from FPIs as they await the outcome of Indian general elections to frame their investment outlook. And, while Indian equities have historically performed and generated wealth, it is reasonable to believe that recent trends in volatility could continue. If that is the case, we are reminded of the necessity to diversify across more stable asset classes.

In light of recent equity market volatility, and economic changes, US Freedom Capital continues to stand by its investments in US real estate. Protected by the stability of the world’s largest economy and 250 years of property rights, US real estate brings high returns at significantly lower risk. Many of our projects are focused on non-cyclical asset classes, which produce higher returns and zero volatility.

Our best wishes for your health and prosperity in 2019!

US FREEDOM CAPITAL

David E. Gunderson Chief Investment Officer	Arindam Sengupta Deputy Chief Investment Officer (India)