Nishant Gupta & Anil Ghelani
While visiting Buenos Aires in Argentina, one of the must visit attraction is the famous stone obelisk monument at the busy plaza with the traffic bustling in the background. This is sure to immediately remind the visitor of a very similar looking obelisk monument in Washington DC, with the White House in the background.
Unless you are a student of history or learning architecture, you would not realise the difference between the two. But if we look at it from the world of investment, being in Washington or in Buenos Aires, consensus could mean a very big difference for your portfolio.
Stabilise, Liberalise, Privatise – defines the Washington consensus. On a broader context, the Washington consensus is less populist, more technocratic and is set of rules based on prudent fiscal policy, lower taxes but wider tax base, trade liberalisation, deregulation and privatisation of state corporations. Governments play a less active role, as they believe market forces would align themselves and solve for all economic issues.
On the other side, Buenos Aires consensus is more populist, less technocratic and is a set of rules that are completely opposite to what the Washington consensus are based on. It is very important for investors to know which consensus defines the modern state of economics, as either one of the two could have a bearing on asset prices.
Two key events that stood out in last few years and have had a material impact on global growth and financial markets are – the trade wars and the current pandemic crisis.
We have witnessed how the US–China trade war has evolved in last three years, with protectionism taking the centrestage. US President Donald Trump and his other associates in the Republican Government won the elections in 2016 on the promise that they would lower taxes, provide greater incentive to domestic manufacturing and curb trade imbalances with its partners. This started through import duty hikes and soon moved to other dimensions. Protectionism, which is opposite of trade liberalization, is a key characteristic of Buenos Aires consensus.
This crisis has been the biggest threat to social, economic and financial aspects of economies. The global economy slipped into a state of ‘deflation’ – slower growth and falling inflation. In a deflationary environment, demand collapses, velocity of trades reduces and solvency risks increase. To provide economic and financial stability, central banks and governments have made coordinated efforts.
Monetary policy actions have been seen in the form of supporting government’s borrowing programs and other measures to provide stability to financial markets. There has also been fiscal stimulus, including direct cash transfers and bailout packages for specific industries.
The pandemic has forced governments to re-evaluate their trade and economic policies (i.e. promote domestic manufacturing, e.g. Make in India). It has obligated companies to re-evaluate their strategies to de-risk dependency on different countries for their supply chain. Expansionary fiscal policies (opposite of Fiscal Prudence) and de-globalisation are also some of the key characteristics of the Buenos Aires consensus.
What should investors do?
Economic engines are running on both gears of fiscal-led policy stimulus and central banks’ balance sheet expansion, and the world is leaning towards the sentiments of the Buenos Aires consensus. Chances of introduction of a vaccine sooner than later could boost sentiment, leading to pent-up demand and inflationary concerns. Hence, it could be useful for investors to consider having allocation to commodities as part of their asset allocation, which could help them hedge against inflation risks.
In the past, it’s been difficult for investors to make money in commodity stocks because either they have invested in times when stock prices have already moved up sharply or they have invested in companies that do not show capital discipline, taking huge borrowings, generate low free cash flows and have low shareholder payout.
The underperformance in commodity stocks started in 2018 when the global growth was impacted by trade wars. That underperformance got accentuated with the advent of the current pandemic in March 2020.
On the demand side, if we look at purchase managers index (PMI) for manufacturing and services or industrial production for March and April 2020, almost all economies de-grew to very low levels. Because of lack of demand, commodity prices had corrected sharply which led to decline in production as companies found it economically unviable. In situations where demand has tapered off and supply-side remains constrained for a longer time, any pent-up demand or change in sentiment primarily because of vaccine launch could lead to higher demand, thereby leading to higher commodity prices.
Commodity companies are not doing large capex, which would help improve free cash flows and ensure higher shareholder payouts in the form of pidends or buybacks. Many commodity companies, both domestic as well as global, currently appear to be trading with a margin of safety for investors in terms of valuation metrics being lower that their long-term average.
To summarise, fiscal-led stimulus, balance sheet expansion by central banks, revival of economic growth, disciplined capital structure by companies and margin of safety in terms of valuation are some of the key points which merit a look at commodity companies to be added to a portfolio as a tactical allocation for investors.
They may consider funds having a focus on commodity companies and would do well if they choose to invest in funds, which can give them exposure to both domestic and global commodity companies as it can help persify country-specific risks. However, they need to be cognizant of some macro risks such as geopolitical tensions and delayed economic recovery from the pandemic crisis and keep a close watch on developments in this space.
(Nishant Gupta, Senior Manager for Product Management and Anil Ghelani, Head of Passive Investments & Products at DSP Investment Managers. Views are their own)