Do you view the current inflationary scenario as transitive or durable? How much do you think inflation prints are going to influence market swings going forward?
It’s never as good as it appears, and never as bad as it feels.
Investing sentiment and market cycles oscillate between euphoria and pessimism. Just like we could not predict the economic recovery after COVID, it’s hard to say if we are indeed headed for a recession. Governments and global central banks have earlier shown the ingenuity and resolve to solve seemingly impossible situations.
Have a look at the US10 year Treasury chart above. Does today’s yield of around 3% look unnatural to you? If the markets and US economy have seen even higher yields earlier, why do we have so much noise today about a possible recession?
The first part of answer lies in monetary tightening. Have a look at the chart below:
Unlike in previous market upheavals, the FED is today both raising interest rates and reducing it’s sizeable balance sheet. Withdrawal of liquidity is further forcing interest rates up!
Now, let’s see the following chart to assess second piece of the puzzle - inflation:
In a normally rising scenario, the FED and other central banks can measure their interest response – this ensures enough time for them to assess how the economy is responding (contracting too fast or a gradual correction). Unfortunately, with inflation running red hot at 40 high, the FED doesn’t have the luxury to raise interest rates slowly.
To conclude, we are at a position that market participants haven’t seen in decades! This uncertainty is fuelling dramatic volatility and questions of a possible recession.
So, what could be the positives? See the charts below:
The US government’s revenues (similar trend for other major economies) are at all time high! This is a result of a resurging economy and a boom in stock markets last year. To add, spending by US customers on goods and services is an all time! There are other encouraging data points on savings rate, exports growth etc.
Therefore, I am not in the camp that sees imminent and inevitable recession. In my opinion, the odds are balanced – we need to be realists and not overtly pessimists.
To conclude: we cannot predict, we can prepare!
FII’s have pulled out record sums over the past few months, but markets have fallen but not capitulated. Would you say that we’ve turned a corner in a sense when it comes to our traditional reliance on FII funds to prop up domestic stocks?
Absolutely. FIIs have sold over US$30 billion over last 12 months. Indian investors have bought almost an equal amount. This is unprecedented in the history of capital markets.
In our opinion two factors are driving this change. First, Indians now save US$ 700 billion every year! Yes, it’s a staggering number. Even a 4-5% allocation to equities (historical trend) results in US$ 30-35 billion inflows every year.
Second, access to investing is now significantly wider and simpler. This is powered not only by the digital platforms, but also by regulatory reforms across identify (KYC), payments and product innovation.
We are a big believer in the power of India’s investors!
What’s your broad take on equities right now? Do you think we’re nearing a bottom, or is there more pain in store?
Absolutely, we have seen reasonable contraction in valuation and time correction because of interest rates and inflation movement over last 8 months. However, with coordinated steps taken by global central banks, we could be out of this situation. Markets are forward looking - we should get back to normalised growth in next 2-3 quarters which will reverse the outflows from equity markets globally.
Considering the above factors like FII activity, fed rate hikes, etc what do you believe an investor should look to add to the product suite and why?
Long-short funds work on two core principles:
Minimizing losses over maximizing gains
Since ongoing risks triggered by economic, geopolitics, liquidity and sentiment are pervasive feature of modern markets, a long-short strategy helps in limiting an investors’ downside. This means, in a sharply falling markets, investors in long-short funds can expect a lower fall.
This is achieved by systematically hedging the portfolio and by being agile in lowering the overall exposure (net delta, in technical parlance).
By falling less than the market in turbulent times, and by swiftly catching the uptrend, these funds aim to outperform over market cycles.
Do not mirror the Benchmark (NIFTY or others)
Such funds do not mirror the Benchmarks (NIFTY 50 or others). Therefore, portfolio allocations are swiftly moved to stocks in sectors that are likely to perform in a particular cycle. For example, in today’s environment, the portfolio allocation could be over-weight real estate, Banks and underweight consumption – with no regard to how these sectors weigh in the NIFTY.
Long-short funds typically target a performance range rather than only focusing on the NIFTY of any other benchmark. This aligns with investors’ goals of maximizing their wealth.
From a macro perspective, what factors are going to influence market momentum for the remainder of 2022?
India’s economic resilience will be tested in this uncertain environment. Markets will take a cue from how we ride the rough weather.
As an investor, we would watch trendlines across following:
Currency movement (INR depreciation)
Crude price
Consumer spending
Credit creation
Domestic interest rates
Continuing uptrend in Real Estate
One year from now we will start looking at FY25, which will coincide with general elections in India and hopefully, much lower inflation environment. Both will be very supportive for the markets. Also, FII selling has been at an unprecedented level over last 8 months and once that reverses one can expect much higher returns over next 12-18 months.
Are there any specific sectors you are bullish on right now, from a 3–5-year perspective?
Many sectors have witnessed sharp downgrades and therefore, a contraction in valuation. We would avoid sectors which can relatively underperform. We believe best of commodities and FMCG is behind us.
We are positive on Real Estate, Banking, and IT Services.
Where do you see crypto assets going from here? We’ve had some influential personalities calling out crypto and NFT’s as “100% based on the greater fool theory”. Do you subscribe to this view?
Crypto offerings are today not regulated by any securities regulator in the world. Therefore, investors are exposed to unknown risks. Some of these risks have recently materialized with great losses. I will advice investors to be cautious until clear regulations are in place.