The last one month has been one of even greater volatility for the markets. While I was cautious on the markets due to factors like high inflation, spike in bond yields and persistently rising crude oil prices the Russia Ukraine crisis put a whole new dimension to the volatility angle. Historically geopolitical news flow has had a short term impact on the markets with no sustainable long term impact. However higher interest rates and reducing liquidity impacts risky asset pricing in many ways along with potentially slowing down economic growth.
At the beginning of the year my view was that the first half of the year will be tough for Equities and followed by a revival in the second half. This played out in all the world markets except for India where markets have held up extraordinarily well in the context of muted growth numbers, high valuations as well as reducing earning growth projections for the next year.
We have seen most world markets including the USA correct and are down substantially from levels at the beginning of the year. The China and Hong Kong markets went into a downward spiral before their government stepped in yesterday to support the markets. The US Fed has started its interest rate hike cycle yesterday and gave a hawkish signal by indicating six more rate hikes and unwinding of the balance sheet from May. The big upmove in risky assets globally has followed the balance sheet expansion of various central banks. The unwinding of balance sheets will impact valuations of growth stocks. The US FED balance sheet currently is around $ 9 Trillion and has doubled since the current easing cycle started post the start of the pandemic. They are likely to start unwinding by around $ 75-$100 billion per month from May which will be the fastest pace of unwinding we have seen historically. Rate hike along with balance sheet unwinding is very restrictive and not understood by many. On the flip side it could also get inflation down faster than expected.
The bond market is already into a significant bear market which should sustain going forward. The cuts in most Emerging Markets in general have been severe. The Hang Seng Index fell 40% from the top of last year before their government stepped in with positive comments. As such valuation adjustment in most Emerging Markets has been quite significant. Indian Markets on the other hand have largely held on despite valuations now being the highest in the Emerging Market universe and valuations premium of the Indian Markets over EM’s at the highest in history. While one can argue that the markets fell to 15800-900 levels last week but it was a one day move which was taken out very fast and markets went above 17000 very fast. As such there has been no consolidation at downward levels which is also required for the froth to go out.
Foreign investors have been continuous sellers in the Indian Markets for several months now. However domestic flows into equities via Mutual Funds, Insurance Companies as well as direct inflows have been very strong. This is one of the reasons why markets have held on so strongly. However markets are a slave of earnings eventually and valuations do matter. At Nifty levels of 17000 markets are around 15-20% over historically average valuations.
There is one view in the markets that the impact of potential US Fed as well as other central banks tightening has already been built into the markets. Normally things get built in prior to the event however this time I do not think that the markets are building in the pace of monetary tightening which is going to happen. Also the speculative intensity in assets like Cryptocurrencies, NFT’s etc. is so intense that if these asset prices burst it will have repercussions across the board.
Over the last few weeks we have seen earnings downgrades in a variety of sectors by many analysts, specifically consumer and auto sectors. Due to a muted pickup in credit growth which is still at just 8% some analysts have also cut estimates for banks for next year. In this context there is no case for a major upmove in the overall markets and the Nifty this year. This view can go wrong if inflation falls much faster than expected and the pace of monetary tightening globally comes down. Looks unlikely at this stage but given the kind of volatility we have seen where crude went from $ 80 to $ 130 and then $ 100 in just a few weeks who really can predict what exactly will happen.
There will be specific opportunities in very strongly performing companies and sectors, there will be opportunities as particular sectors and stocks get sold down on market panics as well as when leveraged players are forced to exit positions due to sudden market moves and this will provide opportunities. This strategy involves keeping cash on the sidelines to deploy on big selloffs. In some of our portfolios with cash we could not deploy last week as the correction and pull back happened too fast. We will look for opportunities going forward. The reason some cash is important is that it sometimes becomes difficult even for professional investors to decide what to sell to buy some great idea when opportunity comes. In any case there is no case for a runaway up move in the markets and thus having some cash does not hurt anyone.
In the last one year the worst month for the markets has been November 2021 when markets fell by 3.9%. As such a belief that markets cannot fall is very high in the minds of traders and investors. Historically most years have got months with 7-10% corrections and some with more than that.
Overall long term prospects in India are robust given our demographics, economic changes driving efficiency, a move towards green and sustainable energy consumption as well as reducing import dependency. In the long term we are always bullish, but we are more bullish to buy at the right valuations. This strategy has worked for us in the past and should work in the future too.