This week was all about headlines about yields flattening, yield levels inverting and whether or not a recession is imminent. But the markets are telling you something else.
Yes, the markets are showing much more complacency than the data suggests. Yesterday, euro zone inflation hit 7.5% and European markets were still in positive territory. They have surpassed their pre-war level so clearly that there is a huge disconnect between the stock markets, what is happening in the economy, and what the bond markets are showing. But my experience is that bond markets are much more accurate predictors of what is in store. So I would be cautious. I have been cautious for the last three or four weeks. I have been warning investors to be careful. I have been wrong over the last week as the market has rallied quickly.
But what are the three big factors right now that we’re a little skeptical about which will impact the markets? One is that geopolitics is largely out of the way. It is a contained war and it will be a persistent war until it is finished. But it’s not having as big of an impact in terms of geopolitical sentiment. What it is having an impact on is the geoeconomic reality. It is having a big impact on commodity prices. There will be a shortage of fertilizers. There is already an agricultural shortage and that will worsen. So food shortages are coming and inflation. Second, we started the year with signs of Fed tightening and that continues. It will continue and May 3-4 will be a very important event where we expect a 50 bps hike from the Fed, largely discounted by the markets. The third part is what does China do? Both Morgan and Goldman released reports now putting Chinese growth for this year at 4% due to COVID lockdowns. I think it is a very problematic point for the global economy and for global markets. So how fast the Chinese stimulus comes and how fast China comes out of zero COVID and lockdowns will be very decisive in the direction of the markets. Nationally, we expect some earnings downgrades for the roughly 50% of companies that are price takers in the commodity complex. We are very positive on the financials and happy to see that Bank Nifty is recovering. Energy, materials, real estate, cement, industrials are the sectors that tend to do well in a high inflation environment. Finally, I would like to say that even when the yield curve inverts, from the time of the first investment until the recession begins, stock markets tend to outperform. Even when the interest rate hike cycle begins during the first 12 months, US markets tend to outperform. So we’re not seeing a huge impact on the markets, but a combination of all of this and the easy money politics that we’ve seen from 2008 onwards makes it very uncharted territory that we’re in. And we have not seen withdrawal of liquidity, which is coming
The big talking point in the coming week would be the RBI monitoring policy decision. Experts now believe that it is possible that the comment will change at least a little because they have been quite moderate. Do you expect the stance to change from dovish to neutral and expect a rate hike already?
Not for both of us, and I’ll agree with you. In the last policy, they had forecast that inflation will cross around 6% and then start to decline. That’s not going to happen, but that’s because of supply chain and commodity side pressures that no central bank can really stifle by raising interest rates. So I would say that they will recognize this risk of inflation that is global, it is driven by commodities, and they will say that this carries a risk on the growth side as well. They will stay with politics as it is today. They will keep it in an accommodating name and with no change in interest rate. The third thing is that they have been taking money out of the market, so the waste of liquidity has stopped. To some extent, hardening has happened. I think they will continue with that. They have been supporting the rupee, which is an unstated policy. Credit growth is expected to increase, but inflation, but they don’t really have a solution for that any time soon. I hope they stick to this policy for at least this time, see what the Fed does in May, and then act around June.