When global bond yields reverse, it means a recession is coming. A global recession is bad news for stocks. So when the sophisticated US bond market tells us a recession is coming, how do we deal with it?
Just take a step back and think about it. Most of the names we like are not cyclical plays for obvious reasons. Companies like Alkyl, GMM, Pfaudler, which supply raw materials to the pharmaceutical industry, are not cyclical games because the pharmaceutical industry is not a cyclical game. Even less obvious names like Pidilite or Asian Paints aren’t cyclical either.
So the first thing to note is that neither you nor I are experts at calling the business cycle and I have made it clear to clients from the time we created Marcellus not to expect us to be timing the macro cycle or the cycle of the basic products. We have no experience in that. I don’t think anyone does it out there. So synchronizing the business cycles, the commodity cycles, has not been a smart way to invest in any country, not just India, and so it’s something that we’ve stayed away from doing.
India has faced some of the biggest challenges in the last five years. In the last five years, one hasn’t exactly seen an economic boom in India. We’ve had GST, demonetization, Covid, and despite those repeated shocks to the economy, companies like Pidilite, Asian Paints, and Titan have compounded free cash flows by 25%. So if you can get through an economic downturn like our country has had from time to time over the last five or six years and come out with 25% free cash flow capitalization, I’ll happily take it.
In addition, the job creation data is spectacular. The EPFO published this data five, six days ago. In the last three difficult years, India has created 32 million jobs in the formal sector. France’s total workforce is 30 million, UK’s total workforce is 30 million. India has created as many jobs in the last three years in the formal sector as the entire labor force of the G7 countries. That gives an idea of the solidity and resilience of the country and that is why I am not going to lose too much sleep over the inversion of the yield curve in the United States.
I’m just trying to understand the loop part. If a bear market is approaching, technically a 25-30% drop can easily happen because equities also have this inherent mean-reverting nature. If a rising tide takes everything higher, will a receding tide cause everything to go down?
I have partially acknowledged your point by saying earlier that we have reduced our investments in automobiles and automobile auxiliaries. Maybe we didn’t think of it in macro terms when we did it, but maybe withdrawing our investments in cars and auto auxiliaries is an acknowledgment that from a global perspective, maybe not from an Indian perspective, the best of economic expansion is done. . .
But at the same time, I urge you to think about the fact that if I look at our own client base, the biggest fear is interest rate hikes. This constant fear that interest rates will go up and if interest rates go up there will be some pullback in the market. So it’s very paradoxical. On the one hand the US market is worried about a recession, on the other hand the Indian market is worried about higher rates and obviously there is a contradiction there.
The Federal Reserve is unlikely to raise rates and push the US into recession at the same time. I don’t think both are activated together. We’re going to get a mix of the Fed pushing rates up by, say, 100 bps or so over the next 12 months and at the same time the overheated economic recovery that we’ve seen in the West where US economic growth is running on around 4.5-5% and a giant IT services company like Accenture is posting 28% revenue growth shows the incredible rate at which the United States is growing.
We will see a cooling off of the frenetic economic recovery in the western world and we will get some degree of normalization in interest rates after Covid. Both are healthy corrections, healthy normalizations in the post-Covid world. It should also not be used by people who are looking at this for tactical portfolio positioning. I don’t think that kind of investment will work. So in part I will admit that the economic recovery in the West should slow down. It has overheated and the Fed has made it very clear that a rate hike is coming. So both bring us to some degree of normalcy as best we can, given the Ukraine scenario.