Costs are rising at a scorching pace. Earlier this week, HUL chief Sanjiv Mehta said he hadn’t seen this kind of inflation for many years. Asian Paints’ management said raw material cost inflation was the highest in four decades.
It’s a global trend. The Flash Purchasing Managers surveys for October saw input prices galloping. In Japan, input prices rose at the fastest pace in 13 years. The Eurozone Flash PMI survey said, “An unprecedented input cost increase was recorded in manufacturing while service sector costs rose at the sharpest rate since September 2000.” The UK Flash PMI showed the fastest pace of input cost inflation at private sector companies since the index began in January 1998. In Australia, the survey said input prices had risen to a record high. And in the US, both input price and selling price inflation hit a new series peak.
Investors fled gold for cryptocurrencies as inflation worries perked up, while Bitcoin soared on the back of the launch of its ETF.
So far, the official response has been that inflation is transitory. The IMF’s recent World Economic Outlook is typical. It said, “Looking ahead, headline inflation is projected to peak in the final months of 2021, with inflation expected back to pre-pandemic levels by mid-2022 for both advanced economies and emerging markets country groups, and with risks tilted to the upside.”
Not everybody is convinced. The Bank of England may be close to breaking ranks—BoE governor Andrew Bailey has said that he ‘will have to act’ over rising inflation. Goldman Sachs global head of commodity research Jeff Currie wrote in this FT article that the supply crunch is the result of years of underinvestment in old economy sectors. His conclusion: commodity prices will have to considerably overshoot to provide an incentive for investment.
Will this have an impact on growth? The October Flash PMIs have improved for the US, Japan, Australia and the UK as these countries emerge out of COVID-induced restrictions, but there has been a sharp slowdown in the Eurozone.
In India, hope lies in the one billion vaccinations milestone, but our Herd Immunity tracker pointed out we still have a long way to go. Nomura says there are initial signs of a slowdown in demand in the mass segment. The research report said, ‘Since rural consumption is driven more by mass segments, we believe consumers are feeling the pinch of rising product prices. On the other hand, urban consumption should benefit from re-opening-led recovery.’ The government has been trying to cool down edible oil prices.
The simple question we asked for HUL is: if sales growth is slow, margins are flat and this situation could continue, then why should investors pay top dollar to own the FMCG bellwether? One cautiously optimistic answer: the valuation premium is likely to sustain, although investors have to trim return expectations. The same question, with the same answer, can also be asked of Nestle India. For Asian Paints, though, valuations leave little scope for comfort, as cost pressures bite. As we pointed out, consumer companies are caught between a rock and a hard place.
It isn’t just consumer companies that have been hit by higher input costs—JSW Steel, Havells India, Shakti Pumps, Rallis and the farm economy have all been affected by rising input costs. Shortages have also hit the passenger vehicle sector, despite robust demand.
Of course, there are also companies that have proved resilient. These include TVS Motors, Jubilant FoodWorks, UltraTech with its pricing power, ACC, Mahindra CIE with its EV opportunities and Avenue Supermarts.
We took another look at Zee Entertainment after the shenanigans there, weighed the merits of Wipro vis-à-vis Infosys, considered whether HDFC Bank and HCL Tech could rebound, analysed coal inventory and electricity prices and updated our Economic Recovery tracker. Devyani International too is set to gain from the easing of Covid restrictions. Indian Hotels, Syngene and Navin Fluorine are some of other stocks we analysed during the week.
Given stretched valuations, we advised investors to wait for a pullback before buying some of these stocks---IRCTC, of course, is the cautionary tale here. UBS has in a recent note said the Indian market is ‘extremely expensive’.
Aswath Damodaran, professor of finance at Stern School of Business, New York University, told us his views on a wide range of issues affecting the Indian market in this interview. Damodaran said ‘ESG is so intent on knee-capping the fossil fuel companies that the bounce back in production that usually brings oil prices down may not happen as quickly this time.’ This is remarkably similar to what Monetary Policy Committee member Jayanth Varma said at its last meeting. He said, ‘the ongoing transition to green energy worldwide poses a significant risk of creating a series of energy price shocks similar to that in the 1970s. This means that the upside risks to long term inflation and to inflation expectations are now more aggravated.’ Although Varma’s is a dissenting view, RBI has started withdrawing liquidity, which has led to higher bond yields.
On valuations, Damodaran said one of the factors boosting Indian markets is the hope that India will be the engine driving global growth in the next decade or two, replacing China. His take on that story: ‘India may be able to benefit, but only if it keeps its end of the bargain.’ That bargain includes improving infrastructure, speeding up the regulatory process and making it more predictable and getting politics out of economic decisions.
On China, in The Eastern Window, we tried to find out why, in the midst of all the economic challenges that China faces, Xi has continued to be so aggressive militarily. We had two FT articles this week on Xi’s policies here and here. Worries about the impact of these policies on the Chinese economy continue. Jayanth Varma said he is concerned ‘about the tail risk to global growth posed by emerging financial sector fragility in China reminiscent of Japan of the late 1980s.’
China watchers may be enriched by studying the views of Hungarian economist Janos Kornai, who passed away this week at the ripe old age of 93. Kornai was celebrated for his analysis and critique of the socialist economies. He wrote ‘Economics of Shortage’ in 1980, about the chronic shortages that plagued the socialist economies. The book sold 100,000 copies in China and was probably a factor in the shift from the command economy to a more market based system. In an interview with economist Olivier Blanchard, Kornai said, ‘it’s a revolutionary book, because the conclusion is that cosmetic changes and superficial reforms do not help. You have to change the system as a whole to get rid of the dysfunctional properties. That is the book’s main contribution.’ Kornai was proved right by the collapse of socialism in East Europe.
Will he be right about China too?