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Stock markets are celebrating the turn in inflation, but the bond markets are looking at the coming slowdown

June 25, 2022 / 12:28 PM IST
(Representative image: Reuters)

(Representative image: Reuters)

Dear Reader,

A whiff of change wafted through the markets this week. The focus shifted from worrying over inflation to concerns about growth. The advance Purchasing Managers Indices (PMIs) for the current month for the US and the Eurozone showed slowing growth, but while they indicated inflation was cooling in the US, it continued to rise relentlessly in the Eurozone. They also reflected stalling demand and falling business confidence. The New York Fed’s economic model predicted an 80 percent chance of a hard landing for the US. UK consumer confidence hit a record low. In China, housing starts and property transactions reached extreme lows.

The worries over an imminent recession in the US, the UK and the Eurozone sent commodity prices sharply lower. Copper prices have moved down dramatically. My colleague Ravi Ananthanarayanan wrote about the dark clouds hovering over steel. Crude oil prices too fell. That dissipated some of the inflationary fears. The markets are now pricing in the Fed Funds rate at 325-350 basis points by year end, a lower estimate than a week ago. The 2-year Treasury yield has come off sharply. German 10-year yields dropped from 1.9 percent to 1.4 percent in five days.

The fall in yields led to a rally in equities, aided and abetted by the extreme bearish sentiment that prevailed. As market expert Shyam Sekhar wrote, ‘In my experience, such pessimism on the Street has its own way of moderating. Look carefully and one can see early pointers of falling commodity prices, improving supply chain efficiencies, rising production in critical commodities and moderating demand.’

The market’s concern has been that supply constraints will force central banks to tighten, even though demand is weakening. The fall in commodity prices and shipping costs this week raises the hope that central banks may not need to tighten so much. That has helped the bounce in the markets.

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Of course, inflation may still remain high for a considerable time. Mohamed El-Erian says in this FT article, free to read for Moneycontrol Pro subscribers, that policymakers must not waver in the good fight against inflation. Shishir Asthana points to the steep rise in gas prices in Europe after Russia reduced supplies and IEA chief Fatih Birol said this may be a precursor to a total cut off in the winter. That has sparked talk of a ‘Lehman moment’ in Europe, with the world’s largest hedge fund doubling down on its short position in European stocks. Another risk is the cryptocurrency crash, which could ripple through other markets.

Nevertheless, the looming US recession need not break the back of Indian IT stocks. Indeed, we said that among mid-cap IT stocks, Coforge and Zensar offer good opportunities. Vatsala Kamat wrote about the danger that macro headwinds pose to the incipient recovery in corporate capex, the prospects for which were looking bright because of the decade-high corporate profits/GDP ratio. But government capex plans remain on track, which boosts the case for construction stocks. Sectors such as sugar, though, may be at risk as the government is considering an export cap to keep inflation in check.

For now, as the minutes of the Monetary Policy Committee meeting indicate, growth momentum in India remains robust and the focus remains on containing inflation. Our Economic Recovery Tracker shows improving consumer sentiment and employment, although the quality of employment may still be suspect. Our Monsoon Watch indicator shows the aggregate rainfall deficit is down to 2 percent, which augurs well for the kharif crop.

Inflation in India is mainly the result of high energy prices and if they come down, so too will inflation. But the rupee remains under pressure and while Moneycontrol Pro columnist Ananth Narayan has said a bit of rupee depreciation is entirely welcome, the problem is that it could increase inflation. Even so, the RBI may take the policy rate to a neutral zone and stop there.

There are other silver linings, the successful World Trade Organisation meeting being one of them. Maersk boss Soren Skou scotched talk of the death of globalisation as premature. The energy crunch has been a boon for thermal power units, including Jindal Power, which have begun to see a reversal of a decade-long fall in capacity utilisation. But that is a very dubious silver lining, considering the toll it will take on reducing greenhouse gas emissions.

The fall in market valuations, of course, spells opportunity, though not for all stocks, some of which remain too expensive, while others may be bargains in spite of high multiples. SastaSundar Ventures, for example, is an interesting value proposition after the correction. We also recommended a platform business with cash flows whose stock has corrected 50 percent. Most banks will do well in a rising interest rate environment. Castrol, Gland Pharma and Mazagon Dock were other stocks we considered. We found Suprajit Engineering’s long-term outlook promising, despite the semiconductor crisis. And perhaps Radico Khaitan may provide some comfort in these times of trouble.

Our regular features this week included Crypto Conversations, FX Learn, The Green Pivot, Personal Finance, The Eastern Window and Start-up Street.

On topics of current interest, we had stories about why Agnipath is necessary, why China isn’t a financial superpower and what the crisis in the Maharashtra government means for national politics.

While the narrative has changed during the week, there is still a huge amount of uncertainty. This FT story says we’ve only seen the first phase of the bear market and the next leg will be driven by earnings recessions.

So when will the market turn decisively? Ajay Bagga said markets will start to rally a few months before the economic cycle bottoms. And when will FII flows turn, the big question for the Indian markets? Moneycontrol Pro columnist Ananya Roy picked out some answers to that question from an RBI study.

On Friday, in a speech to the PHD Chamber of Commerce, RBI deputy governor Michael Patra said that inflation may be peaking, adding that ‘The key is the direction of change in inflation – not its level – in these extraordinary times.’ But in the same speech, he also said, ‘The monetary policy action is not without consequences. It will take its toll on spending and demand.’ Stock markets are celebrating the turn in inflation, but the bond markets are looking at the coming slowdown.

Cheers,

Manas Chakravarty
Manas Chakravarty
first published: Jun 25, 2022 12:28 pm
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