View: Markets are walking a tightrope

The Indian markets are walking a tightrope (of hope) passing through a deep valley of concerns like worsening global macro, poor domestic macro, worsening valuation-corporate fundamental matrix, and tightening liquidity.

The present narrative in the global market is definitely not comforting. In the developed western economies in particular, even the investors who took the classical moderate approach to asset allocation -- e.g.,“100-age” (percent allocation to risk asset 100-investors’ age and the balance to fixed income) or “60:40” (60% risk assets and 40% fixed income for working people and vice versa for retirees) -- have witnessed material losses as both risk assets (equities, crypto, etc.) and fixed income (bonds, REITs, etc) have witnessed a sharp correction.

Reportedly, 60:40 portfolio of US stocks and bonds is down 21.6% in 2022, the worst performance since 1931. In India also, most balanced funds (which invest in a mix of equity and bonds) have yielded marginally positive or negative returns in 2022.

From whatever is happening around the world, and whatever is being prophesied about the future, at least the following five things are reasonably clear to me:

(i)    Economic growth is declining and it is not an immediate priority for the policy makers

(ii)   The “innovative monetary policy” adopted after the global financial crisis has outlived its utility and is no longer effective. In fact the side effects of these policies are now appearing in most economies.

(iii)  No policy maker is in control of the economic events happening in their jurisdiction. Most have resorted to conventional means of policy management to tackle a situation which is largely created by unconventional policies, misplaced political aspirations, demographic transition, natural calamities, and egotistic pursuits of some political leaders.

(iv)   The cost of factors of production (wages, interest, material, and machines) is rising across the globe due to factors like demographic changes, under-investment in physical capacity building in the past two decades, climate change, and unwinding of unprecedented monetary stimulus.

(v)    The Indian markets are walking a tightrope (of hope) passing through a deep valley of concerns like worsening global macro, poor domestic macro, worsening valuation-corporate fundamental matrix, and tightening liquidity. The best case for markets is that it will cross the valley of concerns with no or little damage. The worst case is that it will lose balance and fall down. Generally speaking, the risk-reward ratio of investing in Indian markets is not very encouraging at this point in time.

In my view, the markets have already called the central bankers’ bluff, as I had expected five months ago. There is no evidence of aggressive rate hikes leashing the prices, while growth has been crushed.

In the words of reputable William Hunt Gross (popularly known as Bill Gross), without interest rate “carry” (the positive difference between 2 and 10 year Treasuries, for instance), our half-century-old, financed-based economy cannot thrive. In the 1980s the then Fed chairman Paul Volcker slayed 13% inflation by introducing a negative carry of 500 basis points or more for 3 years. This resulted in a deep 3 year recession. Today central bankers are employing the same tactics, but our significantly higher levered economy cannot withstand the same amount of negative carry. The question is how much and for how long...while inflation is the Fed’s seemingly solitary focus at the moment, economic growth and financial stability may soon gain equal importance. Recent events in the UK, cracks in Chinese property-based economy, war and a natural gas freeze in Europe, and a super strong dollar accelerating inflation in emerging market economies point to the conclusion that today’s 2022 global economy in no way resembles Volcker’s in 1979. A negative carry of 500 basis points now would slay inflation but create a global depression.

Besides, Volcker tightened with the world progressing towards the end of the Cold War era. Today, the world is entering an era of a fresh and perhaps more intensive Cold War.

In India also, fissures have been reported in the Monetary Policy Committee. At least two members of the MPC have warned against unmindful rate hikes in current circumstances.

My feeling is that central bankers would be forced to review their tactics and the dollar will revert to its rightful place. The only uncertainty is if this would happen well in time to avert a global depression.

Considering these circumstances, what should be the strategy of a small investor like me!

More on this tomorrow…