Moneycontrol Pro Weekender | Great expectations

Are the markets rallying because they have great expectations for the rest of the year?

Dear Reader,

With half the year over, it’s customary to pause and take stock of what we can expect in the markets in the second half. Benchmark indices in most major markets are well above their levels at the beginning of the year. In India, the Nifty has been scaling new heights.

A look at the MSCI country indices puts things in perspective. The MSCI India index in dollar terms, as on 27^th June 2023, was higher by 2.7 percent year to date. Compare that to Korea, up 16.2 percent, or Mexico, up 26.6 percent. Much depends, of course, on the time period for comparison. If we take the 5-year average, there are only a handful of markets that have done better than India, one of them being the US. On the other hand, the less said about the performance of MSCI China, the better.

Are the markets rallying because they have great expectations for the rest of the year? Inflation is on the way down and rate hikes are at or near their peaks. A note by Systematix Institutional Equities says, “Markets are increasingly factoring in a hyper goldilocks scenario which assumes that high inflation in the US and AE (advanced economies) will glide back to normal without triggering a recession. Consequently, market risk premium has dipped to the lowest 1st quartile typically associated with an ultra-easy monetary policy. These presumptions have ratcheted up valuations and revived portfolio flows into EMs, including India which has underperformed due to rich valuations.”

But the Bank for International Settlements has said the next phase of disinflation will be more difficult. A look at the mid-year outlook reports indicates plenty of doubts. Morgan Stanley’s report has the title, ‘Soft Landing, Hard Choices’; Barclays’ is ‘Managing the Slowdown’ and Allianz says, “With inflation still high and an economic downturn likely around the corner, we think it could be a bumpy second half of the year, particularly as markets may have to adjust expectations in key areas.” JPMorgan’s report has the title, “Too good to be true.”

Of course, these reports may well be off the mark. Credit Suisse’s note at the beginning of the year, for instance, was titled, ‘A Fundamental Reset’. Unfortunately, it was Credit Suisse that was fundamentally reset, not the markets.

Be that as it may, KKR and Citi Global Wealth say the current doubts about the market are welcome. The Citi note says, “At the moment, investor sentiment appears poor, and that creates potential opportunities. Bearishness, as measured by short equity interest, is at multi-decade highs… investors are waiting for a decline in market indices before shifting assets into equities. This may be the most anticipated bear market ever. It is also an argument for why market timing will not work. If everyone is waiting, any decline may be brief and untradeable.” The caution on the US markets, however, has been accompanied by a call to diversify into emerging markets.

One reason is high US valuations. In May, the Fed’s Financial Stability Report said equity price growth outpaced growth in earnings forecasts, pushing the forward price-to-earnings ratio to a level notably above its historical average. And that was before the move up in the markets in June.

A chart in the RBI’s Financial Stability Report shows the US market is less expensive than India, which is the second most expensive market in the world, after Japan. Of course, as a celebrated quote usually attributed to Lord Keynes goes, “The markets can remain irrational longer than one can remain solvent.” Bears licking their wounds in the market will nod their heads in agreement.

Apart from valuations, there are other reasons for caution. The RBI report, while in general upbeat, also said, ‘‘Moderation in real wages and recent signs of tempering of private consumption are emerging as constraining factors, alongside weakening external demand, which may impact export prospects.” Our Monsoon Watch column says that while the rain deficit has narrowed, worries persist, although the Indian Ocean Dipole effect could mitigate the El Nino impact on India. A Motilal Oswal strategy report says, “An expected slowdown in consumption and/or residential real estate in FY24 could unsettle credit growth in the country.” Its thesis is that the rise in consumption was fuelled by a fall in net financial savings to a three-decade low—in other words, that was pent-up consumption. In future, though, that tailwind will no longer be present.

That is precisely the argument that analysts in developed nations have been making, arguing that the ‘excess savings’ -- the result of handsome handouts during the lockdown days -- are being run down and although the US economy is doing all right at present, it’s a matter of time before the rate hikes start biting. We had pointed out that the June Flash PMIs show growth finally slowing in the developed economies.

For the Indian markets, a CLSA note says, “Valuation is very rich; margins and ROE are eroding; EPS estimates are unrealistic.” Nor should the markets expect any help from the central bank cutting rates any time soon. As this story pointed out, “Bringing down the inflation from 7 percent to 5 percent was relatively easier as the impact of supply chain shocks and one-off price jumps tend to fade away with time. But, getting from 5 percent to 4 percent will require major change in pricing behaviour of economic participants. As the RBI governor said, “It is always the last leg of the journey which is the toughest.”

In the long run, everything will depend on whether the central banks in the advanced economies are able to stick to their objective of withdrawing liquidity. Analysts have pointed out that The Goldman Sachs Financial Conditions Index reached its current level of restrictiveness over a year ago -- and has eased considerably since last autumn. The Chicago Fed’s Adjusted National Financial Conditions index is at around the same level it was back in April 2022, when the rate hikes were just beginning. After all, it is the exponential growth in liquidity that has driven asset prices and economic growth in the developed economies over decades. Those that have grown large and fat in the swamp will resent it being drained. And while Jerome Powell has said he will continue to have a tight money policy, the US elections are coming up next year.

For India, economists have always drawn attention to the contrast between the slowing global economy and the resilient Indian economy. But perhaps it is the slowing global economy, and lower oil and commodity prices, that have made the relatively insular Indian economy so resilient? If, as is widely predicted, the global economy will slow further in the second half of the year, it may not be a bad thing from India’s point of view, as long as it’s not a deep recession.

Cheers,

Manas Chakravarty

Here are some of the other stories and insights we published this week, apart from our technical picks in the equity, commodity and forex markets:

Stocks 

Time to look at this oleochemicals derivatives play; HDFC-HDFC Bank merger: should investors bet on it? Ideaforge; Time to take profit in Zensar? Cyient DLM; ICICI Securities delisting; ICICI Securities—is the swap ratio fair? How to navigate the plethora of IPOs; Bharat Dynamics; Transport Corporation of India; Weekly tactical pick; Motherson Sumi Wiring India

Markets 

Is Vix the best indicator of market volatility?

In the Money

Financial Times 

America is feeling buyers’ remorse at the world it built

The Putin system is crumbling

The Australian group with a grip on global infrastructure

India gears up for multibillion dollar battery subsidies

How the US and Europe can beat China’s Belt and Road

Immigration

Geopolitics 

Russia: A banana republic with nukes

Wagner’s gambit—non-event or heralding post-Putin era?

India-US trade truce—will it move the bilateral trade needle?

PM Modi’s US visit—these two deals matter the most

The Eastern Window: US readying India to ease some of the burden of decoupling from China

Saudi money and Chinese technology make a formidable geopolitical combination

India’s basmati exporters in geopolitical hot soup

India needs both Iran and the US to take advantage of vital INSTC trade corridor

Companies and industry 

Mid-sized hospitals could deliver outsize returns

FMCG: Kiranas mount a comeback

BHEL

Trade generic market gets a boost with Dr Reddy’s entry

Ipca

What is driving real estate growth?

Policy 

When do off-market transactions lose their kosher tag?

National Action Plan needed to tackle flood damage

Economy 

Lower goods trade deficit improves current account dramatically

Pro Economic Tracker

Banking and finance 

Homes may be affordable, but home loans are not

Banks must figure out how secured is a loan to an NBFC

SBI Cards growth is remarkable, but potential profits are not

Why Indian PSU banks chiefs deserve better pay

Tech and startups 

Will Byju’s survive?

Meltdown at Byju’s should end the free pass for startups

PE investments in EVs powers ahead

Agritech-focused Omnivore makes its first close of third fund

Coming soon: a prepaid card for the Bharat market from RuPay and Payworld

Interview with Omnivore’s Mark Kahn

Personal Finance 

Prepaying your home loan early can save you lakhs

Online shopping got easier even if you forget your credit/debit card details

The importance of financial inclusion between couples

Financial knowledge not the problem in India, financial attitude is

The different term insurance plans on offer

Interview with IRDAI chairman Debashis Panda

Politics 

Could Patna become the launchpad of opposition unity once again?

The Green Pivot 

Smart meters

China solar module prices fall to record lows

Climate finance—will the Paris push bridge the North-South gap?

Others 

Marketing Musings—selling the luxury bug

The great management flattening