Moneycontrol Pro Weekender: Investors have no choice but to embrace volatility

Dear Reader,

At the end of a volatile week, the benchmark Indian indices are little changed. But as an equity markets investor, you would have heard the cannons to the right and the cannons to the left volleying and thundering. Multiple events that grabbed the headlines this week are far from over and they will continue to impact the markets in the days to come. In short: embrace volatility.

Is Russia going to invade Ukraine?

US President Joe Biden certainly seems to think so. He has warned that Russia is set to invade Ukraine in the coming days and accused it of engaging in “a false flag operation to have an excuse to go in”. Ukraine and Russia have been blaming each other for some shelling close to the border and the West fears that the Kremlin will use this as a pretext for invasion.

Earlier in the week, there were reports of Russia withdrawing forces from the border, but the US has called this claim “false”. On Friday afternoon, Russia said it will start certain nuclear exercises and drills.

There are desperate attempts to find a diplomatic solution. Although Biden is convinced that Putin wants to invade Ukraine, he stressed that room for diplomacy remains, reported CNN on Saturday morning. Next week, US Secretary of State Antony Blinken will meet Russian Foreign Minister Sergei Lavrov, the State Department said.

War, huh, yeah/What is it good for? Absolutely nothing

Oil close to $100 a barrel and rising

The tension at the Ukraine broader has not only roiled equity markets, but also pushed crude oil prices onwards and upwards. But the Ukraine conflict is not the only factor.

As we explained earlier this week, demand is rising around the world as it learns to live with the coronavirus. Indeed, our research team’s Herd Immunity Tracker examines the possibility that India is reaching the endemic stage of COVID-19.

While demand is rising, oil supplies are lagging. The spare capacity of oil producing nations has halved from a year ago. Barring a few such as Saudi Arabia and Russia, other producers are struggling to meet their quota.

Some analysts are now predicting Brent crude to top $150 a barrel because of underinvestment in exploration and production and global supply chain issues.

This rise in oil prices is ominous for a country that imports a significant portion of its energy needs. It could pump up inflation, widen the trade imbalance putting pressure on the currency, upset the central bank’s calculation and nip the nascent recovery. Although currently, the folks at Mint Street seem to be more worried about how to keep the government’s borrowing costs down.

The green hydrogen policy unveiled earlier this week has come at the right time. A surge in electric vehicle use could also dampen oil demand. (On a side note, renewables are the biggest opportunity for capital goods makers even as China is ramping up capacity).

The biggest tail risk of them all

Oil might lead to volatility and upset macroeconomic stability, but equity markets’ main fear would still be a hike in interest rates by the Fed. One would have thought this possibility would have been well digested by now, but apparently not.

Bank of America’s February fund manager survey found that hawkish central banks remained the most prominent tail risk for global markets in 2022. A net 41 percent of fund managers polled pointed to rate hikes while only 4 percent believed that the COVID-19 pandemic was the biggest tail risk.

Well, the fears are not unfounded. The US 10-year yield has crossed 2 percent and retail inflation is at a multi-decade high of 7.5 percent in America. Many analysts now expect a big-bang rate hike when the US Federal Reserve meets next in March. Gold is already rallying, partly thanks to safe haven demand. We tried to answer the question whether this rally is sustainable.

The minutes of the last Fed meeting though were less hawkish than expected. But within the Fed Open Market Committee, there seems to be little consensus on the number and size of rate hikes expected in the current year. In fact, as this FT piece points out (free to read for MC Pro subscribers), the biggest challenge for Fed chair Jay Powell is to build a consensus within the institution.

Support from home

All said, foreign institutional investors have turned turtle on India for quite some time now. Domestic investors have picked up the slack. Net inflows into equity mutual funds have been quite healthy. Retail investors accounted for $19 billion of net purchases in the cash market in 2021 even as the number of demat accounts has more than doubled in the past three years.

With the Life Insurance Corporation of India filing papers for its share sale, some such as Zerodha’s Nithin Kamath expect more retail investors to hit the market.

Speaking of LIC, India’s largest IPO (we estimate it will raise a minimum Rs 50,000 crore) has naturally evoked a lot of interest. This is despite the fact that previous disinvestment candidates like Coal India have been laggards for more time than not after listing. LIC, too, is unlikely to appreciate much after its listing and is unlikely to fetch the same valuations as its private sector peers. On the other hand, there are some side trading opportunities that will emerge during the IPO, we said.

With reports emerging that the issue could open up for subscription around March 11, some also fear that it could withdraw some liquidity and add to market volatility, but that remains to be seen since high net worth investors still have access to NBFC's IPO funding route till the end of March.

Summing up

Where does this all leave us? While volatility could persist for quite some time, a structural change that could happen is investors pivoting away from growth.

“The change in equity market leadership looks ever more pronounced in terms of the shift from growth to value stocks as investors have discounted ever more rate hikes following last week's higher US inflation," wrote the pundit Chris Wood in the Jefferies Greed & Fear report.

Sanjeev Prasad of Kotak Equities has warned investors not to expect too much in 2022. Flat to modest gains in the coming months would be a good outcome for domestic equity investors, he wrote in a mid-week note.

Perhaps, this indeed will be the year of the stockpicker, as Morgan Stanley predicted way back in November.

And if that is your game too, you have come to the right place. Our team has insights on Bharat Forge, Trent, AGS Transact Tech, SpiceJet, RateGain, Berger Paints, IPCA Labs, Ashok Leyland, MSTC, Nazara Technologies, Goldiam International, Eicher Motors, Tata Power, Cummins India, Hero MotoCorp, Divi’s Labs, Gulf Oil, Concor, Sapphire Foods, Vedanta, Macleod’s Pharma, Tata Chemicals and Heidelberg Cement India.

What else did we write this week? Here’s a pick of the best.

Falling raw sugar prices a red flag for sugar mills

SEBI ruling on referral fee for brokers is investor unfriendly

FMCG stocks are stuck between inflation and a hard place

The Eastern Window | India exploring new diplomacy route to tackle China

A simplified capital gains tax regime is fine, but don’t kill the golden goose

Trade winds | To limit China import dependence, India must look outwards

Personal Finance | Look before you leap into new-age thematic funds

From our Crypto and Start-up corner

Start-up Street | Crises in start-ups and the art of managing them

Crypto Learn | How staking, swapping, farming can add to crypto earnings

This trading strategy works well for navigating volatility in cryptocurrencies

Algo Rhythm | How to use in-sample & out-sample data to build your algo strategy

When you count users instead of dollars, the NFT world is tiny

Tail Piece

A mysterious yogi became the guru of the chief executive officer of the country’s largest stock exchange and guided her decisions for 20 years. Sounds like a Bollywood movie plot!

It has serious ramifications for corporate governance and NSE’s listing plans. Read them or if you want to take it easy on a Saturday morning, delve into the life of a spiritual stock exchange CEO.

Cheers,

Ravi Krishnan