Returns in the market, especially for the short term, depend on the precision of estimating how much risk has been priced in. If it's done correctly, one can easily avoid pitfalls.
In the last few months, markets have lacked a precise direction. If it has not gone up, then it has not gone much down either. Such a situation can give a sense of security, suggests Chris Wood, Global Head of Equities at Jefferies, especially when risks to the market are on the rise.
“Everybody involved in the world of private equity has an incentive to delay price discovery for as long as possible, which means that the impact of monetary tightening will be even more delayed than normal amid continued seemingly benign financial conditions,” Wood wrote in his latest weekly newsletter Greed & Fear on March 9.
The US Federal Reserve has been extremely hawkish and interest rate risks have been higher than ever for the market. Other central banks, including the Reserve Bank of India, have also been raising rates consistently. In the upcoming Federal Open Market Committee (FOMC) meeting, most economists are anticipating another 50 basis point hike over the current 4.75 percent with a terminal fund rate in the vicinity of 6 percent.
One basis point is a hundredth of a percentage point.
Wood argued that the market has priced in the rapid rise in interest rates with a lag. “From a bigger macro perspective, the even longer lags in monetary policy in this cycle create a bigger risk of an even more pronounced bull trap market rally than normal as investors are becoming convinced that the downturn can be avoided,” he said. “And all bear markets are characterised by such bull traps.”
Not everyone agrees – at least not completely. According to analysts at UBS, while markets have fully priced in three further Fed rate hikes to 5.5 percent, tightening towards 6 percent would firmly test the historical pain thresholds, especially for emerging market assets.
In India, which is grappling with sticky inflation, UBS believes that the RBI will maintain its hawkish stance. “We believe Indian equities have further downside risk on valuations as support from domestic flows has room to weaken further with rates going up/staying higher, particularly if more sticky US inflation is fanned by rising oil prices amid China reopening,” the analysts wrote earlier this week.
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They added that corporate earnings are showing signs of weakness, which is not helping either. Moreover, leverage levels back to pre-pandemic highs, working capital at eight-year highs, inflation creeping into sticky costs like employees and selling, general and administrative expenses (SG&A), they said listing risks.
Deepak Jasani, Head of Retail Research at HDFC Securities, also cited these risks. However, he added that India is relatively insulated from global risks such as the US Fed rate hike. However, he sees foreign flow tapering due to more rate hikes.
“There is going to be volatility. There is no point predicting a direction,” said Deepak Shenoy, Founder of Capital Mind, a Sebi-registered portfolio management service and wealth advisory firm. “What are you going to do? Not buy stocks because you are afraid? I think the panic is unwarranted at this point in time – both in India and in the US.”
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