Subdued sentiment keeps market away from record highs in last 8 months | Are we done with the correction?

Russia is one of the largest oil and natural gas producers while Ukraine’s prime exports include seed oils, corn and wheat.

Policy tightening, which we have been hearing of since the last quarter of 2021, became reality this financial year and at high speed, with the US Federal Reserve setting the ball rolling and raising its policy rate by the highest in almost three decades. With other central banks taking the cue and ending their easy-money policies in a bid to tame inflation, experts are now flagging the threat of a recession in some of the developed economies, including the US.

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“Central banks worldwide were clearly taken by surprise at the violent inflationary impulse triggered by the Russia-Ukraine war, and all talk of the transience of inflation has now been buried and, indeed, replaced by desperate tightening. The main protagonist is the US Fed, and others like the Swiss central bank, RBI (Reserve Bank of India), etc., are toeing the US Fed line,” said R Venkataraman, chairman at IIFL Securities.

He expects monetary policy to be tightened more rapidly than the market can take, and this to be amplified by liquidity contraction through reserve ratio increases or central bank balance sheet run-offs. “The exceptions are China and Japan, who are fighting their own battles,” he said.

All this suggests that markets have further downside unless central banks pause if inflation eases, and that looks unlikely. Demand for crude oil may soften because of monetary policy action, but how will demand for food go down?

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The US in May reported inflation at 8.6 percent, the highest since December 1981, and the UK, which posted 9.1 percent inflation due to rising food and energy prices, has already indicated that inflation can cross 10 percent soon. The US Fed has a target to bring inflation below 2 percent, which most global experts feel looks unlikely at least in the next one year, while the central bank is likely to take interest rate beyond 3 percent by December 2022. A Reuters poll of economists indicated the Fed funds rate to be in a range of 3.25-3.5 percent by the end of this year including another 75 basis point hike in July.

India reported more than 7 percent inflation based on the Consumer Price Index, which is well above the RBI’s target of 4 percent (+/- 2 percent), and the central bank itself indicated that it will remain above 6 percent till the end of December 2022, assuming oil prices at $105 a barrel. It has raised its inflation forecast to 6.7 percent for FY23 against 5.7 percent earlier.

Hence, “the high inflation print is likely to persist for another two quarters, after which favourable base effects and probable easing of non-crude commodity prices and softening of vegetable prices could begin to take effect”, said Rahul Bhuskute, chief investment officer at Bharti AXA Life Insurance.

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He said elevated oil prices impact inflation directly and indirectly; the price of crude oil is among the most important factors in the inflation basket.

International benchmark Brent crude futures traded at $110 a barrel on Wednesday, having fallen by $10 per barrel in the last one week partly due to recession fears and reports suggesting US President Joe Biden may pressure US oil companies to reduce prices given the inflation concerns. But still, oil has large oil held above the $100 a barrel level since March this year, barring a few instances.

“The year 2022 is likely to be a challenging one for the equity markets. The Nifty continues to exhibit signs of weakness, driven by consistently high inflation, scope for large interest rate hikes, stubbornly high commodity prices, relentless FII selling and zero visibility on the outcome of the Ukraine-Russia war,” said Bhuskute.

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He feels much also depends on Indian domestic investors who have been providing some sort of support in the face of significant and continued FII selling. If the Indian domestic investor also gives in, the market is likely to see more downward pressure, he said.

FIIs have been a key factor pushing the market down, selling more than Rs 3.85 lakh crore worth of shares since October 2021 till date, which is huge, though domestic institutional investors tried to compensate by buying Rs 2.86 lakh crore worth shares in the same period.

Experts are hopeful that FIIs could be substantial buyers in India next year, especially after signs of this rate hike cycle ending.

“While we have witnessed relentless selling by FIIs in the current calendar year due to higher valuations as well as possibly redemption pressures, we could witness substantial purchases in India next year, with potential portfolio reallocations,” said Shyamsunder Bhat, chief investment officer at Exide Life Insurance.

Presently, bears are so strong that 75-85 percent of stocks in Midcap, Smallcap and Nifty500 indices are in negative terrain and of which 80-90 percent stocks saw double-digit corrections.

In addition, in the last eight months, investors have lost around Rs 38 lakh crore of wealth as the BSE market capitalisation dropped to Rs 236 lakh crore from Rs 275 lakh crore.

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