Moneycontrol Pro Weekender | Edge of Euphoria

Dear Reader,

It took just one slightly softer retail inflation print for the US market to soar to new highs, a sign of the euphoria gripping investors. The Bank of America survey of global fund managers for the current month was the most bullish since November 2021, and this survey was carried out between the 3rd and the 9th of May before the latest consumer price inflation print.

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The survey found that allocation by investors to stocks is at its highest since January 2022 and that allocation by institutional investors is ‘approaching retail investor optimism levels’. The sudden spike in the GameStop price brought back fears about another bubble in the making. Yet, as this FT story underlined (free to read for Moneycontrol Pro subscribers), nothing much had changed on the inflation front. It said, ‘yields and equities are showing relief. But the basic picture has changed relatively little. There were no big positive surprises that would upend the market’s forecasts for interest rates.’

That’s borne out by the market’s odds of a rate cut by September--these odds are now around 51 percent for a 25 basis point rate cut, compared to 48.6 percent a week ago. It’s hardly a big deal.

The S&P Global Investment Manager index, however, noted that, for the markets, ‘Sentiment has been buoyed by better-than-anticipated earnings performance, which has propelled shareholder returns and equity fundamentals to the fore in terms of perceived market drivers.’

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The Bank of America survey, on the contrary, says the rally has been driven by optimism about rate cuts rather than growth in earnings per share. Indeed, the survey found that global growth expectations fell for the first time since November 2023---while a net 11 percent of fund managers expected a stronger global economy over the next 12 months, by May that had turned into a net 9 percent of them expecting a weaker economy. The Composite PMI for the US for April had indicated a slowdown in the economy. The PMI report had pointed to the softest expansion in the year-to-date, while new business decreased for the first time in six months. And this story says that while the massive fiscal stimulus in the US has benefited the stock market, ‘’there too unease is spreading now.’’

Among the fund managers surveyed by the BofA, 61 percent believe that ‘below-trend growth and above-trend inflation’ is the most likely scenario for the global economy over the next twelve months. Another 22 percent expect "above-trend growth and above-trend inflation", 7 percent (rank optimists) say "above-trend growth and below-trend inflation", and 6 percent (diehard pessimists) believe for "below-trend growth and below-trend inflation" as an accurate description of the outlook for the global economy.

The worm in the bud is inflation, which 41 percent of investors believe is the biggest tail risk for equity markets. Simply put, investors believe that any threat to growth will be taken care of by rate cuts. But if inflation stays high, above the central bank’s target, will it then be wary of cutting rates, or will it, as some are already advocating, opt for a higher inflation target and use that as an excuse to cut rates? After all, Powell has a proven ability to turn on a dime and we mustn’t forget the US election in November. After all, Powell has a proven ability to turn on a dime and we mustn’t forget the US election in November.

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Talking of inflation, the Bloomberg Commodity index has continued its steady climb from the depths it plumbed in February. The BofA survey says that investors increased their allocation to commodities to net 13 percent overweight, the largest overweight since April 2023. The past 3 months have registered the largest increase in commodities allocation since August 2020.

Metal prices have taken heart from signs of recovery in the Chinese economy. The BofA survey of Asian Fund Managers for May says, "China
equity market is 28% off the January lows on burgeoning hopes of a turnaround as policymakers seek to address investor concerns. Net 41% of the panelists expect the China economy to strengthen over the next 12 months, versus -10% in February, as easing expectations abound on rising government bond issuance. Investors have relinquished the wait-and-watch approach in favour of building exposure on incremental signs of easing and wiped out the underweight allocation from prior months as the breadth of panelists favouring China rises to an 8-month high.’’ The latest numbers show that while Chinese consumption growth has slowed, industrial output growth has accelerated. On Friday, the Chinese authorities lowered down payments and mortgage rates to prop up the tottering property sector, while also encouraging local governments to buy homes and convert them into affordable housing.

The shift of attention to China has left foreign investors exiting India’s high-priced market. Among the stocks analysed by my research colleagues this week, high valuations were pointed out for Berger Paints, Dixon Technologies, Thermax, MapmyIndia, and Radico Khaitan, to name a few. There’s also some uncertainty on the strength of consumption demand, despite Colgate being the latest to confirm stronger growth in rural markets. Our analysis of M&M’s excellent results, for instance, points to sluggishness in farm equipment sales. And another story tells us that the gloom over the rural economy continues.

While a net 31 percent of investors were overweight India in March, that has slid down to a net 18 percent overweight in May, according to the BofA Asia survey. For China, over the same period, investors have shifted from a net underweight to a neutral positioning.

Nevertheless, our columnist Aaron Chaze says the emerging global macro trend will benefit emerging markets, especially India. The BofA global fund manager survey had said that the current net 4 percent overweight on EM equities is 0.7 standard deviations below its long-term average, so there’s plenty of scope for that to go up.

This week, US president Biden hiked tariffs hugely on a range of Chinese imports, while Presidents Xi and Putin had a bromance in Beijing. Are the markets being too complacent about geopolitics? Only 18 percent of fund managers say it was the biggest tail risk for markets. Most investors are of the views expressed in this FT piece by the global chief economist at Citigroup, which said ‘the best strategy for investors is generally to lean against the markets’ initial reaction to geopolitical events.’

Fair enough, but then the author goes on to say, ‘’We see little evidence that these tensions are more severe than would be expected drawing on the experience of the past century.’’ Well, the last century did see two world wars.

It does bring to mind that wonderful movie ‘Dr Strangelove or: How I Learned to Stop Worrying and Love the Bomb’, which had this surrealist bit of dialogue:

‘’General "Buck" Turgidson: Mr. President, we are rapidly approaching a moment of truth both for ourselves as human beings and for the life of our nation. Now, truth is not always a pleasant thing. But it is necessary now to make a choice, to choose between two admittedly regrettable, but nevertheless *distinguishable*, postwar environments: one where you got twenty million people killed, and the other where you got a hundred and fifty million people killed.

President Merkin Muffley: You're talking about mass murder, General, not war!

General "Buck" Turgidson: Mr. President, I'm not saying we wouldn't get our hair mussed. But I do say no more than ten to twenty million killed, tops. Uh, depending on the breaks.’’

Cheers, Manas Chakaravarty

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

Stocks

IdeaForge Technology—sign of possible stock re-rating, Medi Assist, Blinkit adds spice to Zomato, Relaxo Footwears, Tata Motors, Eicher, Cipla, Mahanagar Gas—why recent correction is not a buying opportunity, Voltas Q4, Varun Beverages, Jindal Steel and Power, Bharat Forge, Polycab India Q4, Should investors bet on the pricey Go Digit IPO, Aditya Birla Capital, Airtel, Devyani International—should one buy this stock after the steep correction? UPL—growth outlook uninspiring; leverage continues to hurt, Ami Organics, Safari, NCC-why it continues to remain our preferred bet in the construction space, Syrma SGS, Navin Fluorine, Why this IT services major looks interesting post correction.

Markets

Are quant funds worth the hype?

Know the maths behind index trading

Bonds are a good play as RBI may not wait for US to cut rates

Small cap schemes stole the show in April, but not all got it right

Why Bernstein believes ‘low voter turnout’ shouldn’t lead to investor panic

Companies and sectors

A ray of hope for gas-based power plants, Cipla, Tata Motors: Risks to growth mar euphoria over zero debt, Focus on fewer products in US helps Indian pharma, UPL, Why JSW Energy has an edge over Tata Power, What capital goods firms’ results show, Haldiram’s potential sale, New life breathed into telcos.

Financial Times

Can Europe’s economy ever hope to rival the US again?

Martin Wolf: Increased longevity will bring profound social change

America’s ‘cable cowboy’ lost out in infra boom

Economics and policy

Food inflation rises in April

Decoding Economics: Who gains, who loses from building roads?

How to make Heat Action Plans more happening?

MGNREGA must be used as a rural growth enabler, not as a mere jobs generator

RBI tightens screws in infra projects

Regulators need to bat more proactively for the consumer

India finally moves on to food standards, but enforcement has miles to go