Israel-Hamas not as big as Ukraine for equity markets: Ajay Bagga

Furthermore, it was mentioned that central banks are vigilant about market conditions and prepared to intervene should the need arise. Currently, there is no major issue on the horizon. Nevertheless, there remains the potential for a more significant concern, particularly in the case of direct Iranian involvement or an Israel-Iran conflict. Bagga observed that Iranians had proxies like Hamas and Hezbollah positioned near Israel's borders, effectively obviating the necessity for a direct confrontation. The primary concern for the markets, therefore, centres around the extent to which the situation might escalate.

Ajay Bagga does not foresee a widespread reduction in positions and perceives no urgency for Indian investors to hastily make investment decisions. However, he emphasised that Indian investors should closely monitor two key factors: 1) oil prices and 2) global risk sentiment, as these have the potential to lead to some foreign institutional investor (FII) outflows. Nevertheless, he highlighted that India continues to represent a "buy on dips" market, implying that if there happens to be a knee-jerk reaction in the markets, domestic funds are likely to step in and increase their investments.

Lastly, he expects the markets to experience some turbulence but that it will be capped due to limited exposure. In the case of India, direct exposure to the Israeli economy is limited, with only a few companies having offices there, most of which have established business continuity plans. Also, approximately 18,000 Indians work in Israel. However, these factors should not significantly impact the Indian markets. The primary concern revolves around geopolitical risks and the potential for escalation, with Russia, China, and Iran on one side and the United States supporting Israel on the other. This is the current risk that we are facing, said Bagga. Excerpts from the interview:

Please share with us your initial assessment of the knee-jerk reaction of the equity markets with regard to the latest events in the Middle East.

There is a flight to safety. So the dollar is up. There will be buying of yen and Swiss Francs, which are normally safe-havens. Gold is up. Oil is up, basically, because of the fear of a supply disruption or a distribution disruption in case Iran is called out for this attack as the chief planner and if more sanctions are announced against Iran. Iran is supplying about 3.2 million barrels a day into the global pool. It has gone up by 600,000-700,000 barrels this year, and the US has been soft on sanctions on Iran. Most of this oil is going to China. So, if this conflict does not spreads beyond Israel-Palestine with Iran as a backer of the Palestinian terrorists, if it's limited to that, then we should see only a couple of days of reaction. If it does not spread, then all bets are off. But mostly, what we see is that there will be an on-the-ground takeover of Gaza and occupation of the Gaza Strip by the Israeli army, just like the condition was up until 2005. They will try to dismantle the Hamas presence on the ground. So, expect that. There is a marching of about 100,000 Israeli army reservists on the Gaza border. So, expect any action, and till some clarity emerges on that, I think markets will be a bit roiled. India – directly we don't have much exposure to the Israeli economy. Few companies have offices there. But they would have business continuity plans. About 18,000 Indians are working in Israel. But none of that is really moving or shifting our markets. The issue is the geopolitical risk, and will this increase in scope with Russia, China, and Iran on one side and the US backing Israel on the other side? That is the risk that we are running right now.

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Suppose oil prices were to triple from current levels. What themes could be in focus?

It's not like 1973 at all, where oil prices were $2, $4, and they went up to $20. There was an actual oil embargo by the oil suppliers in the West because of their support for Israel in the 1973 war. None of those conditions exist today. In fact, most of the Middle East is aligned with the US and the West rather than against them. It's not in the national interest of any of the oil producers to see oil going much above $100/barrel, because that will have very strong consequences in terms of bringing the global economy to its knees and destroying demand. Their own budgets will get hurt. Nobody wants that to happen. So, I think sane voices will step in. I don't see oil going much above the $100 mark. There could be a limited spike in case Israel shoots a few missiles at Iran or Iran openly declares that it's at war with Israel in support of the Palestinians. Such things could spoil the sentiment. But otherwise, the major producers are very clear – they would not like to go above $100 because then that will really hit demand on a very sustained basis, and their own budgets will be in jeopardy. And it will lead eventually, in a two- to three-month scenario, to a very sharp fall in oil demand and oil prices.

What's your allocation going to look like now?

Right now, it's a risk-off sentiment. So, you stay with your allocation right now. Based on this geopolitical risk, there is not much change that's happening. The positions that have been taken off are the leveraged positions. Normally, hedge funds would have borrowed money for carry trades. So, there will be a rush into safe havens like gold, dollar, yen, Swiss Franc, and such assets, so that the leveraged portion and the risk-averse short-term portion of global flows will go out. The rest—this is not that big of an event right now. (But) the Ukraine event was a big surprise for the markets. Its scale surprised the markets even further. But following the events of 2014 and 1994, the markets bounced back within three weeks. After Ukraine, still markets had gone up.

And of course, the central banks remain on the sidelines, so that if conditions tighten too much in the markets, they will intervene. So, I'm not seeing a very big issue right now. Of course, the bigger thing that remains on the table is Iran's direct involvement, or, say, an Israel-Iran conflict. Remember, the Israelis were the ones who took out Saddam Hussein's nuclear reactor. And at that time, of course, it was a very different world. We are 30 years later. Today, the Iranians have proxies in terms of Hamas and Hezbollah sitting on the borders of Israel. So, they don't need to come into the picture on a full-frontal attack. They will stay as a proxy power. So, that is the concern for the markets—how big could this spread to? Right now, nobody is cutting positions. And I would not say that you would need to make any investment decisions based on that in India. For Indian investors, oil is the only thing, and global risk-off sentiment and whether that would lead to some FII outflows – those are the two things. But I would say India remains a buy-on-dips market. So, if our markets have a knee-jerk reaction, we will see domestic money coming in and buying more.

Do you see that trend changing due to the escalated geopolitical concerns? What would it mean if it got bigger, and what would be its effect on the earnings season?

In terms of earnings season, we see automobiles doing well. We see metals and mining seeing some amount of turnaround. We are expecting capital goods companies to report very good numbers and banks and NBFCs to continue the good numbers based on what we have seen. Some of the consumer portion should do well. Durables: we were expecting a turnaround now, with the festival season starting in another five days. We were really hoping the durables would start picking up, and inventories have been added by distributors in anticipation. For the earning season, the soft points will be IT, to a limited extent, pharma, where I think there are issues, and textiles, gems and jewellery – those kind of sectors that have been hurt by the global merchandise exports going down. But the other bigger domestic segments will do very well. Real estate continues to do well. So, we don't see an issue with domestic earnings. Flows-wise, we have seen, right from mid-August onwards, some kind of net outflow from the Indian markets, which is in keeping with emerging markets losing flows because of a strong dollar. Those conditions are still in place.

We don't expect those FII flows to reverse in a rush. Globally, it is a risk for a little more time. But the good news is that rates are nearing their peak, inflation is on a downward trend, oil has become the big joker in the pack, and the geopolitical tension in the Middle East has become a cause for worry. But having seen it from 1948 to now and the market reactions, these are very small economies. Israel is a $500 billion domestic earnings economy. (It would) hardly (have) any impact on the oil market. (It has) 300,000 barrels a day of refining capacity. Palestinians have no capacity. So, it is more Israel-Iran, which becomes an issue. If it's Saudi-Iran – (then it) becomes an issue. And the role of Russia and China, given that Russia has boots on the ground in Syria. But there are saner voices. Turkey will not want a conflagration right now, seeing where it is economically. Biden can definitely do without it. He will look for a Camp David kind of success. Like Jimmy Carter did in 1979 with the Israelis, Biden was looking at a Saudi-Israel handshake to create a good upsurge for himself going into the elections.

So, nobody behind the curtain wants this to spread. Israelis had to attack because a thousand people entered their homeland and massacred their civilians. So, for the domestic population, a symmetric attack will be needed. That will come in the form of occupying Gaza again, which they left in 2005. They will occupy it again. But there, it's very asymmetric. It's not two sovereign nations fighting. Israel will be able to bring force to it. And if we can avoid the spread of it, then the markets will again focus back on the higher for longer, the Fed issues, and the October 12 US inflation number. I think those will become more important again than this geopolitical risk.

What is your assessment of the Monetary Policy development with regard to the sale of bonds, where the yields shot up? Do you see any cascading impact of that development on Indian equity markets?

See, we have a fiscal issue. We have stayed above 6 percent for a very long time, and we have been borrowing a lot, but the government has transmitted its intention for the second half of this year very clearly. The RBI is a central bank that talks very transparently; doesn't believe in shocking the markets at all. I think it was an overreaction, especially if within the next four to five months we start seeing global dollar bond buying of Indian bonds, global money coming in, then it will ease the situation even further. Right now, the yields have moved up in anticipation of five State elections being announced today and national elections coming up. There will be more spending on subsidies, which has been factored into the budget. So, maybe there'll be more bonds selling on behalf of the government by the RBI. That is what the market has factored in. Otherwise, we see inflation going into the 5-5.5 percent print over the next three months. We don't see food inflation running away. The government is taking supply-side measures. Oil remains the joker, as I said. But the good news on oil is that since April last year, the government has not allowed retail oil inflation to go up; they have held the prices. Then you shot the refiners at that time because they would be made to take the losses until the new government comes in next May. The losses will be moved to the oil refining PSU balance sheets rather than burdening the retail consumer. So, it was a counterintuitive move based on the Governor's statement on bond selling, but I don't see it being very sustainable because all the fundamentals are pointing elsewhere.