Markets at a crossroads: factors beyond geopolitical conflicts


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The most certain thing in global markets is uncertainty. While the world was already grappling with issues such as the current geopolitical conflict, supply chain disruptions and rising commodity and food prices that led to rising interest rates, it was also later found that he had gone into “risk aversion” mode.


There is a reason behind the concerted actions of central banks around the world. The Reserve Bank of India hiked rates ahead of the US FOMC meeting not only to keep inflation under control but also to keep the Indian rupee balanced against the US dollar. India is vulnerable to high energy prices due to its heavy reliance on imports. In times of already high energy prices, all denominated in US dollars, managing the stability of the rupee becomes even more critical. Moreover, the timing was right as LIC’s mega show had decent anchor participation and subsequently fully subscribed status.

The United States has experienced multi-decade high inflation in recent months. The massive quantitative easing that began after the first wave of COVID-19 led to increased business liquidity and sustained consumer demand. However, this has also resulted in strong wage growth and high house prices. Add to that supply chain bottlenecks and rising oil prices after the start of the Russian-Ukrainian conflict, all of which led to a spike in inflation. Inflation is the one horse every central bank wants to tame. Faced with this dilemma, the Fed has no choice but to raise rates, even if this negatively impacts growth.

So, the question on everyone’s mind is whether inflation has peaked and also when will it be brought under control? Whatever the opinion, the easiest weapon available to central banks is to raise interest rates. An increase in interest rates by the US Fed causes the US dollar to appreciate against all currencies, including the rupee. So essentially the US dollar has appreciated against all currencies and it’s not just the rupee that has depreciated. Take this example, Canada is the 5th largest exporter of oil and gas in the world. Oil prices are 50% higher than last year, but the CAD has depreciated almost to the same extent as the USD over the past year as the INR. Rising US interest rates are making US Treasuries more attractive and as a result investors are fleeing emerging markets in favor of the perceived safety and attractiveness of US fixed income securities. FII withdrew nearly INR 6400 crore from Indian markets for this reason in May. Japan, meanwhile, recently saw the yen depreciate to its lowest level in 20 years after the Bank of Japan announced a permanent program in which it will continue to buy an unlimited amount of government bonds. at 0.25% for an indefinite period. Collectively, all of these developments make the USD and US Treasuries a safer haven.

All of these developments have important consequences for investors. Rising interest rates will increase the cost of capital. Closing the Fed’s $95 billion-a-month bond-buying program will reduce the easy liquidity and cheap money that has fueled asset prices. Add to that a slowdown in global GDP growth and it’s no wonder the S&P 500 has been on a 5 week losing streak. Big tech companies that have been the main beneficiaries of low interest rates and ample liquidity have seen significant stock price corrections. The Nasdaq is down 24% from its peak, while many technology components of the Nasdaq are down 30-70%. Indian markets have also seen strong sales and are down 10% from this year’s highs.

At a time like this when markets are at a crossroads, we like to own companies in India and around the world that are debt-free, generate free cash flow and have pricing power. These companies have a low payback period and coupled with their financial performance; make a strong case to be held in any portfolio. At this point, we find it reassuring to maintain the strategic asset allocation between Indian equities, US equities and US fixed income. The approach of maintaining a cash allowance of at least 10-15% is ideal for such scenarios. In conclusion, diversifying into weakly correlated asset classes and maintaining a cautious attitude will enable portfolios to better manage this period of uncertainty.


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