The conundrum of rising commodity prices, rising inflation, and thereby tight monetary policy may keep the Indian markets volatile for some more time. Higher inflation brings with it rising interest rates which in turn impacts multiple sectors and their growth prospect.
A rising interest rate environment comes with its own set of hurdles and the relative impact of inflation and rising rates is visible on the markets. So it is important to understand the behavioral performance of equities during stances of hikes in rate cycles.
In a recent note, Edelweiss Mutual Fund (Edelweiss MF) pointed out that historical evidence suggests that equities have done well after the initial phase of volatility recedes in a rising interest rates environment. In fact, equities have delivered one of the best returns during the 2004 to 2008 period when interest rates and inflation kept rising, it noted.
Let's take a look at the below table to understand:
As we can gather from the table above, between 2004 and 2008, when the RBI raised repo rates by 3 percent (from 6 percent to 9 percent), the rise in benchmark Nifty is 114 percent. Also, between 2013 and 2014, when the rates were hiked 75 bps from 7.25 percent to 8 percent, the Nifty50 index gained over 40 percent.
However, this conundrum of high inflation and rising interest rates may impact the earnings of businesses in each sector differently, noted Edelweiss MF.
The data below shows how different sectors have performed during high inflation and low inflation conditions in the last 10 years. As seen, Auto, Pharma and Banks have performed well during high inflation regimes while businesses that have their demand and input costs sensitive to inflation and rising rates have done poorly, the MF pointed out.
"During such periods, sectoral winners change dramatically, and it is important to keep portfolios well aligned to reality. Hence, it is crucial to position sectoral and stock allocation well during such periods when market returns may not come from the broader group, but select businesses and sectors," advised Edelweiss.