After a span of more than a few decades, the global economy is reeling under tremendous inflationary pressure.
The excesses created to counter the economic impact during the Covid period are now haunting the global markets in the form of inflation. The Russia-Ukraine war added fuel to fire by further accentuating supply chain disruption and energy crisis globally.
Stock prices and market returns are largely based on expectations of companies’ future earnings. Higher prices for materials, inventory and labour can impact earnings.
Moreover, rising interest rates also hurt profits and can delay prospective capital spending. As inflation erodes the rupee value of earnings, it also has a bearing on the valuations and multiples.
While extended periods of inflation can happen, they are scarce and rare. Sustained periods of inflation are a rarity in US history with only one instance of inflation exceeding 5% for 10 consecutive years (1973-82) and only seven consecutive years of 5% inflation in US history (two of those were in the 1800s).
The US Fed is solely focused on reigning in inflation even at the cost of the US economy slowing down considerably. US 10-year bond yield has spiked 140 bps since Aug 2022 to reach about 4% level while crude prices have fallen sharply below their peak of nearly US$130/bbl to US$90/bbl levels.
This signifies rising fear of slowing global growth amidst rising interest rates and aggressive quantitative tightening (QT) expectations from the US FED going ahead.
Such an environment isn’t conducive for equity investors as they tend to move away from riskier assets to safe-haven (like USD).
However, there is light at the end of the tunnel. Over the last 30 years, the Fed was forced to end its rate-tightening cycle every time the yield curve inverted.
Although this isn’t expected to happen anytime soon, this event should be closely monitored as it will lay the foundation for the next rally in the global equity markets.
Europe (EU) on the other hand is facing unprecedented times with a war it cannot openly fight and inflation which refuses to tame. The main hit to the EU economies has been higher energy prices.
As European gas prices soar 8 times their 10-year average, countries are introducing policies to curb the impact of rising prices on households and businesses. These include everything from cost-of-living subsidies to wholesale price regulation.
Rising input costs, notably for energy and fertilizer, have already started inflating again. commodities as well. Thus, unlike other nations which are resorting to rate hikes to curb inflation, EU nations are compelled to extend subsidies and allowances to their countrymen to meet their rising energy bills.
At the onset of winters, the EU braces for a period where humanity will be put to the test and face severe duress. A hard landing of the EU does not augur well for the global economy nor for India as well considering the EU is one of the key EXIM partners and thus a concentrated effort by the global economies to aid the EU is the need of the hour.
India on the other hand is amongst the most important drivers of global growth in 2022. Timely measures by RBI and good monsoon season point towards slowing inflation rate which augurs well for the country.
On top of that, a steep correction in global crude oil prices ensures that imported inflation remains under control. India is the only shining star among the top 5 global economies in the world currently.
Consequently, India is gaining a higher share from global funds targeting emerging markets. However, the Indian economy and Indian stock markets cannot decouple against global markets.
We can very well continue to outperform the global markets but cannot be an outlier. Indian markets are already trading at a significant premium to their peers in emerging markets and such outperformance cannot last forever.
Moreover, with the rising interest rate scenario, domestic demand may see a downtrend during post ongoing festive season.
Thus, Indian investors should not get jolted by corrections but rather embrace them as an opportunity to foray into quality stocks and consider SIP as a good option to create long-term portfolios for wealth creation. Believe in the India story, the best is yet to come.
(The author of this article is Chairman, IIFL Securities)
Disclaimer: The views and recommendations given in this article are those of the author. These do not represent the views of MintGenie.