Summary
- Nifty is down 17.8% from its 52-week high and 13.2% YTD, driven by FII selling of ~US$30bn since October. But, the market impact has been muted by nearly equivalent DII buying – the first time that India has seen such robust domestic buying support in the face of FII selling
- Inflation continues to be the key macro factor roiling markets globally – central banks are now increasing interest rates significantly across the world, which is affecting both equity valuations as well as bond prices
- The India growth story continues to be intact, in our view, despite the unexpected shocks from the Russia war – India private capex growth back after a gap of 7-8 years, government plans on infrastructure spending and cleaned up balance sheets of public sector banks allowing them to lend are the three key drivers for India GDP to grow 8.0-9.5% pa over the next 3-4 years
- Having said all of the above, making money in markets in 2022 will be much tougher than in Apr 2020 – Sep 2021. Therefore, we recommend investors to go with fund managers that have seen multiple market cycles and have a long track record in outperforming markets through cycles.
Markets
As of 17th Jun, Nifty 50 is now down 13.2% YTD, while it is fallen 17.8% from its 52-week highs. Nifty MidCap and Nifty SmallCap fared worse – they are down 15.9% and 27.8% YTD, respectively. From their 52-week highs, they are down 22.2% and 31.5%, respectively.
The key liquidity driver for the market has been FII selling – FIIs have now sold the most ever in a single continuous period, in absolute terms, since they started investing in India in 1992. FIIs have sold US$31.1bn of Indian equities since October, and have sold US$26.0bn in 2022. On the flip side, DIIs have bought US$27.7bn of equities in 2022 – and, that is the key reason why Indian markets are down only 17.8% since peak, despite such massive selling. Indian retail investors are still holding the line (if one goes by equity SIP inflows) and have not been panicked by FII selling, like in the past – to this, we now have an extensive class of HNI, UHNI and family offices who are willing to buy the dip, because they can see the underlying strength of the Indian economy.
However, investors should note that DIIs are showed some signs of flagging in the past week – and, this is something to monitor. In the past, we have seen FIIs reverse and come back to buy when domestic investors start lagging – and, the Jun-qtr results will be factor to consider.
Macro Factors
We have been talking about inflation being the key macro factor for 2022 – in January, we said that all central banks will be forced to raise interest rates to deal with inflation, which is not transitory, and we have now arrived at the business end of this interest rate cycle.
The FED raised interest rates by 25bps in April, 50bps in May and 75bps in June with the FED rate now at 1.75% – we lead with this data point because the FED rate has global ramifications for liquidity. The US 10-yr T-bill is already above 3.3% and is drawing in liquidity. The FED has indicated another two 75bps hike in 2022 to get ahead of inflation, and a target rate of 3.50-3.75% in 2023.
One affect of this rising rate has already played out in the US equity world – with the highly valued tech sector taking a massive beat down. The second aspect of this is just starting to play out – we will see increasing corporate bankruptcies in the US, and most of the so-called zombie companies are likely to go under. Revlon is the major bankruptcy announcement last week. The chances of an US recession in 1H 2023 has increased now, with its flow through effects for the rest of the world.
The only contra thing to keep in mind is whether the FED will have the nerve to keep following through on both rate increases and quantitative tightening – once Wall Street really starts to howl and White House increases its political pressure. The past track record of the FED staying its course in the past two decades is poor. But, the problem for the FED now is if it once again kicks the can down the road, then the next crisis could be the end of the FED as a credible actor, and all that entails.
Among other global players, the Bank of England was the first to raise rates among major economies and it has now raised rates four times to 1.25% – and, it looks like it will stay the course in the face of mounting recession likelihood in the UK. Brexit has also limited its policy choices, and the government seems to recognise that.
The ECB said it will hike rates by 25bps in July, its first in 11 years – and, consider some tightening of its balance sheet. In response, the “fear factor” (Italy sovereign rate minus Germany sovereign rate) spiked so much that the ECB had to call an “emergency” meeting to consider “fragmentation” risks. Fragmentation means that the Southern European nations’ sovereign bond rates diverge hugely from the Northern European nations’ rates. Such a fragmentation would lead to increased default risks for “PIGS”, and potentially even France.
This is the context why we prefer US investment options to European investment options – in the US, even if they have a credit crisis, the market is allowed to clear out very quickly, so that the next economic cycle can start from that lower base. European growth never really recovered, in comparison, from the 2008 bust and it is now facing a crisis just at the thought of the ECB raising rates from zero.
The BoJ continued to keep interest rates at -0.1% and continues policy attempts to increase inflation to 2.0%. Japan is the only developed country that is actively seeking inflation and low to moderate inflation will be good for the country, given its demographics. An inflationary Japan can add a powerful growth factor to the global economy.
The India Growth Story
The RBI hiked rates by 40bps in a surprise mid-cycle increase in May, and again by 50bps in June to 4.9%. We were expecting a 100bps rate increase for 2022, at the start of this year, but the Ukraine war and consequent increasing fuel and food prices have added to inflationary pressures in India. We now expect a 150bps hike for 2022, but think that inflationary pressures are starting to level out for India – the government’s fiscal and export policy moves have added to support RBI’s monetary moves.
India cut excise duties on petrol and diesel, increased subsidy support for fertilisers, banned the export of wheat due to lower than expected production and raised export duties on steel. While the first two moves will likely increase the fiscal deficit by 50-60bps, it tamps down on inflation and supports growth, which should lead to the fiscal deficit being funded over time. We can already see robust growth in both GST and direct tax collections. For a change, monetary and fiscal policies are moving in tandem in India.
We believe that the domestic story is restarting for India after a gap of nearly 7-8 years. Since 2012-14, Indian companies have been deleveraging their balance sheets. They have not spent on fresh capex as well, after the huge burst of capex between 2006-2012. As a consequence, Corporate India has one of the most deleveraged balance sheets of the last maybe three decades, and capacity utilisation across various industrial sectors is now running at 80%+.
Thus, we expect a capex driven growth cycle to start or one which has already started – we also expect this to be supported by government spending on infrastructure projects, which will create a demand pull for the private sector. The Feb 2022 budget was one of the best Union Budgets that we have seen in a long time – of course, the government needs to execute on its plans.
Finally, banks have also cleaned up their balance sheets significantly over the past 6-7 years, and are now able to lend to fresh corporate capex or other borrowings. Thus, we have a trifecta of positives for the Indian market, which we probably last saw in the 2000-01 period.
We expect the Indian economy to grow at 8.0-9.5% pa over the next 3-4 years. Without the Russian war on Ukraine, we would have seen 8.5-9.0% GDP growth in FY23, but it is likely to be lower by 50-100bps now. Corporate earnings should grow 17-20% pa over the next 3-4 years. Valuations have also corrected for most companies, except a few market darlings. Thus, investors have a wide canvas to choose from – India has always been a stock picker’s market, and it has returned to its normal shape.
Recommendations
Having said all of the above, making money in markets in 2022 will be much tougher than in Apr 2020 – Sep 2021.
Therefore, we recommend investors to go with fund managers that have seen multiple market cycles and have a long track record in outperforming markets through cycles. The rising interest rate scenario will lead to unexpected outcomes in many segments – which has to be balanced against the underlying growth dynamic of different sectors.
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