Markets swoon in April, again
Equity markets tumbled across US and Europe in April, due to multiple reasons. First, inflation numbers continued to increase globally – this has a direct effect on consumption levels. Second, the Russia-Ukraine war now looks like it will be a protracted affair – this increases market risk premiums globally, besides feeding into inflation. Third, with rising inflation, market expectations of where interest rates will settle have moved upwards.
We look at inflation and the case for India in separate sections in this note – so, I won’t spend much time here except to say that Central Banks now fear inflation can become persistent, and are now more inclined to take aggressive, pre-emptive action. This implies that interest rates will rise more, and for longer – and that is bad news for bonds and highly valued equity shares, especially those companies which don’t seem to have any real path to positive cash flow generation. Even though the unexpected strike by the RBI (what were they thinking?) in the first week of May roiled the Indian stock market, inflation @5-8% is not bad for reasonably valued Indian stocks, with low leverage, as long as the Companies are increasing profits and cash flow at a rate 2-3x nominal inflation. In fact, such stocks do well in a moderate inflation environment, due to higher investor interest while interest rates go up.
In the Russia-Ukraine war, the battlefields shifted in April. After effectively beating the Russian army in its attempt to take the capital, Kiev, Ukraine now faces the Russian army in the South and the East – as Putin attempts to either absorb or set up client states in the Donbas-Luhansk region and establish a land bridge between Crimea and Russia. A secondary but important objective seems to be to deny Ukraine any use of its own ports for exports of food grains and minerals. Given that Ukraine is considered the Wheat Bowl of Europe, this has adverse ramifications for food grain availability and prices, especially for African countries that depend on imports.
The previous slim chances of an armistice have also been crushed by the revelation of Russian atrocities in Bucha, a suburb of Kiev. At the same time, while Russian forces have regrouped in the East and South of Ukraine, and have nearly taken the strategic city of Mariupol, UK military intelligence estimates that 25% of Russian troops (deployed at the start of the war) as “combat ineffective”. The continuing conflict and the increasing chances that this may spill over into a NATO country bordering Ukraine increased global risk premia last month.
From a resolution perspective, this has become a race for time – can Ukraine hold out in the East before it receives all the additional arms supplies or will Russian forces be able to break through and link up with forces in the South, effectively partioning the country. The US has authorised a further US$1.3 billion via security packages and economic assistance to Ukraine[1] and the UK has pledged US$375 million in military support[2]. This support also comes with the risk of further escalation since Putin is now claiming that Russia is fighting a proxy war with NATO in Ukraine – Putin and Lavrov have both referred to Russia’s nuclear weapons, holding them out as a threat against NATO. This remains the most volatile factor for all markets currently, besides the obvious human costs being incurred in this war.
Oil prices moved to US$110/bbl in April, and we now believe that this level could hold for longer than we previously estimated, as the war drags on and affects supply. The joker in the pack is the Chinese economy, which is showing signs of significant stress – if Chinese demand tails off in 2H 2022, then that will have a cooling affect on oil prices. Of course, sustained high prices of oil is not good news for the Indian economy and its trade balance – but we believe that the rising growth rates that we are witnessing will mitigate much of the adverse effect. And, once oil prices start going down, it will provide a further impetus to economic growth. As a data point, we look at the all-time high of GST collections in April 2022 at Rs1.68 lac crores – we also note that GST collections have been rising steadily since January 2022 – this is the clearest, single yardstick to measure economic growth in India.
Markets have been keeping a close track of the FED and its likely pace of rate hikes. Valuations have come down drastically for US tech stocks, before a relief rally at the end of April, and the US posted negative GDP growth for 1Q 2022 on annual basis for the first time since early 2020. However, this figure did not spook markets – in fact, equities gained on the day of the data release! A key reason is that most of this drag in GDP came from the trade balance, rather than consumption. The GDP number also did not deter the FED from raising rates by 50bps in their meeting on 4th May, the same day that the RBI pulled a surprise on India.
Indian equities have been following global trends to some extent, but earnings have been the key driver for markets this month. Here is a roundup of the earnings season so far and how it has impacted various sectoral indices.
| Index | Monthly Return | YTD Return | Return Since 52-wk high |
| NIFTY 50 | -1.3% | -3.0% | -8.1% |
| NIFTY MIDCAP 100 | 1.8% | -3.0% | -10.1% |
| NIFTY SMALLCAP 100 | -0.1% | -10.2% | -14.9% |
| NIFTY BANK | 0.7% | -0.9% | -13.7% |
| NIFTY AUTO | 6.4% | -0.3% | -8.8% |
| NIFTY FMCG | 7.2% | 1.6% | -9.1% |
| NIFTY IT | -12.5% | -19.2% | -19.8% |
| NIFTY MEDIA | -6.9% | -4.5% | -13.8% |
| NIFTY METAL | -7.3% | 12.4% | -7.3% |
| NIFTY PHARMA | -2.2% | -4.9% | -9.9% |
| NIFTY REALTY | -20.9% | -9.4% | -20.9% |
IT was the largest drag on the Nifty, after Infosys results showed margin compression – the company missed earnings estimates by about 6% and the market priced this in immediately, as the stock fell 7% on the day of the earnings release. TCS, HCL Tech, and Wipro have all followed suit citing attrition and rising travel costs. In the banking space, HDFC Bank, ICICI Bank, and Axis Bank have all reported improving earnings and asset quality yoy, but the market reactions have been mixed. Nonetheless, the Nifty Bank index has recovered over the past two months, after being beaten down at the start of the year. The Nifty Auto index was boosted largely by Maruti and Bajaj Auto results despite an unprecedented increase in input costs – price increases in passenger vehicles segment has allowed car companies to keep margins intact. The commercial vehicle segment has seen robust demand, as demonstrated by Tata Motors’ report of 80% sales growth in April, yoy. Britannia and HUL, both reported an increase in PAT since they have been able to pass on the increasing input costs onto consumers. Tata Steel reported a 47% yoy increase in profits, but this was already in the price, given the strong performance of metal stocks YTD.
Although earnings have been relatively positive in 4Q FY22, majority of the indices are still in the red YTD, barring metal and FMCG, which is seeing a positive sectoral rotation from investors.
DIIs and Retailer Investors to the Rescue
Reports suggest that foreign ownership of Indian stocks fell to a 3-year low[3] in March due to aggressive selling over the six months to March 2022. Although FII selling cooled down in April, they were still net sellers at Rs17,143cr (US$2.2bn). India is not the only market taking such a hit – Chinese equities have seen net outflows close to US$1.01bn in April[4], taking the Shanghai Composite Index down 7% in April. The Hang Seng and KOSPI indices have both been down by 7% and 3%, respectively. Even the Nikkei Index was down close to 3% for the month.
However, we would like to highlight one very important fact here for all investors – FIIs have sold US$21.9bn of Indian equities between Oct 2021 – Apr 2022, but the Nifty is down only 10% from its peak in Sep 2021. This author has been tracking Indian equities for 20+ years and this is incredible resilience. It is an indicator of financialisation of savings in India, and such a trend is typically a multi-decadal event. If Indian investors continue to put in money in equities/MFs, despite the events over the past seven months, then that provides robust support for Indian equities. Individual stock performance can vary, depending on valuations and earnings growth, but the Indian stock market is fundamentally stronger and deeper now.
In terms of numbers, DIIs bought Rs30,843cr (US$4.0bn) in April, more than compensating for the FII outflows. As of December 2021, direct retail ownership was 9.7% of all NSE-listed stocks (signifying a 0.5% increase in five years) and mutual fund ownership stood at 7.4%[5]. Data from AMFI shows that annual SIP contributions were up by almost 30% from FY21 to FY22[6].
Going forward, even if domestic support does not sustain at this level, we expect India to be the favoured destination among emerging markets for FIIs, once the interest rate cycle settles down. As far as BRICS is concerned, Brazil’s political uncertainty, Russia’s reputation due to the war, South Africa’s relatively low economic growth, China’s sputtering economy, and the China+1 narrative are all putting India at the top spot, let alone the green shoots that we see from the India growth story.
Is this The 70’s Show? We don’t think so
In 2022, the key macro factor has been the rise of global inflation – US inflation reached 8.5% in March, marking a 40-year high. The last time US inflation was at this level was back in December 1981, and this was a period of both rising energy prices and increasing aggregate demand, in the US economy.
The rise in inflation started due to supply chain disruptions caused by covid lockdowns and a break down in global trade, and this was then aggravated by a change in demand from services (travel, hospitality, tourism, etc which were not available) to a demand for goods in the US, and in Western Europe. This was then further aggravated by covid payments made by the US federal government in 2020, putting money in the hands of consumers, many of whom spent it on buying stuff. And, then we had the Russian invasion of Ukraine to aggravate inflation still further, by increasing energy costs and causing more disruptions in the global supply chain.
As a result, we now face a rising interest rate regime across the world – the FED increased rates by 25bps in Feb and 50bps in May, the Bank of England has increased rates four times now and the ECB is expected to follow suit soon. The FED had previously said it will take six hikes of 25bps each, and it will start to reduce its balance sheet – the current expectation is that after the 50bps hike, the FED will take at least another two 50bps increases. It may even end up taking three hikes of 50 bps each, and swap markets are pricing in the likelihood of steeper rate hikes.
India’s inflation has also been rising and hit 6.95% last month. The RBI held its hand at the last MPC meeting in April, choosing to err on the side of growth one last time – but, it then reversed course rapidly by announcing a surprise MPC meeting and a rate hike of 40bps to 4.40% on 4th May. It also increased CRR by 50bps to 4.50%. In the April meeting, the RBI had also indicated that it will be shrinking its balance sheet from here onwards.
In a rising interest rate regime, both equity and bond prices take a hit. Bond prices start falling as yields start rising, and this will continue until the FED has finished tightening for this cycle. Equity prices come off because rising interest rates has a twofold effect – one, it makes existing valuations more expensive (DCF modelling – the cost of capital goes up; also reduces terminal value) and for companies with leverage, it increases interest costs and depresses margins. We have already seen one round of this effect on both equity prices and bond prices, both in the US and India. For example, Netflix is down by approx. 72% since its all-time high in November (September 2017 was the last time that the stock was at this level). On an aggregate basis, the NASDAQ 100 index is down approximately 21% from its highs in November last year and highly valued stocks have plummeted. The following table shows the top 10 losers from the NASDAQ 100 index since their 52-week highs:
| Company | Return Since 52-wk high |
| Pinduoduo Inc. American Depositary Shares | -75.9% |
| Zoom Video Communications, Inc. Class A Common Stock | -75.8% |
| DocuSign, Inc. Common Stock | -73.2% |
| PayPal Holdings, Inc. Common Stock | -73.0% |
| Netflix, Inc. Common Stock | -71.7% |
| Moderna, Inc. Common Stock | -70.7% |
| Lucid Group, Inc. Common Stock | -69.5% |
| Match Group, Inc. Common Stock | -56.3% |
| Biogen Inc. Common Stock | -55.8% |
| Okta, Inc. Class A Common Stock | -54.7% |
Despite the stagflation narrative and fears of a slowdown or even recession, the US economy posted strong payroll numbers in March – 431,000 non-farm jobs were added, and the unemployment rate fell to a record low, 3.6%. However, it is important to note that labour force participation is still not back to pre-pandemic levels, and this is coupled with increasing job vacancies[7]. Therefore, despite record-low unemployment, the US economy still has demand for labour, which may not be filled any time soon. It is then likely that wage hikes will continue in the short-term to attract labour, and we may see an increase in both wages and the cost of living.
None of these are indicators of looming stagflation – especially, since Companies are hiring and indeed, desperate to fill vacancies. Indeed, we feel that US faces the risk of a credit shock in 2022 more, rather than that of a recession or stagflation. We will deal with the credit shock possibility in another issue – the thrilling tale of American Zombie Companies!
Meanwhile, the unemployment rate in the UK is back to pre-pandemic levels and has had the fastest economic growth among G7 nations in 2021. However, the IMF has pegged the UK to have the lowest GDP growth rate among G7 nations in 2023, citing an early pandemic rebound relative to peers and a potential reversal of tax relief policies. The unemployment rate in the Euro Area is also on a decreasing trend (even in countries like Spain, Italy and Greece, which have the highest unemployment rates in Europe).
But Europe does face higher inflation threats now, thanks to rising energy costs. Sharp increases in gas prices have taken Germany’s inflation close to its 50-year high. The risks of stagflation are probably higher in Europe than in US, because of the former’s historical lower growth rates. But we think one factor not being adequately considered is higher defence equipment production in Europe – this will lead to growth and employment in a sector that has traditionally depended on exports for most of its growth. On the inflation side, we believe that only normalisation of supply chains will lead to price stability.
The World Bank’s estimate of 2022 global growth has shrunk from 4.1% to 3.2%, and the IMF has also trimmed their forecast from 4.4% to 3.6%. However, it is important to contextualise these figures. The IMF estimates that the global economy grew by 6.1% in 2021, completely reversing the de-growth in 2020. According to World Bank Data, the average global growth rate from 2010 to 2019 was 3.2% and it was the same for 1999 to 2008. So, these agencies are still estimating global growth for 2022 to be in line with the average of the last two decades of positive GDP growth, despite the sharp upturn in economic output and a war.
This implies that once supply chains normalise, so should inflation, real wage growth, and consumption-led demand. We are not by any means implying that the current high inflation is transitory, nor are we attributing this phenomenon entirely to war. We are simply pointing out that once geopolitical tensions ease, inflation is more likely to be led by sustainable demand-side factors compared to the key factors that have led to the current scenario (ie, excess money printing, supply chain constraints, and war).
The Case for India – Growth is Back
India has been less affected in equity markets, compared with both the US markets and other emerging markets, by the rising interest rate cycle because 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. Consequently, Corporate India has one of the most deleveraged balance sheets of the last three decades, and capacity utilisation across various industrial sectors is now running at ~75-80%+. 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 February 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 for 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 50bps 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. Nifty is now trading at ~19x FY23E and ~16x FY24E earnings, which is in its normal range. 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.
For India, growth is the only panacea for all its problems – and, even with inflation at 6.95% currently, we believe Indian equities, in general will do well from here over the medium to long term. Moderate inflation has not been a drawback for Indian stocks, if companies continue to show growth, especially cash flow growth and reduction in leverage.
Having said that, making money in equities in 2022 will be much tougher than in Apr 2020 – Sep 2021, when practically all stocks went up, whether they had a reason to go up or not. With FII flows also being more volatile in 2022, investors will have to really research their stock selections. 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 must be balanced against the underlying growth dynamic of different sectors.
Atreyi Recommendations
We expect markets to remain volatile until there is a clear resolution of the Russia-Ukraine war. Additionally, we expect a risk-off bias to continue, as equity and debt markets alike feel the full force of a reduction in the FED’s balance sheet. US 10-yr Treasury yields have risen to 3.0%, and this cycle may see a peak at ~4.5%.
While there are short-term challenges in 2022, we remain bullish on the India story. The current global scenario has posed some roadblocks and delays to the capex cycle. For equity investors, we recommend sticking to fund managers with long track records of navigating well through tough times. We also recommend SIPs in Flexi Cap funds for long-term growth.
We recommend investors to allocate at least 10% (ideally 15-20%) of their portfolio to gold as a hedge against equity and bond market volatility. Even if it looks like Gold is not doing anything now after a sharp rise at the beginning of the year, it will be too late to buy Gold if there is another global dislocation – the prices would have spiked already.
For debt allocation, we recommend exiting all debt-related mutual funds – MTM losses are coming down the pike and investors can see even negative returns from their debt funds. We recommend buying high quality direct bonds, REITs, or preference shares, instead.
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[1] https://www.cnbc.com/2022/04/21/us-sends-800-million-arms-package-to-ukraine.html
[2] https://www.reuters.com/world/uk/britain-promises-further-375-mln-military-aid-ukraine-2022-05-02/
[3] https://www.financialexpress.com/market/foreign-institutional-investors-fii-ownership-in-nse-500-companies-falls-to-3-year-low-at-19-5/2500862/
[4] https://www.reuters.com/world/china/chinese-markets-continue-see-foreign-investment-outflows-april-2022-04-22/
[5] https://www.bloombergquint.com/business/retail-stock-ownership-at-14-year-high
[6] https://www.amfiindia.com/mutual-fund
[7] https://finance.yahoo.com/news/march-2022-jobs-report-labor-department-unemployment-usa-210149591.html
