The period of easy money making in markets – from May 2020 to October 2021 – is over. The market scenario, globally, has turned tough. Excessive volatility is here to stay for some time. Investors should prepare for tough times.
The immediate short-term is dominated by geo-politics. The Ukraine – Russia tensions have reached a critical point. As I write, we do not know how this will pan out. If there is Russian invasion of Ukraine the consequences for the economy and markets will be bad. The US has declared that it will not militarily intervene in the conflict since Ukraine is not a member of the NATO. But the sanctions on Russia would be swift and strong. This may include cutting off Russia from the global payments system SWIFT and denying Russia access to dollar. Russian economy will be hit hard. Emerging economies would be impacted by the surge in crude and natural gas prices.
For India, the surge in crude prices has come at a time when inflation is rising. January 2022 CPI inflation is at 6.01 percent. Petroleum prices have risen more than 20 percent since the last revision in November. Once the elections to five states are over, prices are likely to be revised. This has the potential to push inflation beyond the RBI’s target even though the RBI has projected CPI inflation of 4.5 percent for FY23. The widening trade deficit will weaken the rupee.
If the Ukraine-Russia tension eases and de-escalation begins the macroeconomic environment will turn for the better. But the biggest threat in 2022 – monetary tightening by the Fed – will continue to haunt markets. Inflation in US at 7.5 percent is at 40-year highs. Now the market consensus is that the Fed is behind the curve and will start rate tightening in March. Estimates range from four to seven rate hikes in 2022. The 10-year bond yield recently shot up above 2 percent. Capital outflows from emerging markets are likely to increase. In India, FIIs are likely to continue on the sell-mode until inflation data from US indicate softening trend.
Q3 results indicate sharp turnaround in the earnings of sectors like IT, metals, mining, energy, telecom and financials. Growing credit demand, improving asset quality of banks and deleveraging corporates augur well for capex and economic growth. The consequent earnings growth can impart resilience to markets.
Since valuations are high, markets are vulnerable to sharp corrections. Therefore, this is not the time to buy aggressively. Investors wanting to invest in the market now may stagger their purchases over several months. Those who are fully invested in the market may consider partial profit booking as a measure of abundant caution. A good strategy would be to churn portfolios: selling stocks in underperforming sectors and buying into performing sectors, particularly those with fair valuations. IT, financials, telecom, construction related sectors, metals and specialty chemicals are performing well. The prospects for autos are turning brighter. Financials are performing well, their prospects are improving and, more importantly, are fairly valued.