Markets are trying something different, aren’t they? There is a problem in the bond market, yields have inverted but equity markets are saying it’s time to move on.
Well the yields were briefly inverted on Friday last week and Monday this week since then they are longer inverted. But you are right, the bond market is the most important thing to watch right now and the Federal Reserve has been indicating a quite aggressive and frontloaded hiking cycle which started last month and the futures market tells us the terminal rate will be at about 3% next summer.
But James Bullard, the St. Louis Fed who is a well known hawk said he would like it to be maybe at 3.5% by the end of this year. The reason I am telling you is that currently the 10-year treasury is at 2.6% but if we think back to 2018-2019, in the last rate hike cycle, the peak in the Fed funds was 2.5% which is quite a bit lower than 3-3.5%. That is where it looks like we are going and the 10-year was at a peak of 3.2% back then. I am just thinking that if we are really on our way to 3-3.5% with the Fed funds rate, we should be thinking about a 10-year treasury, maybe around 4% or something like that. I do not think the market will be comfortable with that.
So why are equity markets not nervous? Are equity markets saying it’s time to look beyond 2022 and focus on 2023? Is this the forward looking nature of the equity market which in a sense is not really adding to lot volatility or any kind of free fall?
The reason I love the market so much is precisely because of this. We will look back and we will understand why they are going up but right now, I do not think anybody can tell you with a straight face that they know. I will say the technicals recently have been strongly indicative of resumed uptrend.
For example, we have recouped two-thirds of the loss so far this year and when we look at history, we find that most of the time when markets go up two-thirds, they go up the whole 100% and take out the old high. But I can see numerous other technical indicators from the spike and then retracement in the volatility index and the advance decliner oscillators that all point to usually the market being up 12 months later after these kinds of things happen.
I guess if I had to choose a fundamental reason for the strength in the market it will be that inflation will come down and the Fed would not have to raise rates as much as we think. But right now, I do not see why the inflation rate should come down. So, it’s a little bit weird.
But as an equity investor, what should one do given that at an index level and at many stocks and sector levels, we are sitting close to the all-time peak and then there are worries about what the quarterly earnings are going to throw up in terms of an inflation hit?
I do not have a good answer because I am a little flummoxed myself. What I would just say is that over time, it is obvious that being invested in the market is better than owning cash. So if I had to guess which sectors would do better than others, I would say that the so-called long duration stories, the technology stories, the companies that have lots of great stories but not much profit, are not the place to be in a rising rate environment. The place to be in is commodities. Banks have become really beaten up but if rates are going up, then banks benefit from that. So, I would have thought commodities and banks are the better place to be right now.
Russia is an un-investable market right now, China has got the unique set of challenges. In Turkey, inflation has touched 60%. Will Indian markets be a disproportionate beneficiary of what is happening in the world?
No, I do not think so because they are lumped into this emerging market asset class. When people read the news about Russia or Turkey or Sri Lanka, they will just think I do not want to be in emerging markets. So, perhaps within the emerging market asset class, investors who specialize in that would favor India but that kind of investor would be a small minority of the total pool of wealth that gets dedicated to equities globally.
In a world where inflation is real and it is here to stay, how can one make portfolios which are Teflon coated against inflation and protect the purchasing power?
The answer is simple. One owns commodities and there are countries that are very obviously correlated to commodities both in their currencies and their markets. These are Australia, Canada, South Africa, Indonesia and Malaysia. There are probably a couple of others that I forgot but those are the main ones. I might have thrown in the UK just because the UK economy is not commodity based. But the stock market, funnily enough, has a lot of commodity exposure. We just bought Canada a few days ago to get that kind of protection and the reason is that the companies are very well run, the currency correlates with commodities, has a good banking sector too. I guess the cherry on top is I am Canadian and so we decided to put some money to work there.
You have time and again said you want to go where you are going to get at least 15% earnings growth. As we enter the new financial year in India and ahead of the earnings season, how confident are you that that is the place to be because you will see more than 15% earnings growth?
We started the year with 18%. Now we are at 15% and I feel pretty confident that we can maintain a forecast of 15% for the next fiscal year because the oil price is not going to go back up to 130 thereabouts. When we look at what is driving earnings growth in India, this year it is sectors like IT and banks and the commodity companies themselves. I think 15% is achievable and it is something that makes India a bit unique because in America for example, they will be lucky if they get 6% maybe.
You have talked about banks, tech and commodities. Would the The investment strategy for commodities be only through the equity markets or also on holding commodities?
The precious metals are easy to buy through ETFs or funds. The other commodities are trickier to buy. I certainly would not want to dabble in the futures market. It is complex and the rolls make it quite expensive in things like oil. So equities are a good way to play them in the sense of the producers of them and then specific to the precious metals we could also access the physical bullion in ETF form and I am very comfortable doing that.
If I may just extend your point on commodities, interest rates will move higher and may stay higher for a long period of time. What happens to the underlying demand for commodities? If the underlying demand for the commodities remained low, do not you think underlying prices and commodity denominated markets could suffer?
I do not think we are at that point in any of the commodities yet, where we are witnessing demand destruction. Six months from now, it might be different but I have seen no commodity go down because of anecdotal evidence of decreased purchases of it and some of these can be very elastic. Oil is typically very elastic, food as well and the main reason why they should remain strong is that we have a war which does not look like it is going to end any time soon. That is exacerbating a lot of supply and energy for example as well as food and those can trickle through the entire chain in really quite remarkable ways.
The other thing I might throw in on the durable goods side is that Covid is the worst ever in China and do not think they can back away from the zero Covid policy and so we could also get some return to the supply chain disruption in the durable goods and that would also be inflationary.
It will impact durables, electronics, automobiles. Even shower gels in the United States have seen supply disruption. You folks are overweight in India but will stay overweight?
Yes, we will and if I could briefly tell you, the three reasons we like it is number one, Indian growth was subpar over the last decade for reasons that are no longer with us – the NPAs, the deep structural reforms. So point number one is there is a lot of catch up in the economy and that is happening naturally now on growth that should have happened during the previous decade, but for the reasons I just mentioned did not.
The second thing is the digital side and that has a very beneficial impact on improving efficiency in the economy. I did want to say a third one. It is the demographic dividend and the working age population is in excess of the dependent age population that happened four years ago. It will remain the case until 2055 and when I look back at history, when other countries enter this kind of golden period of demographics, they were accompanied by strong stock market performance over the following 10 years.
What would your assessment be? Are we going to take out the new all time high and go further because what is your assessment as far as that goes?
We will because as much as everything we talk about is negative, somehow the market climbs the wall of worry and as I said earlier, it is only in retrospective that we will be able to understand why this is happening. But we believe that the US stock market, which has recouped two-thirds of its loss so far this year, will take out a new high. That is the benchmark for the world. So if the US market can take out a new high, other markets that are open and India is one of them, will follow it.