Inflation trails have been the bearer of bad news lately. With the 2008 financial crisis and global growth optimism at record lows, fears of stagflation are highest, as shown in BofA Securities’ June Global Fund Managers survey. Not surprisingly, expectations of global corporate profits also fell to 2008 levels. The BofA survey said the Lehman bankruptcy and other Wall Street crisis moments such as Covid caused such a sharp drop in profit expectations.
The bloodbath in global equities reflects the panic among equity investors. The fear gauge, CBOE Volatility Index (VIX) and India NSE VIX, are up 90% and 37% respectively so far this year.
At the center of all this is the US Federal Reserve and speculation as to how far it will go to contain inflation. The Fed’s two-day meeting ends on June 15. Expectations of rate hikes are roughly in the range of 50-75 basis points (bps) and there is some murmur of 100 bps hike.
The worry is that the Fed may go ahead with raising rates faster than previously thought, thus increasing the risk of a recession. In addition, the Fed’s quantitative tightening program will pull the plug on excess liquidity in the system, which is another downside for equities.
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Against this background, Lance Roberts, Chief Portfolio Strategist at RIA Advisors, remains concerned about the dire global economic fallout. “When the Fed reduced its balance sheet in 2018, it ran a $30 billion monthly pace with very little inflation. Starting this month, the Fed will increase that reduction to three times the previous run rate, with inflation Around 9%,” he said in his report on June 14.
Furthermore, Roberts cautioned that while the Fed believes they can achieve this shortfall without disrupting equity markets or causing an economic contraction, history tells otherwise. “Amid rising inflation, dwindling wages, slowing economic growth and the Fed intent on tightening monetary policy, there’s a storm on the horizon,” he said.
In addition, other central banks follow the pace of tighter monetary policy by the US Fed. If emerging market (EM) central banks fail to catch on, they will face the wrath of foreign investors. Without the rate hike, investing in EMs would be a less attractive option for foreign investors.
Duncan Tan, Asia, Rate Strategist at DBS Bank, wrote in his writing, “The emerging narrative for the Fed will place considerable pressure on Asian central banks to accelerate their rate hikes, especially in the context of recent portfolio investment outflows across the region.” ” Research note on June 15. Tan is of the view that the response of Asia’s central banks will go beyond focusing on domestic growth and inflation considerations and extend to financial stability and outflow risks. In India, foreign institutional investors (FIIs) have sold stocks worth $25.3. Arab this year. However, domestic institutional investors are on a buying spree, offering some cushion for Indian equities amid the global turmoil. This said, increased inflation continues to be a pain point for RBI and corporates facing margin pressure.
“We expect some further (earnings) decline in sectors including metals and FMCG, where companies are in the process of passing it on. The Street expects Nifty EPS (earnings per share) to grow 18% in FY13, which is likely to grow at a moderate to 13-14%,” said Sahil Kapoor, head of products and market strategist at DSP Investment Managers he said.
Meanwhile, MSCI India one-year forward price-to-earnings multiple trades at around 17x, a premium of 11x to MSCI Asia Ex-Japan, shows Bloomberg data. India’s valuation is down from historic peak, but still not cheap compared to Asian competitors.