Rising inflation may cloud investment options but some islands of opportunity still exist
Rising inflation may cloud investment options but some islands of opportunity still exist
Wherever you look, the signs are clear that prices are on the rise. Much of the conversation between middle-class and upper-middle-class families is about rising prices, which is hurting their budgets. Most of the people are finding it challenging to balance their budget.
The Wholesale Price Index has been in double digits over the past several months, and the CPI is hovering around 6%. This is true not only in India but also in the developed world. US inflation is now trading at over 7%, and central banks’ response has been relatively slow. In the face of the highest inflation in 40 years, the Federal Reserve raised short-term interest rates by only 0.25%. There appears to be no impact on inflationary pressures or inflation expectations a year down.
At the same time, a bloody war broke out in mainland Europe with Russia invading Ukraine. This has prompted the Western world to impose several sanctions on Russia.
This is mainly due to the increase in the prices of oil, gas and other fossil fuels. What has not been discussed much is the impact on food prices. The region is the foremost supplier of wheat and sunflower oil to global markets. This has led to a rise in the international prices of oilseeds.
effect on metals
Metal prices were also hit, with nickel contracts traded on the London Metal Exchange seeing a sudden jump in prices. The prices of other base metals such as aluminium, copper and steel have more than doubled in the past two years. The war has resulted in a shortage of semiconductor chips that was already affected by the pre-war pandemic. The zero-covid policy of the Chinese government means that there has been a fresh lockdown in China. This has further affected the global supply chain. This too is contributing in no small part to the rising inflationary pressures around the world as China remains the factory of the world.
How does it affect India? What should a defensive-minded retail investor do in the current scenario? The fact is that India has been badly hit by this period of inflationary pressure. The government’s budget figures for the fiscal year, which ended, have been badly hit in two respects: 1) The much-awaited LIC IPO, which was supposed to be done in the budget, has been indefinitely delayed. 2) The government has to spend more on fertilizer and fuel subsidies. This would mean more government borrowing, adding to inflationary pressures.
In the current year, the budget data has estimated the price of crude oil at $75 per barrel and based on these estimates the subsidy has been calculated. It is now clear that these are not valid and need to be reworked.
The rupee has been under pressure and has depreciated continuously in the first three months of the year. This means we are countering inflation by importing fuel, gold, edible oil, and pulses, a key ingredient in our protein basket.
Also, as the rest of the world tightens its monetary policy, we may have to follow suit or sharply devalue our currency. This would mean that we would be importing more inflation which we cannot afford.
How should one invest in the above scenario?
First, we must remember a quote by John Maynard Keynes from the book The General Theory of Employment, Interest and Money Where, in Chapter 12, he compares the markets to a beauty pageant, where judges are rewarded for selecting the most popular of all faces, rather than individually finding them attractive.
An increase in the value of dollars and exports would mean an increase in the value of companies whose earnings are in dollars. A resurgence and strong US economy means that IT exports have performed well, and the IT index has grown by about 50% and will continue to perform well. Adding pharma index to this basket can be beneficial for the investor.
It is reasonable to expect the price of gold to correct in dollars as interest rates climb in the second half and further increase in gold retail sales. Commodity itself can provide a buying opportunity.
Besides, the uptrend in the metals index has run its course due to two factors: 1) A further rise in the prices of metals will reduce the demand for steel, copper and aluminum. 2) An increase in interest rates will mean higher interest payments as most metal companies are highly indebted. Most FMCG companies see a significant improvement in the form of volumes contracting when these larger firms increase costs to offset input inflationary pressures. Hence, it would be advisable to book profits in metals and move to FMCG index during the year. This should be done gradually as the market improves. Selling pressure from foreign institutional investors may allow us to enter the private banking sector at a more reasonable valuation.
There is room for great opportunity, but the reader should remember that ‘markets can remain irrational as much as you can remain solvent’ (John Maynard Keynes). Retail investors will have to be patient and cautious during this year.
(Anand Srinivasan is a Consultant and can be contacted at anand.s.srinivsan@gmail.com. Shashwat Swaminathan is a Research Associate at Ionian Investment Services)