Cocktail of misplaced expectations for stocks

Market


The inflation fever has refused to cool down. A higher-than-anticipated increase in the US consumer price index sent jitters across the US stock market on Tuesday. The annual inflation rate in the US eased from 8.5% in July to 8.3% in August, though this was higher than economists’ forecast of 8.1%.

This pours cold water on hopes that central banks would go slow or pause raising rates anytime soon. On the contrary, the clamour for a 100 basis points (bps) rate hike by the US Federal Reserve (Fed) is getting louder. The Fed is scheduled to meet on 20-21 September.

Pitching hard 

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Pitching hard 

“US stocks are crumbling after a very hot inflation has Wall Street nervous that they were too optimistic in forecasting the end of the Fed’s tightening cycle,” said Edward Moya, senior market analyst, The Americas, Oanda. Markets are no longer confident that the Fed will only deliver a 75bp increase this month, a half-point increase in November and a 25-basis-point increase in December, he added in a note on 13 September.

This means the US central bank may have to be more aggressive on hiking rates to fight persistently high inflation. Overall, this spells trouble for risky assets such as equities, particularly emerging market (EM) stocks.

“After Tuesday’s higher-than expected (US) inflation print, the market is attributing close to 30% probability of a 100bps of rate hike by the US Federal Reserve next week,” said Kunal Vora, head of India equity research at BNP Paribas. In general, higher bond yields are unfavourable for equities. Also, higher US bond yields make EM assets unattractive.

BofA Securities’ September Global Fund Manager Survey showed that the mood among global investors remained super-bearish. Sticky and high inflation continued to be the biggest tail risk to investors’ portfolios, followed by hawkish central banks. Global economic outlook was still bleak with a net 72% respondents foreseeing a weaker economy in the next 12 months. Also, those expecting global profits to worsen over the next one year rose to a new high in September. Consequently, the net percentage of investors expecting a recession surged to the highest level since May 2020.

It is hardly surprising then that investors are ditching equities and hiding in cash. The average allocations to cash rose to the highest level since October 2001 and allocation to global stocks sunk to an all-time low in September.

Long US dollar was the most crowded trade for the third month in a row, said the BofA report. The greenback is considered to be a safe haven in times of economic distress; so, the increased preference among investors for the US dollar can be understood.

Meanwhile, amid the global market weakness, India’s key benchmark indices the Nifty 50 and BSE Sensex saw a modest fall of around 0.40% each on Wednesday. In comparison, some key Asian markets fell about 1.5-2.5%. Return of foreign fund inflows, robust domestic institutional buying and softening commodity prices have helped. That said, India’s valuations are expensive.

The MSCI India index is trading at a one-year forward price-to-earnings multiple of 20x, showed Bloomberg data. This is a premium to MSCI Asia Ex-Japan and MSCI Emerging Markets Index.

“Markets have overlooked some of the negatives that include the weaker than expected Q1FY23 GDP growth, earnings cuts after the Q1FY23 results, higher than expected inflation, elevated current account deficit and rising US bond yields,” Vora said.

Apart from interest rate trajectory, an important near-term monitor for Indian investors would be Q2FY23 earnings performance and managements’ commentary on the upcoming festive season.

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