Vijay Kumar Gaba

 In the next couple of days, the market participants world over will be focused on the FOMC statement on Fed rates, inflation & growth outlook and guidance for the monetary policy direction in the near term (next 3-6months). The “active” market participants in India, in particular, would be staying awake till late midnight on Wednesday to hear what Fed Chairman Jerome Powell has to say.

The fact that Thursday happens to be the monthly derivative settlement for July contracts, makes the Fed decision, and likely reaction in our markets on Thursday morning, even more pertinent for the derivative traders in India.

Besides the derivative traders, the currency traders; bond traders and corporate treasury managers who need to actively manage their Fx exposure, would also staying awake to see how the US Dollar, EUR and US Treasuries behaves post the FOMC statement and try to assess how Indian bonds and INR may react in near term.

Our markets may however be relieved to a great deal if the RBI makes an unscheduled rate decision on Wednesday morning itself, just like it did on 4 May 2022, preempting the pressure on Indian bonds and INR post FOMC decision. For records, in his recent statement, the RBI governor has already spoken about the inevitability of further rate hikes. It would be better if it is done tomorrow rather than a week later (04 August 2022) when the MPC of RBI is scheduled to make a statement on monetary policy.

The European Central Bank (ECB), for example, hiked 50bps last week – their first hike in 11 years- to preempt further slide in the Euro. ECB hiked despite signs of accelerated slowdown in growth and rising fiscal pressures on peripheral Europe.

Since the FOMC decision would be known in less than two days, I do not find any need to speculate on the likely outcome and the market reaction to that outcome. Nonetheless, it would be appropriate to say that the market is pregnant with the hope of a unambiguous ‘pause’ signal from the Fed and consequent weakness in USD and a rather dovish MPC. The chances of disappointment are therefore marginally higher than the chances of positive surprise, in my view.

What should be the strategy of an investor under these circumstances?

In my view, the first thing an investor should do is to have a good dinner on Wednesday; go to bed early and not watch the markets, including business newspapers & TV channels and investing handles on social media, on Thursday.

Second, investors should focus on performance of the companies in their respective portfolio, rather than bothering too much about the general impact of global macro developments. They should assess the ability of the companies in their portfolio to manage the impact of rate and currency volatility on their respective businesses. The history indicates that better managed companies in India have managed this volatility very well without letting it materially impact their performance beyond a couple of quarters in the worst case.

Third, if the change in global rate and currency outlook materially alters the investment argument for a company in their portfolio, they should place a “sell” order for it today itself.

Long Covid, is a term commonly used to describe the lingering adverse health effects of the Covid infection. Another dimension of Long Covid is the lingering socio-economic impacts of the pandemic. While only a small percentage of persons who suffered from the Covid infection are showing medical signs of the Long Covid; the socio-economic milieu of almost every country in the world is suffering from Long Covid.

The pandemic has definitely widened and deepened the socio-economic economic divide across jurisdiction. A significant proportion of the population that was pulled out of the abysmal poverty in the past two decades has slipped back below the poverty line. Accelerated digitalization of social services like education and health has deprived many underprivileged children.

To mitigate the sufferings caused by the pandemic, most governments provided monetary and fiscal stimulus to the poor and small businesses. The stimulus checks (and ration and medicine kits) created artificial demand for two years. This happened when the supply chains were broken across the product lines.

It is pertinent to note that ever since the global financial crisis (2008-09) the investment in new capacities in commodities (mining, metals, coal, oil & gas etc.) was dwindling, while the money to build leveraged positions in commodities was available in abundance and at extremely cheap rates. We had seen a glimpse of these positions on 15^th April 2020 when the WTI Crude Oil Futures settled at negative $37.4/bbl.

Some of the highlights of the socio-economic dimension of Long Covid are as follows:

1.    The sudden and exacerbated demand supply mismatch has caused prices of all commodities, including food, to rise sharply higher. The poor are obviously suffering the most.

2.    The modern monetary theory (MMT) that was working just fine since 2009 seems to be becoming ineffective.

The deluge of new money created since the global financial crisis did not result in any inflation as the new money was not flowing to the end consumers. The new money was mostly adding to the reserves of the banks as the lending standards were made very strict. The credit was mostly flowing to the rich and affluent for investing in financial assets; or it was used for circular trade in government securities to repress the bond yields. Consequently, bonds worth trillions of dollars traded at negative yields; the government borrowed profligately to keep the Ponzi scheme running.

The pandemic has however taken the tide down and exposed the true status of economies, governments and central bankers. The central bankers are now running for cover (withdrawing excess money from the system and hiking rates); governments are focusing on raising revenue (taxes) and distracting the attention of common people to war hysteria & political instability; and economies are slithering into recession.

3.    The stimulus checks, concessional loans and relaxation in lending standards during the pandemic resulted in billions of dollars flowing into the pockets of consumers, like a high dose of life saving steroids. The treatment proved effective and saved millions of lives. However, the effect of steroids has now dissipated. The consumers are struggling with the side effects. Widespread civil unrest, even in the most peaceful jurisdictions like Sweden, and aggression are the consequences.

4.    US consumers are now struggling with 4 decade high inflation, when the mortgage payments are rising as the Fed is getting ready to aggressively tighten. The action of the US Fed, which is preparing to hike another 50bps next month, may not result in any improvement on the supply side. It may however destroy demand and hence bring equilibrium in the markets.

5.    Many emerging markets are now struggling to honor their debt and control inflation to protect consumers. Thankfully the markets are not panicking over Sri Lanka’s default like they did at the time of Greece’s potential default. But if some larger countries join the list of defaulters, markets may react badly.

As I noted a few days ago, for now Mr. Bond is in the driver seat and yields will be driving the global markets. Interestingly, the current generation of investors, traders and money managers have never seen a bear market in bonds. The last bear market in bonds was two decades ago in the early 2000s. It is safe to assume that those below the age of 42-43yrs came out of college after that. Their skills will be tested now.

Even in the equity market, the bear markets of 2008-09, and 2020 were mostly panic driven and recoveries were faster. A pure economic cycle led bear market in equities has not happened since 2003. “IF” the central bankers fail to tame the inflation tiger in the next 6-9 months, we may see an excruciating bear market in equities that will test the skills (especially patience) of investors and traders.

There is an old Chinese curse which says, “May he live in interesting times”. Like everyone else I also do not wish to live in interesting times. But then the world does not function as per my wishes. I must therefore prepare better for the adversities and the opportunities that will follow.

I firmly believe that faith is a better decision making tool than logic. Faith lets you unconditionally accept or reject things. It makes it easier to believe or doubt the things you are thinking about - making the decision making easier and faster. Logic, on the other hand, agitates the minds as it questions the beliefs and raises doubts. It often leads to protraction (and often prevention) of the decision making. It is of course subjective opinion and could be challenged by logical thinkers. Regardless, my experience in life is that whether the decisions are right or wrong is only known in hindsight. There is little empirical evidence available to me, to prove beyond doubt that the impulsive decisions are less or more effective than the decisions taken after applying deep logical thinking. So, I usually take the easier route to the decision making that saves me from thinking and

The context for mentioning this is a little complex. It is widely expected and accepted that the Federal Reserve of the US will soon embark on the path to accelerated rate hikes. For the record, the Fed policy rate remained at 0 to 0.25% from 2009 to 2016. It was gradually hiked to 2.5% between 2016 and 2019 and then sharply cut back to near zero during 2019-20. The analysts are scrambling to adjust their valuation models to accommodate a 2% to 2.25% hike in Fed policy rates in the next 12-15 months. The portfolio managers and investors are also struggling to reorient their investment strategy to be in sync with the new monetary policy regime.

As per the latest survey of global fund managers done by the investment strategy team of Bank of America Securities, a majority of the fund managers believe that central bank tightening remains the top risk for the global markets in 2022. Also, the “underweight on tech sector” is highest since 2006, even though the “long technology” is the most overcrowded trade. The fund managers are underweight assets that are vulnerable to interest rate hikes such as emerging markets, tech and bonds.

Fund managers also believe that inflation and asset bubbles are the other two top risks for markets in 2022.

I believe that analysts and fund managers are experts in the field of finance and usually have a strong understanding of economics, especially the impact of monetary & fiscal policies on businesses. They must therefore have strong reasons for their strategy and positioning, supported by logical reasoning and analysis. They must be using complex and elaborate algorithms and analysis tools for decision making, especially since their decisions involve the investors’ money held in trust by them.

However, from where I stand, they appear to be suffering from indecision, lack of conviction and agitated thought process.

With the benefit of hindsight we know that the previous two Fed rate hikes have not been immediately negative for emerging markets. For example, during 2004-2008 Fed rate hikes (1% to over 5%) Sensex gained more than 200% (from 6000 to 20000). During 2016-2019 Fed hikes (from 0% to 2.5%) Sensex gained over 75% (from 24000 to 42000). Even the US equities had also gained materially during those periods. The market corrections happen much later and not necessarily due to rate hikes. Global market freeze post Lehman and lockdown due to Covid actually caused market corrections.

In particular, I would like to highlight the “bearish tech” stance due to Fed rate hikes.

I have strong faith in the digital transition of global trade and commerce. The significant rise in the digital intervention in common men’s life is inevitable. Technological evolution shall continue to impact every aspect of life and business for many years to come. The share of technology in all aspects of life – education, health, entertainment, relationships, trade, manufacturing, services, construction, management etc., shall continue to rise for the next many years. I therefore believe that technology is a good business to invest in for the next one decade at least.

I also believe it is highly inappropriate to classify online retailers and fintech companies, which are large consumers of IT services as technology companies. By this logic, Infosys must be classified as a real estate sector company and Indian Railways as a steel sector company.

I find that most of the global technology companies have net cash surplus on their balance sheets. Higher interest rates would normally mean higher treasury for these companies and higher dividends for shareholders.

Moreover, higher cost of capital should normally encourage most businesses to invest more in technology to enhance productivity; implying higher business growth for IT services companies.

An investor which paints Infosys with the same brush & color as IT services consumers PayTM & Zomato; or highly indebted mobile phone manufacturers, because his algorithm classifies all these companies under technology sector may end up making incorrect decisions. But, someone who has faith in the prospects of technology services may not face any dilemma in decision making.