Vijay Kumar Gaba

 Last year, while discussing this subject, I mentioned, “it is a debate that will continue for many more years and no one will remain unaffected by it. Almost everyone who transacts in money or is part of the global economic system will need to deal with it at some point in time.”

I note that the debate is intensifying, widening, and deepening. Moreover, it is becoming more balanced with many conventional money managers, regulators, bankers, and administrators coming in support of digital currencies as an alternative to fiat currencies.

A few days ago, Larry Fink, the Chief Executive Officer of BlackRock, one of the most influential financial firms globally, commented in a TV interview that under the current circumstances “Crypto will play a role as flight to quality”. He was reported to have said, “Bitcoin is a hedge against the devaluation of your currency”. This comment is in total contrast to his comments in 2017 when he had emphatically condemned the idea of cryptocurrencies, saying “Crypto is an index of money laundering”.

Last month, a leading German Bank (Bank) reportedly entered into a partnership with Swiss trading firm Taurus to offer custody services for institutional clients' cryptocurrencies and tokenized assets. In 2018, Deutsche Bank's chief investment strategist Ulrich Stephan criticized crypto for being "too volatile and not regulated enough." Standard Chartered (A leading British Bank) also made a bold forecast predicting that “Bitcoin prices will climb to $100,000 by the end of 2024.”

Earlier this summer, Hong Kong’s Securities and Future Commission proposed guidelines to enable Chinese users to invest in Bitcoin and some other large-cap cryptocurrencies on registered platforms. This is in total contrast to the stance of the mainland Chinese authorities.

In the meantime, several smaller African and Latin American countries, like the Central African Republic, Uganda, Zimbabwe, El Salvadore, Paraguay, Venezuela, etc. have continued to adopt cryptocurrencies in their monetary system, some even declaring bitcoin as legal tender. Last year, even Ukraine created a ministry of digital transformation with an aim to become one of the foremost authorities on crypto. (see here)  Cryptocurrencies are now legal in many countries/regions like the EU, US, Mexico, Brazil, Israel, etc.

There are speculations that the ardent crypto hater Warren Buffet may also be having a slight change of heart in recent months. In an apparent change of traditional policy, Berkshire Hathway has invested as much as US$600 in two fintech firms - PayTM of India and StoneCo of Brazil. This has led to market speculation that the firm may change its long-held stance on digital assets including crypto.

India’s regulatory thought process on crypto has also travelled a long way in the past five years. The Reserve Bank of India started with a blanket ban on the sale or purchase of cryptocurrency for entities regulated by RBI (all scheduled commercial banks and NBFCs) in 2018. The RBI governor “equated crypto trading with gambling”. The ban was declared untenable by the Supreme Court. Presently, the legal position on dealings in crypto in India is ambiguous. It is neither explicitly unlawful nor a regulated asset. However, last week RBI governor reiterated his stance on the cryptocurrency ban, saying there has been no change in the central bank’s position.

No surprise that Bitcoin has weathered all the pessimism and sharply outperformed gold and equities in the past five years. Since October 2018, Bitcoin has gained over 400%, as compared to ~63% for gold (in USD terms) and ~47% for S&P500.

य: सर्वत्रानभिस्नेहस्तत्तत्प्राप्य शुभाशुभम्, नाभिनन्दति न द्वेष्टि तस्य प्रज्ञा प्रतिष्ठिता

One who remains unattached under all conditions, and is neither delighted by good fortune nor dejected by tribulation, he is a sage with perfect knowledge.

—Srimad Bhagawad Gita, Verse 57, Chapter 2

In the calendar year 2022, a multitude of battles were fought. These battles materially impacted the global markets and investors. Some of the important battles were —

(i)    Russia-Ukraine conflict that polarized the global strategic powers, threatening to unwind the post USSR globalization of trade and commerce;

(ii)   Central banks’ battle against the multi decade high inflation, that resulted from the colossal monetary easing and fiscal incentives to mitigate impact of the Covid pandemic, while keeping the economy from slipping into recession;

(iii)  China’s battle against Coronavirus, that kept significant part of the country under strict mobility restrictions;

(iv)   Businesses’ battle against logistic challenges, supply chain disruptions, and input cost inflation;

(v)    Global communities’ battle against the Mother Nature, as inclement weather conditions (drought and floods) impacted the life in almost all the continents;

(vi)   Governments’ battle against private currencies (crypto) threatening to replace the fiat currencies as preferred medium of exchange; and

(vii)  Investors’ battle with markets to protect their wealth.

It is likely that most of these battles will continue in the 2023^rd year of Christ as well. The outcome of these battles will eventually determine the direction of the global economy and markets in the next many years.

However, standing at the threshold of 2023, it appears less likely that we shall see any sustainable resolution to these conflicts in the next twelve months; though it cannot be completely ruled out. There would of course be some periods of ceasefire creating an impression that a conflict has been resolved, or is close to resolution. These impressions may drive the markets higher and make investors buoyant.

Nonetheless, a sustainable positive outcome from some of these conflicts will definitely be positive for the global economy and markets. It is therefore extremely important for the investors to maintain a equanimous stance. They should neither get swayed by the buoyancy created by temporary ceasefires in these battles, nor get panicked by the intermittent aggravation of these conflicts; while staying fully alert for a significant directional move in the market. They should at least avoid committing to a “bullish” or “bearish” stance early in the year.

I would like to quote two views, of reputable experts, to emphasize the despondency that is defining the global narrative presently:

Noriel Roubini

“Of course, debt can boost economic activity if borrowers invest in new capital (machinery, homes, public infrastructure) that yields returns higher than the cost of borrowing. But much borrowing goes simply to finance consumption spending above one’s income on a persistent basis – and that is a recipe for bankruptcy. Moreover, investments in “capital” can also be risky, whether the borrower is a household buying a home at an artificially inflated price, a corporation seeking to expand too quickly regardless of returns, or a government that is spending the money on “white elephants” (extravagant but useless infrastructure projects)….

…the global economy is being battered by persistent short- and medium-term negative supply shocks that are reducing growth and increasing prices and production costs. These include the pandemic’s disruptions to the supply of labor and goods; the impact of Russia’s war in Ukraine on commodity prices; China’s increasingly disastrous zero-COVID policy; and a dozen other medium-term shocks – from climate change to geopolitical developments – that will create additional stagflationary pressures.

Unlike in the 2008 financial crisis and the early months of COVID-19, simply bailing out private and public agents with loose macro policies would pour more gasoline on the inflationary fire. That means there will be a hard landing – a deep, protracted recession – on top of a severe financial crisis. As asset bubbles burst, debt-servicing ratios spike, and inflation-adjusted incomes fall across households, corporations, and governments, the economic crisis and the financial crash will feed on each other.”

(Read full article “The Unavoidable Crash” here)

Russell Napier

“This (inflation) is structural in nature, not cyclical. We are experiencing a fundamental shift in the inner workings of most Western economies. In the past four decades, we have become used to the idea that our economies are guided by free markets. But we are in the process of moving to a system where a large part of the allocation of resources is not left to markets anymore. Mind you, I’m not talking about a command economy or about Marxism, but about an economy where the government plays a significant role in the allocation of capital. The French would call this system «dirigiste». This is nothing new, as it was the system that prevailed from 1939 to 1979. We have just forgotten how it works, because most economists are trained in free market economics, not in history….

…the power to control the creation of money has moved from central banks to governments. By issuing state guarantees on bank credit during the Covid crisis, governments have effectively taken over the levers to control the creation of money…

…Out of all the new loans in Germany, 40% are guaranteed by the government. In France, it’s 70% of all new loans, and in Italy it’s over 100%, because they migrate old maturing credit to new, government-guaranteed schemes…. For the government, credit guarantees are like the magic money tree: the closest thing to free money. They don’t have to issue more government debt, they don’t need to raise taxes, they just issue credit guarantees to the commercial banks…

…Engineering a higher nominal GDP growth through a higher structural level of inflation is a proven way to get rid of high levels of debt. That’s exactly how many countries, including the US and the UK, got rid of their debt after World War II….

…We today have a disconnect between the hawkish rhetorics of central banks and the actions of governments. Monetary policy is trying to hit the brakes hard, while fiscal policy tries to mitigate the effects of rising prices through vast payouts.

(Read full interview here)

Outlook for 2023

Global macro environment: The present challenges in the macro environment may persist for the better part of 2023. The present monetary tightening cycle may pause in 1H2023, but persistent inflation may delay any easing to 2024. Higher rates may begin to reflect on the economic growth, as softening in employment, consumer demand, housing and other data accelerate. As things stand today, the central bankers shall be able to engineer a soft landing; however a material worsening of the geopolitical situation or an elongated La Nina condition may cause a faster deceleration in the economy. A stronger recovery in China and ceasefire in Ukraine with easing of NATO-Russia tension could be a positive surprise for the global economy.

Global markets: The current trend in the global equity markets may continue in 2023 also. The developed market equities and industrial commodities may remain under pressure and witness heightened volatility; the commodity dominated emerging markets may be highly volatile with a downward bias as commodity prices ease due to demand destruction; services and manufacturing led emerging markets may outperform. Metal and energy prices may continue to ease. Slower global growth may cause a strong rally in bonds and gold prices may end lower.

Indian macro environment: The momentum created by the post pandemic recovery is slowing down. The Indian economy is likely to grow less than 6% in 2023. A sharper global slowdown may actually bring real GDP growth closer to 5% in 2023. Though domestic food prices are expected to ease; a weaker USDINR might keep imported inflation, especially energy, higher. The current account may remain under pressure as export demand remains sluggish. Fiscal pressures may increase and it is less likely that the government is able to meet the FRBM targets for FY24. Worsening of Balance of Payment could pose a major risk, though at this point in time the probability of this appears low.

Indian markets: The benchmark Nifty may move in a larger range of 16500-20100. The risk reward at the present juncture is therefore fairly balanced. The Treasury bond yields may stay close to present level but the AAA-GSec spreads may widen as corporate borrowing costs rise. USDINR may weaken to the 83-85 range. 

Equities – A year of consolidation

The Indian equities consolidated the gains made during 2021 and are ending the year 2022 with marginal gains; unlike other major global markets which gave up most of the gains made during the year 2021. Considering the global economic, geopolitical and financial conditions this is a remarkable performance.

• The benchmark Nifty50 and Nifty Midcap 100 are ending the year with ~5% gain; though Nifty Small 100 has lost 2022YTD 11%. The market breadth has been marginally negative; and volumes below average.
• Nifty has now given positive returns in 9 out of the previous 10 years; with 2022 being the seventh consecutive year of positive return.
• Nifty averaged 17240 YTD2022, 8% higher than the average of previous year. This implies much better returns for the SIP investors.
• For long term buy and hold investors, five year rolling CAGR in 2022 is ~11.6%, which is close to 2016-2022 average. Five year absolute Nifty return in 2022 is ~73%, also close to 2016-2022 average.
• July 2022 was the best month of the year for markets. In July Nifty gained 8.7%; the aggregate return for the rest of 11 months is -3.7%.
• Smallcap stocks underperformed the benchmark Nifty for YTD2022; however on a 3yr basis, midcap and smallcap are still outperforming the benchmark materially. The newly introduced category of Multicap funds is the best performer YTD2022; while on 3, 5 and 10 yr basis smallcap funds are outperforming.
• Foreign investors have been net sellers in the Indian equities (secondary market) to the tune of Rs 1.46trn; while the domestic institutions were net buyers of Rs2.63trn; resulting in a net positive institutional flow of Rs1.17trn during YTD2022. Contrary to popular perception, the Nifty movement led the institutional flows and vice versa was not true.
• Sector wise, PSU banks (+71%) were clear leaders, outperforming all other sectors by large margin. Consumers, Auto, Energy and Metals were other notable outperformers. IT Services, Pharma and Realty have been notable underperformers YTD2022.
• Nifty Bank (+22%) has been a clear leader.
• Presently, technically Nifty is placed in neutral territory, close to 50 EDMA with RSI close to comfortable 44 and short term momentum indicators in buy zone.

Debt and Currency – USDINR weakens, yield curve higher and flatter

• USDINR (-6.1%) weakened YTD2022; while EURINR (+2.6%); JPYINR (+9.6%) were stronger.
• The Indian yield curve shifted sharply higher; though Indian bonds performed much better than their developed economy peers. RBI hiked the policy repo rate by 225bps during the year. However, the most notable feature of the Indian debt market was withdrawal of excess liquidity and consequent sharp rise in overnight and short term rates.

 The year 2022 is proving to be a bad year for the global investors. The investors’ wealth erosion in the US financial markets, in the past one year, matches the losses suffered during the global financial crisis in 2008-09.

 

If we consider the top 10 global stock markets, in terms of market capitalization, eight of these markets have yielded negative returns this year (in local currency), whereas the rest two are unchanged. Given the USD strength against most currencies this year, the returns would be much worse for the global investors who participated in these markets by investing US dollars.

 

Hang Seng, the benchmark index of the Hong Kong stock market that is mostly used by the global investors to invest in Chinese companies through ‘A’ shares of these companies, has seen 33% draw down in the past one year. With this draw down the 10yr return of Hang Seng is negative 25%.

NASDAQ Composite, the benchmark index for technology stocks listed in the US, is the second largest stock market in the world with a market capitalization exceeding US$22trilions. This Index has lost over one third of its value in the past one year. European (Euronext) and Japanese (Tokyo Stock Exchange) equities have also seen a value erosion of over 10% in the past one year.

Besides stocks and bonds, other asset classes like Bitcoin (-70%); Gold (-13%) and US residential real estate (-13%) are also down materially. Even the cash positions are effectively down by 3 to 5%, given the negative rates on saving deposits.

This is however plain statistics. This may be interpreted in a variety of ways by various persons; depending upon which vista point the interpreter is viewing these data points and what colour eyeglasses they are wearing. For example—

(a)   US$100 invested by an investor in US Tech 10yrs ago is still worth US$250, despite it diminishing by one third in the past one year. But, a large number of investors who started investing (or increased their exposure significantly) during the pandemic may be sitting on material losses.

(b)   An investor in US equities who was leveraged 3x in the past one year may have lost his entire capital, regardless of when he started investing or what he earned in the past. The losses would have been worse if the investor was leveraged in US treasuries. Whereas, an investor following a strict asset allocation strategy with no leverage, may not be doing as bad, though he might have also witnessed a drawdown of ~20% in the past one year.

(c)    A handful of highly skilled traders and hedge funds might have made very good profits by taking short positions on various assets, though a large majority of investors and traders have suffered losses.

(d)   A foreign investor, e.g., Japanese or Indian, parking his money in USD deposit may have outperformed a large majority of investors; whereas a US investor investing in Asian securities might have fared much worse.

(e)    Many investors are terming this sharp fall in value across asset classes as a once in a decade opportunity; citing that historically this kind of fall has invariably been followed by sharp rallies. Whereas, there is no dearth of experts who believe that we are not even half way through the corrective phase; and asset prices will fall much more to adjust for the reversal in QE programs unleashed by the central bankers and fiscal profligacies of the governments.

The Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed) has decided to hike the target for the benchmark federal funds rate to a range of 3.75% to 4%, its highest level since 2008. It is an unprecedented fourth hike of 75bps each at the consecutive meetings. The Committee indicated that “ongoing increases” would still likely be needed before the rates become “sufficiently restrictive” to slow down the inflation.

In a post meeting press statement, the Fed Chairman Jerome Powell said, “incoming data since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected.” He added that it was “very premature” to discuss when the Fed might pause its increases.

Further hikes could be lower than 75bps

The FOMC statement promised to take economic risks more clearly into account in deciding the size of any further rate increases. The FOMC statement read, “in determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments."

The statement is being widely interpreted to mean that the future hikes, from the FOMC’s December 2022 meeting onwards, could be lower than 50bps. Though no dot plot (a traditional indicator of Fed official’s view on future rate hikes) was released after the meeting.

No recession, but less chance of a soft landing

Chairman Powell expressed hope that the U.S. economy can escape a recession as the Federal Reserve raises interest rates to lower inflation. He was however skeptical about the soft landing of the economy. He said that given the persistence of price pressure this year, the window of opportunity for a "soft landing" has narrowed; though he is still hopeful of a soft landing.

"Has it narrowed? Yes," Powell said at a press conference after the Fed's latest rate hike. "Is it still possible? Yes."

It is pertinent to note that signs are emerging in the US economy that a hard landing is now probable. The latest PMI came at 45. The stress in households is becoming more evident as personal savings are collapsing; credit card debt is rising at a much faster rate; over a third of the small businesses are unable to pay rent on time. The larger engine of the US economy, the consumer, has already started to stutter.

Markets disappointed

Stock markets corrected sharply after the Fed’s decision, with benchmark S&P500 shedding 2.5% and Nasdaq Composite diving 3.6%. Volumes were large as the market dived post Powell’s press statement, indicating heavy unwinding of positions.

US Dollar Index (DXY) ended more than half of a percentage point higher to close above 112.

Gold and Bitcoin were lower.

The Benchmark 10yr treasury yields were higher by 87bps at 4.10%.

The Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed) is scheduled to announce its latest assessment of the economy and its policy stance tomorrow. A large number of market participants are waiting to hear the Fed chairman, with bated breath. I expect a large number of traders in India to stay awake till midnight to hear Mr. Powell, even though they cannot initiate any trade until 9:15AM on Thursday, when the Indian markets open for trading. Therefore, literally speaking, losing sleep to hear the Fed statement is of little consequence.

The market consensus is for a 75bps hike in the policy bank rate and an unambiguous hawkish stance unlike the previous statement in July, when the Fed sounded little ambivalent about the future hikes. Some experts are expecting even a steeper 100bps hike and raise in the terminal bank rate target to 4.5% (from previously estimated 3.75-4%) by April 2023. This implies a total of 200bps expected hike between September 2022 and April 2023; the steepest hike in the past two decades.

Since March 2022, when the Fed started to hike rates to bring down the inflation, an interesting contest has been seen between markets and the Fed.

1.    The benchmark S&P500 has moved higher after hearing the Fed on 3 of the 4 occasions. Obviously, the messaging of the Fed to the market was lacking in clarity and intent.

 

2.    One of the reasons for defiance of stock prices despite sharp rate hikes is that the Fed has not been able to materially influence the long term yields so far. The US yield curve has inverted sharply in the past six months, indicating that the markets are assuming a sharper recession and a quick reversal in the rate hike cycle (as early as 2H2023).

3.    The commodity prices have not yet corrected in line with the stance of central bankers and forecasts of severe recession. Bloomberg Commodity Index is still higher than the level it was at the beginning of the rate hikes in March 2022; and so has been the inflation. Consequently, the US rates have become sharply negative severely hurting the savers.

 

Obviously, more than the action, the Fed perhaps needs to tighten its messaging to the markets. For example, a clear message that the inflation is not seen coming below the Fed’s upper tolerance band at least till the end of 2023 and it would not be prudent to expect a rate cut before 2Q2024, could make the market reactions more congruent to the Fed’s policy stance.

 Hikes another 75bps

The Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed) hiked the federal fund rate by 75bps yesterday to the range of 2.25% - 2.50%. This is the second 75bps hike in two months. In the post meeting press interaction the Fed chairman Jerome Powell outrightly rejected the speculations that the US economy is in recession. The FOMC members are of the opinion that the strong labor market allows the US economy to tolerate rapid monetary tightening.

For the first time since February 2020, the FOMC statement did not mention Covid or coronavirus.

…leaves the door open for further data dependent hikes

Reiterating the commitment to achieve the 2% inflation target, Powell also indicated that while another unusually large increase could be appropriate at our next meeting, the FOMC would set policy on a meeting-by-meeting basis rather than offer explicit guidance on the size of their next rate move, as he has done recently; thus, leaving the future course of the FOMC action wide open.

As per the Bloomberg estimates, the market consensus is now gathering around two more 50bps hikes in September and December FOMC meetings, with the fed fund rate peeking around 3.4%, lower than the previously estimated 3.8%.

The US economy is estimated to have grown at a tepid 0.4% (QoQ, annualized) rate in 2Q2022 after recording a negative growth in 1Q2022, technically avoiding a recession. The US officially acknowledges a recession if the economy logs a negative growth for two consecutive quarters.

Markets react positively to FOMC – stock rally, yields and USD tumble

The markets took comfort from the growth outlook and Powell’s statement on future rates being data dependent. The market participants appear to have concluded that the FOMC may reach the end of the tightening cycle by the end of 2022, triggering a “risk on” rally in the markets.

·         Battered tech stocks surged strongly with the benchmark Nasdaq rising 4.06%, the largest one day gain since November 2020. The broader index S&P500 gained 2.62%.

·         US Dollar Index lost 0.66%.

·         2yr SU Treasury yields fell 10bps; while 10yr benchmark yields were down 5bps at 2.78%.

…but deeper yield curve inversion signals recession as consensus

The US yield curve is now inverted the most in two decades, highlighting that the markets strongly believe a recession is around the corner. The 2yr yields are now over 30bps lower than the benchmark 10yr yields – clearly indicating that the market sees higher risk of recession than the Fed. The deeper yield curve inversion is seen to imply that Fed may actually return to the path of easing as early as 2023.

Click here to see a nice compilation of analysts’ reactions to the FOMC statement.

 Markets in 1H2022 – As tough as it could be

The first half of the current calendar 2022 was perhaps one of the toughest six month periods for the global markets. In fact, for global equities, the 20% fall in MSCI All Countries index 1H2022 during 1H2022 is the worst ever on record.

The global government bonds are also having the worst year in 150years, as the global central bankers reversed the course of monetary policy. Indian benchmark yields have risen 14.5% during 1H2022.

Energy and Food prices have risen in this period, largely due to war between Russia and Ukraine; but other commodities like industrial metals, steel, and precious metals have mostly shown a downward trend. Gold (-1.3%) is trading marginally lower while silver (-15.6%) has lost in line with industrial metals.

The new age assets like cryptocurrencies have also been decimated in the global melee. The bellwether bitcoin lost over 58% of its value during 1H2022.

USD has gained close to 10% during 1H2022, while JPY and GBP have been significant losers. INR has been a relative outperformer.

 Equity Markets in India

Indian equity markets had their share of pain during 1H2022. Though the benchmark Nifty50 fell ~9.5%, outperforming many major global markets, the pain felt by the investors was significantly deeper.

The market breadth was extremely poor. Only 35 stocks registered gains for every 100 shares declining. The smallcap Index was down ~25%. Besides, the sectors where most exuberance was seen in the past couple of years, namely, IT Services (-28%), Realty (-19%) and Metals (-16%) underperformed the benchmark index materially.

The net institutional flow to the secondary market was marginally positive, though the foreign institutional investors were major sellers (Rs2.25trn).

Anecdotally, non-institutional and household investors usually have largest exposure to the sectors that are showing highest momentum; and hence may have lost much more value than the benchmark Nifty may be indicating.

The market activity has diminished materially in 2Q202, further indicating that the non-institutional and household investors that played a major role in the secondary market in the past couple of years, might have withdrawn to the fringes.

Nifty yielded positive return in 9 out of past 10years

Notwithstanding the global problems (Grexit, Brexit, Taper Tantrum, Covid-19) or local issues (Demonetization, GST, drought, slowing growth, Covid-19), Nifty50 has yielded positive return in 9 out of 10 years (2012-2021). The negative return in 2022 (if at all) must be seen in the light of strong performance in 2020-2021.

First episode of major FPI selling in Indian equities

The foreign institutional investors were major sellers in the market. As per the final figures released by the SEBI, the Foreign Portfolio Investors (FPIs) sold INR2.25trn worth of Indian equities in the secondary market during 1H2022. The selling particularly accelerated in 2Q2022, as the war between Russia and Ukraine intensified and Fed committed to larger rate hikes. In Asia, as per the Strait Times, the foreign investors sold USD40bn worth of equity in 7 Asian markets; of which India accounted for ~USD14.5b.

In the past, FPIs have been net sellers in three out of the past 20years. In the past 10years, they were net sellers only in 2015 and 2021. However, in no case the selling was major in relation to the total market or the total FPI holding.

Nonetheless, the net institutional flows in Indian markets remained positive for 1H2022, as the domestic institutions pumped INR2.32trn into the market. There has been no instance of net negative institutional flow in the Indian markets so far.

Global markets

The global markets are arguably witnessing the worst meltdown since the global financial crisis. The pain is visible across asset classes like equities, precious metals, bonds, cryptocurrencies and industrial metals. Only energy and agri commodities have yielded positive returns.

The developed market equities led by USA and EU have been the worst performers, followed by emerging markets and Japan. Volatility has spiked sharply.

Reversal of monetary policy direction has resulted in sharp decline in bond prices, leading the yields higher. USD has accordingly strengthened.

Though inflation has been one of the top concerns, the traditional hedges like Gold and Swiss Franc have not been in demand, as has been the case historically. The decoupling of traditional hedges from inflation trajectory has substantially complicated the trading strategies. Obviously, the jitteriness and bewilderment is materially accentuated as compared to the previous episodes of global market corrections due to macroeconomic factors.

 No need to lose sleep over NASDAQ

When the independently priced cryptocurrencies were melting in the past few months, a stablecoin Tether (USDT) has been relatively much more stable. The value of USDT did show some volatility, but it was marginal in comparison to some other stablecoins like Terra and independently priced cryptocurrencies.

Being a technology challenged crypto illiterate person, I must outline my understanding of a stablecoin to make the context clear. In my understanding, a stablecoin is a crypto token which is backed by some financial or real asset, whose value is pegged to a fiat currency like USD. In simple terms, it is a tradable electronic entry priced in a fiat currency (like ADR of an Indian company tradable in US) which has an underlying asset like bonds. Theoretically, the price of a stablecoin shall move in tandem with price of the underlying; but in practice the movement in price could be less or more than the underlying.

Curious by the relative stability of USDT, I discussed the issue with some experts and crypto traders. While no one offered any satisfactory answer, the common thread was a conspiracy theory. It is commonly believed that a significant part of trade by “sanctioned jurisdictions” like Russia, Iran etc., is happening in stablecoins, USDT being the most popular one. Secondly, it is suspected that USDT is also a preferred currency for money laundering in many emerging economies.

Of course, I do not understand much of this, so I cannot make any intelligent remarks on this. Nonetheless, I must say that (i) tech enabled alternatives to gold are here to stay for long; (ii) the challenges to USD as the exclusive global reserve currency are rising gradually; and (iii) the global economy (and markets) might delink from US economy (and markets) sooner than previously estimated.

The experts have extensively talked about Japanification of the US economy (and markets) since the global financial crisis (GFC) hit the world in 2008 and the US Federal Reserve unleashed a torrent of quantitative easing (dollar printing). With massive monetary and fiscal corrections now becoming increasingly inevitable, in view of the rapidly changing (a) global trade dynamics and (b) global geopolitical balance; the probability of experts’ prognosis about the US economy coming true is rising gradually.

In my view, the forecast for the global economy and markets for next few years must account for these probabilities; howsoever small these probabilities may appear for now.

I would therefore not like to undermine the movement in NASDAQ and S&P500 to form my view on Indian markets and/or deciding my allocation to say IT services sector, for next few years. I would also like to read the predictions about a “lost decade for equities”, in relation to developed markets, especially US, without correlating it to India. I am also aware of the fact that equities in two major global economies China (15yrs) and UK (5yr) are already witnessing this phenomenon of lost decade; and this has not impacted the performance of other European and Asian markets materially.

In simple words, I do not see much merit in drawing correlations between GOLD-S&P500; Nifty-S&P500; and NIFTY IT-NASDAQ. The Beta of Nifty vis à vis S&P500 and NASDAQ shall reduce incrementally. There is no need to stay awake till late night to watch US markets.

The September 2020 Global Fund Managers' survey conducted by the Bank of America research team found that 58% of the global fund managers believe that global equities are now in a bull market. This percentage is materially higher than the 46% in August 2020. The proportion of fund manager who believe it to be a bear market rally has reduced in September 2020 to 29% from 35% in August 2020.

An overwhelming proportion of fund managers believe that "Long US Tech Stocks" is the most crowded trade. Though, the fund managers believing gold to be a crowded trade has reduced materially in September, as compared to August. "Short USD" trade is also seen gaining some popularity .

Continuing with the theme, JP Morgan Research (as quoted by Niels Jensen of Absolute Partners), finds that S&P500 is now pricing in almost 0% probability of a recession in US; while 5yr US Treasuries are pricing in almost 100% probability of a recession.

In his latest communication to investors, Niels warns that investors (and fund managers) may be flirting dangerously with TINA (There is No Alternative) in their chase for equities, especially US Tech Stocks. As per Niels, One of the most reliable predictors of long-term equity returns is the starting earnings multiple. When earnings multiples are in the low 20s, the best you can hope for over the next ten years is low single digit annual returns. As you can see, 10-year returns turn negative when the starting multiple is about 25 or higher.

Niels highlights that, as per Shiller's Cyclically Adjusted  P/E Ratio (CAPE), S&P500 trades at massive 32x earnings multiple, which means apocalypse may just around the corner and the investors must be running to the hills.

In a later post, I would like to evaluate where India stands in all this.