Do it yourself

In the US, banking panic started at regional level in 1930, with many smaller regional banks faced crisis. However, as Great Britain decided to leave the gold standard for GBP on 21 September 1931, the panic spread throughout the country. Foreigners became concerned that the US may also follow Great Britain and end gold convertibility of USD. There was a rush to convert USD into gold. The collateral was that depositors became concerned about the safety of their money and started withdrawing currency from their accounts. A global rush to convert USD into gold and an internal rush to withdraw currency from banks drained out the banking system reserves and choked the money supply – exacerbating the deflation and propagating the great depression. There was a spate of bank failures in the US during 1931-1933.

The Federal Reserve Bank of New York responded to the situation by hiking rates in October 1931, to encourage investors to deposit money in the US banks or buy US bonds. There was an immediate relief, but that did not last long. The Fed started buying bonds from the market in 1932 and hiked the rates again in February 1933. It did not help much in restoring the confidence of investors in USD. In March 1933, the Federal Reserve Board suspended the gold standard for USD; President Roosevelt announced a national bank holiday and suspended all outbound gold shipments. The provisions that allowed the holders of specific treasury bonds to convert their bonds into gold were also revoked (many commentators have implied this action to be a sovereign default by the US).

1931 was the first year in recorded history of the US when both US Treasury Bonds and US Stocks yielded negative returns in the same year. The following two years marked a watershed in the history of the US financial system.

Bretton Wood agreement of 1944, established USD as the reserve currency of the world. The agreement, inter alia, provided that all the participating nations would allow free conversion of their own currencies into USD at all times; and the US will allow conversion of USD into gold at a fixed exchange rate of USD35 per troy ounce of gold. At that time the US manufactured over half of the total global production, as most of Europe and Japan lay shattered due to WWII. Obviously no one objected to the reserve currency status of the USD.

In the next 25yrs, Germany and Japan made substantial progress. The US share in global GDP fell from 35% to 27% during 1950-1969. The US participation in the Vietnam war (1964-1970) took a significant toll on the US economy. Besides, other political efforts like “Great Society” etc., also weakened the US economy. The “reserve USD” became highly overvalued, impacting US exports and causing a sharp rise in trade deficit. The US was forced to print more USD to keep its obligation under the Bretton Wood agreement. This led to a sharp decline in the gold coverage ratio of the USD. The inflation also shot up sharply.

To stem the run on US banks, the Fed had increased its key policy rate to 9.75% by October 1969.

1969 was the second time in recorded history of the US when both US Treasury Bonds and US Stocks yielded negative returns in the same year. Two years later, in August 1971, president Nixon unilaterally abandoned USD peg to gold, hence rescinding the 27yr old Bretton Wood agreement. For other participants in the agreement, it was a virtual default on the part of the US. However, the advent of “petro dollar” a few years later sustained the reserve currency status of USD.

Presently, the USD is arguably highly overvalued. The Fed is hiking rates and reducing money supply. Inflation is high. The economy is on the verge of recession. Trade deficit is rising. Fiscal deficit is at an unsustainable level. The US share in the global economy is shrinking. Large trade partners of the US, like China, OPEC, Japan, etc. are exploring non-USD trade with other trade partners. The US is incurring huge costs in the Ukraine war. And 2022 is the third time in history when both US treasury bonds and stocks have yielded a negative return in the same year.

If history rhymes, we could see some material developments in the US and, perhaps the global, financial system. A sharp USD devaluation, replacement (or supplement) of USD with a new digital currency, end of petrodollar regime (and hence reserve status of USD) are some of the wild guesses I could make.

 The Government of India has rolled out an integrated food security scheme effective from 1 January 2023. The new scheme shall remain effective till 31 December 2023. The scheme is estimated to cost the central government rupees two trillion. Under the scheme, the government would provide 5kg food grains per person to Priority Households (PHH) beneficiaries and 35 kg per household to Antyodaya Anna Yojana (AAY) beneficiaries, free of cost.

The scheme has apparently subsumed two extant food subsidy schemes of the central government, viz.,

(a)   Food Subsidy to Food Corporation of India (FCI) for discharge of obligations under The National Food Security Act, 2013 (NFSA). Under this scheme Under the scheme, 5 kg food grains per person is provided to Priority Households (PHH) beneficiaries and 35 kg per household to Antyodaya Anna Yojana (AAY) beneficiaries at a subsidized rate of Rs 3 per kg for rice, Rs 2 per kg for wheat, and Rs 1 per kg for coarse grain.

(b)   Food subsidy for decentralized procurement states, dealing with procurement, allocation and delivery of food grains to the states under NFSA, popularly known as the Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY) started for 9 months in April 2020 to mitigate the effect of Covid pandemic on poor and extended twice thereafter. Under this scheme beneficiaries registered under the NFSA were provided an additional 5 kg of foodgrain per month for free.

This implies that by implementing the new integrated food security scheme:

(i)    The central government would save about Rs1.5 trillion on food subsidies in the calendar year 2023.

(ii)   The beneficiaries registered under NFSA would get free ration for one year; though the quantity of ration available will be less.

(iii)  The state governments who were claiming credit for free ration actually funded by the central government will not be able to do so.

The new scheme is thus a fiscally prudent and politically smart move by the central government. It has however evoked a variety of criticism. For example, the political opponents are criticizing the government that the very fact that over 81 crore still need subsidized or free food indicates the failure of the government's economic policies. The economic and financial market experts have criticized the government for failing in controlling subsidies. Their criticism is that the government is increasing subsidies which it will find politically inexpedient to unwind; and hence burden the future governments.

In my view, the criticism may not be fair, or, inter alia, the following reasons.

·         The National Food Security Act was enacted in 2013 by the UPA government, in recognition of the fact that the fundamental right to life enshrined in Article 21 of the Constitution includes the right to live dignity that essentially includes the right to food and other basic necessities. This in fact is a globally accepted good practice for welfare states.

·         The fact that 75% of the rural population and 50% of the urban population is entitled under NFSA to subsidized food does not necessarily imply that as many households cannot afford to buy food for their sustenance. This could just be a mechanism to compensate for poor minimum wage structure; faulty agriculture pricing mechanism; disproportionate indirect tax structure; and inadequate social infrastructure, especially health and education. Besides, this should be seen as a direct and effective wealth redistribution mechanism.

·         Number of people availing subsidized food cannot be a good measure of poverty.

·         The incumbent government has shown resolve in managing subsidies by not increasing fuel subsidy, despite political pressures, increasing fertilizer prices and imposing GST on common food items. Despite being a challenging year, the government is most likely to meet its budgeted fiscal deficit targets. Consequently, the Indian bond markets have shown remarkable stability, defying turmoil in the global bond markets.

·         The restructuring of food subsidy schemes could be the first step in the direction of further rationalization of food subsidy from 2024 onwards.

Overall, in my view, NFSA, like MNREGA, is a transformative legislation. This ensures a dignified life for over 800 million people; and thus provides stability and resilience to the economy. The government’s commitment to obligations under NFSA must be commended, not criticized.

Blackrock Investment

Key message

The Great Moderation, the four-decade period of largely stable activity and inflation, is behind us. The new regime of greater macro and market volatility is playing out. A recession is foretold; central banks are on course to overtighten policy as they seek to tame inflation. This keeps us tactically underweight developed market (DM) equities. We expect to turn more positive on risk assets at some point in 2023 – but we are not there yet. And when we get there, we don’t see the sustained bull markets of the past. That’s why a new investment playbook is needed.

Themes

1.    Pricing how much of the economic damage is already reflected in market pricing. Equity valuations don’t yet reflect the damage ahead. We will turn positive on equities when we think the damage is priced or our view of market risk sentiment changes.

2.    Rethinking bonds. We like short term government bonds and mortgage securities. Long-term government bonds won’t play their traditional role as portfolio diversifiers due to persistent inflation.

3.    Living with inflation. We see long-term drivers of the new regime such as aging workforces keeping inflation above pre-pandemic levels. We stay overweight inflation-linked bonds on both a tactical and strategic horizon as a result.

Credit Suisse

Key message and themes

·         Economy: We expect the Eurozone and UK to have slipped into recession, while China is in a growth recession. These economies should bottom out by mid-2023 and begin a weak, tentative recovery – a scenario that rests on the crucial assumption that the USA manages to avoid a recession. Economic growth will generally remain low in 2023 against the backdrop of tight monetary conditions and the ongoing reset of geopolitics.

·         Inflation is peaking in most countries as a result of decisive monetary policy action, and should eventually decline in 2023.

·         Bonds: With inflation likely to normalize in 2023, fixed income assets should become more attractive to hold and offer renewed diversification benefits in portfolios.

·         Equities: Markets are likely to first focus on the “higher rates for longer” theme, which should lead to a muted equity performance. We expect sectors and regions with stable earnings, low leverage and pricing power to fare better in this environment. Once we get closer to a pivot by central banks away from tight monetary policy, we would rotate toward interest-rate-sensitive sectors with a growth tilt.

·         Currencies: The USD looks set to remain supported going into 2023 thanks to a hawkish US Federal Reserve and increased fears of a global recession. It should stabilize eventually and later weaken once US monetary policy becomes less aggressive and growth risks abroad stabilize.

·         Commodities: In early 2023, demand for cyclical commodities may be soft, while elevated pressure in energy markets should help speed up Europe’s energy transition. Pullbacks in carbon prices could offer opportunities in the medium term, and we think the backdrop for gold should improve as policy normalization nears its end.

·         Real Estate: We expect the environment for real estate to become more challenging in 2023, as the asset class faces headwinds from both higher interest rates and weaker economic growth.

Morgan Stanley

Key message

Less growth, inflation, and policy tightening mean the US dollar peaks and high grade bonds and EM outperform. US stocks, HY, and metals lag. It's a good year for 'income' investing.

As growth/inflation slow and central banks pause, assets more sensitive to rate uncertainty will bottom first. EM > DM, bonds > stocks. Volatility lower. DXY peaks.

Themes

·         Europe goes into recession, China waits until spring to end Covid-zero, and the US barely skirts recession as housing activity plummets. The silver lining is that this weakness is short and shallow; global growth bottoms around March/April, and improves thereafter.

·         Both valuations and the cycle support a barbell of high-quality 'income' (high grade bonds, US defensive equities) with 'value' (EM stocks and bonds, EU banks/energy, Japan equities, EM tech/semis).

·         We expect the Fed and ECB to make their final hikes in January and March 2023, respectively, with the Fed cutting by 4Q23. Meanwhile, several large EM central banks, which were well out in front of their DM counterparts, start to ease materially. By end-2023, we forecast that policy rates decline by 275bp in Brazil, 250bp in Hungary, and 475bp in Chile.

·         In Asia/EM, we prefer Korea and Taiwan (for semis and hardware), as well as Japan, Saudi Arabia, and Brazil, and look for quality growth and small/mid-caps to take leadership after some momentum reversal. Stay defensive in the US via healthcare, utilities, and staples.

Fidelity International

Key message

Financial stability joins inflation and recession as a third pillar of risk. Aggressive Fed policy to control high inflation risks a severe recession and/or global financial instability, but overly tentative policy could allow inflation expectations to embed.

We maintain our base case for recession in 2023, first in Europe, then the US. Severity will be influenced by Fed policy, gas flows and fiscal response in Europe, and China’s recovery. We see a cyclical (shallow) recession in the US as most likely.

We believe structurally higher inflation resulting from the energy transition, demographics and reshoring will continue to be a key driving factor throughout 2023, even as supply chains ease.

Themes

Asset Allocation: Defensively positioned: underweight equities and credit, overweight government bonds and overweight cash. Prefer the safer haven of US equities to Europe. Neutral on the UK, Japan, EM.

Equities: Cautious on global equities. We are looking to invest in high quality stocks that are best placed to weather market volatility. Most bullish versus consensus in Asia Pacific ex Japan, particularly the Asean markets and India.

Fixed income: US and core Europe duration are relatively attractive, considering hard landing risks in both regions.

Real estate: We expect this Real Estate cycle to be shorter and shallower than previous cycles, due to greater transparency in the markets, so values will adjust quickly.

ING Bank

Key message

We expect to see several different shades of recession in 2023. We should get a rather textbook-style recession in the US with the central bank hiking rates until the real estate and labour markets start to weaken, inflation comes down, and the Fed can actually cut policy rates again. Expect a recession that feels but doesn’t read like a recession in China with Covid restrictions, a deflating real estate market and weakening global demand, bringing down economic activity to almost unprecedented low levels. And finally, look forward to an end to the typical cycle in the eurozone, where a mild recession will be followed by only very subdued growth, with a risk of a 'double dip', as the region has to shoulder many structural challenges and transitions. These transitions will first weigh on growth before, if successfully mastered, they can increase the bloc’s potential and actually add to growth again.

Themes

Inflation will continue to be one of the key themes of 2023. We expect it to come down quickly in America, given the very special characteristics of the US inflation basket, allowing the Fed to stop rate hikes and eventually even cut before the end of the year. In the eurozone, inflation could turn out to be stickier than the European Central Bank would like and also perhaps afford. Inflation in Asia will peak at the end of 2022, and while we're unlikely to see any significant recovery in the region's economies next year, currencies and risk assets should return to growth.

Commodities: This year has been extraordinary for commodity markets. Supply risks led to increased volatility and elevated prices. However, demand concerns have taken the driving seat as we approach year-end. Next year is set to be another year plagued by uncertainty, with plenty of volatility.

Global trade will continue to slow in 2023 amid economic headwinds. At the same time, trade patterns are changing and supply frictions persist in a volatile and more protectionist world. But transport costs of most overseas trade will be lower.

Business decisions will be shaped by the response to the energy crisis, weakening consumer demand and commitments to reduce carbon emissions in 2023.

Geopolitics continues to be an important driver for financial markets and the global economy. Watch out for Russia-Ukraine war; more territorial claims; and more political unrest.

BNP Paribas Asset Management

Key message

The global economy seems on an inevitable march towards recession. The causes are well-known: central banks aggressively raising policy rates to reduce inflation, an energy shock in Europe, and zero-Covid policies (ZCP) and a shaky property market in China.

Much of Europe is already in recession. We expect one to begin in the US in the third quarter of 2023, and while China’s growth will likely not turn negative, it will be below historic levels.

One can easily think of ways in which the situation could yet worsen: a breakdown in a key financial market due to the rapid rise in interest rates, a cold winter and blackouts in Europe, or a flare-up in geopolitical tensions between the US and China.

J. P. Morgan Asset Management

Key message

As we look to 2023 the most important question is actually quite straightforward: will inflation start to behave as economic activity slows? If so, central banks will stop raising rates, and recessions, where they occur, will likely be modest. If inflation does not start to slow, we are looking at an uglier scenario.

Fortunately, we believe there are already convincing signs that inflationary pressures are moderating and will continue to do so in 2023.

Themes

·         Inflation panic subsides, central banks pause.

·         Recession to be modest.

Robeco Asset Management

Key message

in our base case, 2023 will be a recession year that – once the three peaks (inflation, rates, USD) have been reached – will ultimately contribute to a considerable brightening of the return outlook for major asset classes.

The last leg of a steep climb towards the peak can prove treacherous and markets tend to overshoot here. That implies short-term pain as exhaustion and capitulation take hold, following an already dismal performance across the multi-asset spectrum. While cash levels among retail investors are historically elevated and professional investors are moving towards a consensus of a US recession in 2023, we haven’t seen full capitulation in risky assets yet.

Moreover, as often in deep bear markets, countertrend rallies last longer. This time they’re fueled by the ‘bad news is good news’ mantra that took hold in the era of quantitative easing. We expect the last leg of the bear market cycle to emerge in 2023. This will bring the dislocation in assets that will deliver long-term gain, given the asymmetric risk-reward pay-off that will emerge.

Invesco Asset Management

Key message and themes

2023 will be a year of transition from a contraction regime to one of recovery. We reduce the defensiveness of our Model Asset Allocation, while keeping some powder dry for when recovery is confirmed. We are reducing the government bond allocation to Neutral, while increasing the allocation to high yield (to Overweight). We also reduce the cash allocation to zero, replacing it as diversifier of choice with an Overweight allocation to gold. From a regional perspective EM and US are preferred.

Top ideas Japan equities, EM real estate, US HY, Gold

 For the stock markets, the 2023^rd year of Christ is beginning on a cautious note. The global narrative is swinging between an orderly decline to a precipitous crash. With the last man standing Haruhiko Kuroda (BoJ Governor) falling this week, it is clear that the “crusade” against inflation will continue in 2023 - and money will be expensive and tighter. This is most likely to reflect in slower economic activities, and aggressive trade and currency conflicts.

The developed markets that have thrived mostly on the steroids of cheap and easy money will show withdrawal symptoms which may include volatility, recession, protectionism, financial instability etc. The emerging markets largely dependent on exports to developed markets (commodity or merchandise) shall also suffer the collateral damage. However, the emerging market with strong domestic economies, stable fiscal conditions and stronger financial markets might find themselves in a position to take advantage of flight of capital from the developed and weaker emerging markets and lower commodity prices. India, arguably, is placed in the latter category of emerging markets.

It cannot be denied that a precipitous crash in the global markets will hurt the Indian market badly, just like it did during the market crashes of 2000, 2008-09 and 2020. However, in case of an orderly decline in the global economies and markets, India may stand out again in 2023, just like it did in 2022.

As of this morning, the risks to Indian markets are evenly balanced. Absence of bubble in any pocket of the market, low volatility, strong domestic flows, economic growth still close to past decade’s trend, and stable fiscal & financial conditions support the markets; while rising probability of a precipitous crash, a deeper recession than presently estimated and the geopolitical conditions taking a turn towards the worst, pose material threat to the markets.

The investors are therefore faced with high uncertainty in formulating an appropriate investment strategy. I would be extremely untruthful and dishonest to claim that my situation is any better than most of the investors. Nonetheless, after evaluating the entire situation I have shortlisted the following factors that would support my investment thesis for next 9-12 months and help me in navigating the turbulent waters.

1.    There are no signs of a bubble in the Indian equity market.

2.    The earnings growth is likely to stay positive for at least a couple of more years.

3.    Margins may bottom as inflation, rates and USDINR peak sometime during 2023.

4.    The leverage in Indian markets is substantially lower as compared to 2000 or 2008-09. The chances of a sustained crash are therefore much less this time.

5.    Despite the outperformance, foreign investors have not been enthusiastic about Indian equities in the past couple of years. The foreign ownership of Indian stocks is at a multiyear low. Besides, India's weight in MSCI EM has seen steady increase. The probability of an accelerated selling is therefore low.

6.    The valuations are not cheap though closer to the long term averages. Given the slower growth and higher bond yields, it is likely that Indian markets may witness some PE de-rating and trade below long term averages.

7.    The bull case for Indian equities as a whole is weak. The upside from the current levels is limited, given slowing growth momentum and higher rates; whereas a panic bottom could be deep.

8.    There are some pockets of the economy (and market) that are witnessing a sustainable transformation. These pockets offer once in a decade type opportunities. Some examples are Defence production; Biofuels; Real Estate; Manufacturing Modernization; Self-reliance in Intermediates’ Manufacturing; and Modern Retail. These pockets of growth have been well identified and analyzed, therefore, the risks are mostly known and the growth path well illuminated.

9.    Presently the opportunity cost of holding cash is minimal as liquid funds and short term fixed deposits are offering decent returns. There is no rush to go out and deploy cash in equities and other assets.

10.  The developed markets may hit the rock sometime in 2023, though a sustained recovery may elude them for a couple of more years at the least. The stronger emerging markets may find favor with the yield hunters in this scenario.

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 Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed) unanimously decided to hike the key bank rate by 50bps to 4.25%-4.5% target range, the highest since 2007. From near zero in the beginning of the year, this is perhaps the sharpest rise in rates in one calendar year.

In the customary post meeting press conference, the Fed chairman Jerome Powell emphasized on the commitment to rein inflation. He said, “we still have some ways to go” and “I wouldn’t see us considering rate cuts until the committee is confident that inflation is moving down to 2% in a sustained way,” indicating that rates will rise in 2023, though not at the same speed as 2022. The Fed chairman reiterated, “It is our judgment today that we are not at a sufficiently restrictive policy stance yet,” adding “We will stay the course until the job is done.”

The Fed Chairman had stated after the November FOMC meeting that the pace of tightening is less significant than the peak and the duration of rates at a high level. The Fed’s latest stance also emphasizes that the markets should brace for “higher for longer”.

The FOMC statement clearly indicated that they are aware that higher rates will impact the economy adversely. The projected unemployment rate for 2023 has been hiked to 4.6% from 3.7% in November 2022, as the economy is forecasted to grow at just 0.5% in 2023, at the same pace as 2022. The Chairman noted, “I wish there were completely painless way to restore price stability. There isn't, and this is the best we can do.”

It would be interesting to see if the Fed can actually deliver a soft landing of the economy as promised, without triggering a deeper recession, while attaining a milder inflation as per the target.

The Fed Chairman welcomed the recent lower inflation prints, but wants more substantial evidence to believe that the inflation is on a sustained downward path. He said, “the inflation data received so far in October and November show a welcome reduction in the pace of price increases, but it will take substantially more evidence to give confidence inflation is on a sustained downward path.” The Fed now expects the personal consumption expenditures price index, currently running at 6% - to cool to 3.1% in the final quarter of next year and to 2.5% by the end of 2024.

Belying the market expectations, the Fed Chairman clearly hinted that the rate hikes will continue in 2023 and the policymakers projected rates now indicate that we may end the next year around 5.1%, slightly higher than the previous projections. The dot plot now indicates a cut of 100bps from 5.1% in 2024.

 The latest policy statement and the aggressive stance of the Fed, is likely to anchor the inflationary expectations while resting the frequent speculations of an imminent “peak” followed by immediate easing of rates.

The equity markets were disappointed as most participants were expecting a “peak” below5% and a cut in 2023 itself. The stock ended lower after a volatile session. The bond markets were however not too bothered and yields ended marginally lower after the Fed statement.

The global markets behaviour in the year 2022 would remain subject matter of analysis for many decades. Almost all markets – equity, bonds, commodities, crypto, housing, arts etc. - have shown a classical pattern in the current year, despite several unconventional factors impacting the global economy.

If we observe from the averages the behaviour of commodity markets in particular has been very archetypal in a market still enduring a war, inclement weather and supply chain dislocations. S&P Goldman Sachs Commodities Index, has gained ~17% YTD 2022.

Evidently, the first half of 2022 saw a sharp surge in commodity prices led by energy and food prices, ostensibly due to the Russia-Ukraine conflict and severe drought in many parts of the world. However, easing of post Covid logistic constraints and monetary tightening by most central bankers led to an improvement in supplies; demand destruction and unwinding of speculative positions; resulting in lower commodity prices.

 

However, if we analyze the internals of commodities markets we find huge variation in price performances of various commodities within the same category. For example-

·         Energy: crude oil is literally unchanged for the year; Ethanol, Naptha, Propane etc. have lost 15% to 35% for the year; whereas Coal (+147%) and Natural Gas (+84%) recorded huge gains. Wind Energy and Solar Energy prices are down over 10% YTD2022; whereas electricity prices in European nations are higher by 37% (UK) ti 105% (France).

·         Precious metals: Gold is unchanged for the year; while silver(+5%), platinum (+10%), and Titanium (+27%) are ending the year with decent gains.

·         Other metals: Steel (-59%), Tin (-39%), and Copper (-11%) are major losers in the metal universe. Aluminum, Lead, Zinc are also ending the year with some losses; whereas Lithium (+157%), Bitumen (+20%) and Nickel (+46%) have bucked the trend. LME Index fell ~6% YTD2022.

·         Chemicals: PVC (-28%), Soda Ash (-13%), DAP (-13%), Urea (-41%), were some major losers during the year. Polypropylene and Polyethylene etc. are mostly unchanged for the year.

·         Agriculture produce: Coffee (-33%), Cotton (-25%), Rubber (-20%), Palm Oil (-20%), Wheat (-9%), etc. are ending the year with strong losses; Sugar, Cocoa, Tea are little changed; while Rice (+20%), Soy (+17%), Corn (+10%) are some notable gainers. US Lumber prices are lower YTD2022 by over 60%.

As of this morning, the uncertainty in the commodity markets appears much higher than the equities. The following uncertainties, for example, could continue to impact commodities markets in 2023 also:

·         Covid situation in China and growth trajectory post opening. A sharper recovery than presently estimated may again lead to a strong rally in many commodities.

·         A ceasefire in Russia-Ukraine conflict with easing of sanctions on Russia could impact energy and food markets materially.

·         A deeper recession triggered by persistent monetary tightening could result in sharper demand destruction and further inventory unwinding, resulting in further cuts in commodity prices. On the other hand a softer slow down followed by a guided recovery (monetary easing) could result in accelerated inventory rebuilding and sharper price inflation.

·         Extension of La Nina conditions beyond 1Q2023, as presently estimated, could further worsen food supply leading to sharp inflation in prices.

·         Further deterioration in international relations and persistent Sino-US trade war could accelerate central bank demand for gold.

If you can look into the seeds of time, And say which grain will grow, and which will not, Speak. (Shakespeare, Banquo -Scene III, Act I, Macbeth)

The past three years have seen an intense war between the forces of “Greed” and “Fear” in the financial markets. Both the forces have won some battles and lost some. Though the benchmark indices close to their all-time high levels might give an illusion of decisive victory of for the forces of “Greed”; but the negative market breadth, poor volumes, declining participation of the domestic institutions, net selling by the foreign institutions and underperformance of the broader markets in the past one year indicate that the forces of “Fear” have not yielded much ground.

The period 2020-2023 has seen some localized bubbles in the markets, e.g., new age businesses (ecommerce, digital payments, gaming etc.), healthcare (Covid spending) and metals (supply shortages); which have been duly normalized without much damage to the overall market structure. For the 3yr period, the NIFTY IT is still yielding an absolute return of 93%; Nifty Metal is up 166% and Nifty Pharma is up 60%.

There have been two major drawdowns in the benchmark Nifty. The first one was the panic fall due to the outbreak of Pandemic (33% fall during February 2020 to March 2020), which was fully recovered in the next 8 months by November 2020. The second drawdown was due to the geopolitical tensions in Europe (16% fall during January 2022 to June 2022), which was fully recovered quickly in the next five months by November 2022.

For the period of three years, the broader markets are still sharply outperforming the benchmark Nifty. The Nifty Midacp100 is higher by 95% and Nifty Smallcap 100 is higher by 79% as compared to the Nifty50 which has gained 55% in the past 3 years. However this ought not be construed as a decisive victory of the forces of Greed. The anecdotal evidence suggests that numerous new investors who entered the market (or increased their participation materially) in late 2020, may have materially underperformed the benchmark indices; even losing their capital in many cases. Unmindful leverage, excessive trading, ill-advised exposure to poor quality businesses and/or new age businesses at unsustainable price levels may have caused them to underperform or lose capital.

Sharp decline in the value of cryptocurrencies in the past couple of years, almost no return in gold and very poor return in the debt has also impacted the investors’ sentiments in the past one year particularly.

Standing at the threshold of the New Year 2023, both the forces appear tired and looking for fresh supplies. The forces of fear are anticipating a full blown global recession and sharp decline in the global risk appetite; whereas the forces of Greed are looking for a managed slow down followed by a full recovery.

In the context of India, the forces of fear are expecting a full blown balance of payment crisis, higher fiscal deficit, de rating of PE multiples due to failed earnings recovery, and abortion of nascent capex cycle. On the other hand, the forces of Greed are relying on continued government support to capex, strong flows on economic outperformance and stable financial system, peaking of inflation and rate cycle, lower energy prices, fair valuations, and earnings surprises to support their cause. It will be interesting to see how the battle evolves.