Talking Points This Week: Staring Down The Barrel, Finding Hope

Every week, Niraj Shah studies how top business leaders and market makers are navigating the fast-changing financial landscape.

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Every week, Niraj Shah studies how top business leaders and market makers are navigating the fast-changing financial landscape.

This week was punctuated by capitulation in risk assets (read Bitcoin), a subsequent bounce in many of them, and some good feelers around inflation, particularly food inflation. As Charlie Billelo of Compound Capital Advisors noted, a big positive on the U.S. inflation front was that fertiliser prices in America ‘peaked in late March and have been trending downward since, now at the lowest prices since late January, which is important given their high correlation with food prices'. At the same time, there was a serious fear overhang as well. Elon Musk and Nouriel Roubini seemed certain about a recession in the U.S. Since we have written a lot on inflation recently, let’s try and talk about other things. As you will see, despite the best efforts against it, inflation will weave its way in.

Caution Aplenty

Everyone from U.S. Federal Reserve Chair Jerome Powell and Musk to Roubini and India's Monetary Policy Committee sounded the bugle of caution. Powell told U.S. senators that a soft landing will be “very challenging” while aggressively tightening policy to combat inflation. Musk, the world's richest man, believes that it is more likely than not that there is a U.S. recession in the near term. Goldman Sachs economists cut their U.S. growth forecasts and warned that the risk of recession is rising. Roubini said he expects a U.S. recession by the end of the year.

India's Monetary Policy Committee expressed the belief that more rate hikes would be needed to quell inflation pressures, which, in turn, would mean some degree of economic pain, in the minutes of its June meeting released this week. All this aggregated opinion is a stark contrast to the optimism of 2021. Since that fizzled out, can this pall of gloom be short-lived too? Those expecting a mild U.S. recession to be followed by a sharp pickup will be hoping it does.

Reflex Rally

One of the talking points was the big selloff we've seen in Indian mid- and small-cap stocks. On Monday in particular, when mid caps cracked, FIIs sold only Rs 1,217 crore worth of stocks and DIIs bought Rs 2,094 crore worth of shares. The point, therefore, was the nature of the selling, which was symptomatic of capitulation.

Picture this, delivery-based selling in some stocks was low, but price action was high. BDL ended down 11% on a delivery value of only Rs 62 crore and market-cap of Rs 13,133 crore, HAL was down 10% with a delivery value of Rs 108 crore on a market-cap of Rs 57,690, and Triveni Engineering fell 6.5% with a delivery value of Rs 5 crore on a market cap of Rs 5,710 crore. This suggested a lack of buyers on a particular day, and it was evident that it was only a day-long process, as the bounce in the subsequent days was swift. Watch out for the bounce, as a lot of quant indicators were on the oversold side and therefore, it may not be a surprise if it extends itself.

A bunch of greed and fear indicators, including the one run by analysts at Quant Mutual Fund, registered its highest ever reading since the Covid crash of 2020, and at times, bounces from such levels can be sharp and large.

Bullish At The Margin?

These moves were preempted by some in the analyst community, as the sell-side started to turn selectively bullish on specific pockets in India. Whether it is the corrective move that has already taken place or that oil prices have come off a bit that may be aiding sentiment, selective positive calls are being given. Mahesh Nandurkar of Jefferies says that now that the Nifty is down 18% from its high with several stocks down by much more, the firm's scan of their coverage for stocks that are down over 25% from 52-week highs, and which analysts have conviction in, results in some buy ideas. This is particularly because some of the stocks also offer a median 29% earnings CAGR in FY22-24E and a 15% median FY24 RoE. Jefferies highlights stocks like IndusInd Bank, Godrej Properties, DLF, Infosys, Jubilant Foodworks and Dixon Technologies, amongst others in their list.

Vikash Jain of CLSA suggests that the research house's proprietary India Bull-Bear Index signals a crash in equity market sentiment, from 99% bullish nine months ago to 92% bearish now. This is important because the team's back-testing shows 90-95% bearish points to have produced good 3-month / 12-month returns in nearly all instances since 2007, barring the deep bear markets of 2008 and 2020. A sharp fall in trading volume may also suggest waning selling intensity, adds Jain. CLSA has added DLF to its India-focused portfolio. Noted investor Mark Mobius also spoke about select positives in Indian markets, notably technology names and select exporters like textiles.

Can China Help?

The weakness in China has prevented global trade imbalances from correcting and delayed a resolution of the container recycling problems and shipping costs.

Conversely, a rebound in activity in China could trigger the same improvement in production and delivery times we saw in Asia in the second half of 2021 and so far in 2022. According to UBS economists Arend Kapteyn and Pierre Lafourcade, extended delivery times can explain a third of excess U.S. inflation. There are some other encouraging signs that progress is being made. Global mobility restrictions have now largely been removed, automakers in various parts are doing better on the production front, and American automotive producers are continuing to deliver on production levels in the April-June quarter that are 2 million units higher than in January-March due to declining chip shortages. U.S. retailers are now flush with excess goods inventories, a sign that buyers are skirting back from buying aggressively.

Meanwhile, China’s second-biggest online retailer sees worrying signs that shoppers are reluctant to reopen their wallets even as major cities emerge from bruising Covid lockdowns, suggesting consumer spending may take months to recover, a sign that consumer confidence for varying factors may have taken a hit. However, Chinese President Xi Jinping has pledged to meet economic targets for the year even as the government’s zero-tolerance approach to combating Covid outbreaks and a weak housing market put the growth goal further out of reach. If China still manages to meet these targets, it would mean prolific growth in the second half of 2022, one that could benefit the rest of the world as well.

Niraj Shah is Markets Editor at BQ Prime.