Talking Points This Week: Scares Aplenty

This week was more noise and less action. Post Jackson Hole-led mayhem in the U.S. markets on Friday, it was widely expected that the week would be disastrous for equities. The reality was different. The S&P 500 has corrected by a mere 1.6%, as of Thursday's close, and the Nifty 50 has been flat, with a 40 basis-point decline from Monday's open.

What’s to be seen is if the same stance prevails ahead and whether the market stays resilient or buckles under the stress of global headwinds. Note that aside of rates remaining high, the U.S. Fed this week stepped up the unwinding of its near-$9-trillion balance sheet.

Couple these with high yields, rising geopolitical stress (China-Taiwan) and slowing growth—and we have a potent cocktail brewing. Can this bring the recent rise in question? For now, it does not seem to be the case. We talk about the possible views from India and around the world.

Superbubble?

Jeremy Grantham of GMO is calling this a “superbubble”. He wrote, "Only a few market events in an investor’s career really matter, and among the most important of all are superbubbles. These superbubbles are events unlike any others: while there are only a few in history for investors to study, they have clear features in common.”

One of those features is the bear market rally after the initial derating stage of the decline but before the economy has clearly begun to deteriorate, as it always has when superbubbles burst. In all three previous cases, the market recovered over half the initial losses, luring unwary investors back just in time for the market to turn down again, only more viciously, and the economy to weaken, he said. This summer’s rally has so far perfectly fit the pattern.

Grantham notes that everyone must prepare for an epic finale, which could take the markets down by almost 50%! He hopes that the finale does not have a “really bad” ending.

Inventory-Shipment Ratio

According to a note by Nomura, South Korea’s industrial inventory-shipment ratio rose from 1.23 in June to 1.25 in July, its highest in over two years. This shows that an unintended inventory build-up has started and, according to Nomura, will result in industrial production cuts. An inventory destocking cycle is also likely in the coming months, it said.

Since South Korea and Taiwan, both tech-heavy economies, are open, the canary singing in the Northeast Asian coalmines is a warning sign that the global growth outlook is darkening at a rapid clip. Will that slow down the relatively higher growth of countries like India? Most certainly, it could.

And in such a scenario, if imports stay high—due to non-discretionary imports—expect the trade deficit issues coming back to haunt economies like India again.

Margins

An analysis of the Q1 earnings of a common set of around 3,000 listed companies (ex-BFSI) by SBI Securities suggests that Ebitda margins have rotated back to pre-pandemic levels.

From a high of 17.65% clocked in Q1 FY22, the margins in Q1 FY23 are 12.51%, around the 12.57% mark clocked in Q3 FY20. This begets the question, as a very astute money manager posted to me, as to whether India's margin and profit renaissance was an outcome of something truly remarkable or an outcome of India Inc. being made to do something while being pushed against the wall with nowhere else to go? The remaining nine months would give us those answers.

Contrarian View: No Hard Repricing Of Assets

Viktor Shvets of Macquarie asserts that despite abandoning “transit and soft landing”, the Fed struggles to tighten. In the areas where financial and liquidity pressures should be detected, he said in his note, there has not been much evidence of tightening, despite an increasingly hawkish Fed.

He cites how in the most vulnerable areas of CCC and below-rated debt, spreads have only slightly widened from a low of 9.6% in mid-August and pre-Powell speech of 10.1% to 10.5% against a historical average of ~12% and distress of closer to 20%.

A broad gauge of bond market volatility (MOVE) rose from 123 pre-Powell speech to 130, only to ease back again toward 127. The volatility index, VIX, having jumped from mid-August lows of 19-20, seems to have stabilised at around the 25-mark, far from the distressed levels of 40 and above.

Since the actual is so far away from what the narrative would have one believe, Shvets asks how do we reconcile the rhetoric with reality? According to him, at the slightest hint of inflationary pressures easing, the Fed will act against any serious freezing of capital flows to areas that may require them the most.

Investors by and large, he said, understand that the environment could change in seconds if the Fed simply refines its communications strategy, without even touching rates or the balance sheet.

According to Shvets, the global economy should skirt recession, even as some regions like the European Union experience a deeper slowdown, and therefore, while the world may not see a soft-landing, it also won’t see a hard repricing of assets.

This market is proving most people wrong at most times. Bears were on the high when the index was at 15,300, and since then, they have been taken to the cleaners.

The difference is that the participation from the bulls was not that convincing. In fact, at every level, there were call writers who again got taken out by a surprise upmove every now and then. Usually, Mr. Market knows something. The big question—is this time different? It rarely is. But time will tell.

Niraj Shah is Markets Editor at BQ Prime.