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Talking Points This Week: Walls Of Worry, In Davos And Elsewhere

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

<div class="paragraphs"><p>(Photo:&nbsp;Dollar Gill/Unsplash)</p></div>
(Photo: Dollar Gill/Unsplash)

In ‘Talking Points This Week’, Niraj Shah studies how top business leaders and market makers are navigating the fast-changing financial landscape.

Equity markets enjoyed a ‘wow factor’ for a long time through the Covid-19 pandemic. Stocks gave brilliant returns to all and sundry. Now they are up against a different ‘WOW’, a Wall Of Worry. It is a rather high wall of worry, with geopolitics, inflation, fading liquidity, and stalling growth as its building blocks. This is a potent cocktail that is hitting all at once, and like a train running downhill. To top it all, the China-Taiwan issue has also been added to the existing mess. China followed U.S. President Joe Biden’s vow to defend Taiwan militarily by announcing that it held military exercises close to the democratically-governed island, underscoring its anger over the U.S. stance. This was, if not the final straw, then at least one more big burden to carry for equities.

Thought leaders have tried to chart the way out of this complex maze and did so again this week at Davos. The trillion-dollar question is–will it be a long winter ahead?

No Easy Solutions On Offer

Two decades of financial turbulence and more than 10 years of heavy central bank intervention have been tailed by the pandemic, high inflation, and the continuing war in Ukraine. How will leaders secure economic recovery and drive balanced growth, globalisation, and development? The belief is that even if central bankers succeed, progress will take time. Two more years of higher inflation are a long time for business leaders, and an ad hoc crisis response that many have been adopting thus far is reaching the end of its usefulness.

It is in this backdrop that various business leaders articulated the key issues to tackle. Depending on the leader and the context, the top-of-mind issue ranged from climate to Ukraine to supply-chain issues. Covid seems to be a distant memory. Billionaire George Soros warning at Davos that Russia’s invasion of Ukraine has rattled Europe and could be the start of another world war, that our civilisation may not survive, and that all other concerns like fighting pandemics and climate change have had to take a backseat. The inference seems to be that there is no easy solution in sight.

Inflation Fight Sees Fierce Combat

Much like the rest of the world, India is facing rising inflation prints. Monetary as well as fiscal policies are now being put to work to tackle it. After the RBI's moves last at the start of May, early this week the central government announced various measures to curb inflation and lower inflationary expectations. Key among those were export duties on steel products and iron ore in order to cool off domestic steel prices, and reduced taxes on fuel by 7-10%. This was followed up with curbs on sugar exports. This is likely to be a concerted fight against inflation because price rise brings not just economic pain, but also political ramifications. We are merely 24 months away from the Lok Sabha general elections, and a packed state election calendar until then.

Some moves that policymakers in India or elsewhere in the world make may not appear completely consistent with past approaches, but remember that there might be political compulsions to do so. An idiosyncratic case for one aspect can't be made when the entire inflation beast needs to be put down. That's why the same U.S. Fed that the equity market drew much reassurance from now appears to have scant regard for it.

The heat is on, and taming inflation is presumably the only game in town.

It Gets Worse Before It Gets Better

A Morgan Stanley note pointed out that Indian equities are facing their biggest challenge in several months as risks to growth have risen and stock prices remain elevated on a relative basis to the emerging markets basket. Ridham Desai and team note that the Sensex is highly-sensitive to a U.S. recession (not the Morgan Stanley base case), as India’s three biggest bear markets of the past 20 years coincided with U.S. recessions.

The question is, are the stock markets already pricing that in? It would be difficult to assert that the pain is priced in.

  • Valuations are arguably still high, especially when seen in the light of the potential earnings revisions on the downside for FY23 and FY24.

  • A fear-led crash is a must for bottoming out process and that kind of crash has not played out in any major market, other than maybe China. While there has been a correction, there has not been a severe panic crash in the Nasdaq as yet.

  • The volatility has not spiked abnormally, as was the case in March 2020, when the CBOE VIX had soared to levels over 60 and the India VIX had touched a level of 70.

Is there more pain? All indications point towards a yes. Exceptions notwithstanding, it does seem that it will get worse before it gets better. This may not be that dip which got immediately bought into.

False Start Or Virtuous Cycle?

The automotive sector has been reeling under significant cost pressures over the last two years, hit by a 40-100% surge in key commodities prices during the period. So now, lower prices for items like steel should benefit the entire auto space. A Systematix calculation shows that steel costs add up to 15-20% of sales for commercial, passenger, and two-wheeler companies like Ashok Leyland, Maruti Suzuki, and Hero MotoCorp respectively. Safe to say, these stocks would be net gainers of any move that results in a cool-off in prices.

Further, the fuel price cuts too would be incrementally positive for CV players, as freight operators would see an improvement in their profitability. Remember, medium and heavy truck volumes rose a sharp 49% YoY in FY22, after a 56% fall over FY19-21. The traction may continue despite the uptick in interest rates as per most recent brokerage opinions. Therefore, might be interesting to see whether this finally becomes a virtuous cycle for autos or will it be another false start.

By The Way...

Along with Zomato's earnings release was a small addition that caught my eye. Inspired by the book 'All I Want To Know Is Where I'm Going To Die So I'll Never Go There', the company has narrated a conversation between its founders and a fictitious moderator on what they believe are the most pressing questions for investors. Without getting into whether the questions were really tough or not, the format is different, and refreshing, coming from an Indian company.

Niraj Shah is Markets Editor at BQ Prime.