"Any big spike in commodity prices from the current levels will be a negative surprise for the markets because that will force the central banks to tip their economies into recession as the last resort to control inflation," Abhay Agarwal, founder and fund manager of Piper Serica, said in an interview to Moneycontrol.
On whether this is a buy on dips or sell on rise market, he said with large hedge funds like Tiger Global under severe performance pressure he expects that any rise in markets will be used by them as an opportunity to sell.
Therefore, this is not a market to go all in with the objective of bottom fishing, he believes.
What are the factors that you think the market has already priced in now and what is yet to be priced in?
Markets are now pricing in a sticky inflationary environment for the next 12 months and calibrated rate hikes by central banks. Most analysts are modelling continuous hikes by the US Fed and it is already reflecting in the strength of the USD with the dollar index hitting a 20-year high.
At the same time, there is still a popular view that commodity prices have hit a cyclical peak and will slowly taper as rate hikes dampen demand. Any big spike in commodity prices from the current levels will be a negative surprise for the markets because that will force the central banks to tip their economies into recession as the last resort to control inflation.
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Is it still a 'buy on dips' market or the narrative has changed to a 'sell on rise' market?
Since 2008, global hedge funds have been borrowing on the cheap in USD and flooding global assets, especially highly speculative ones, creating bubbles in asset prices. With a reversal in interest rate cycle, global funds do not have access to cheap liquidity anymore.
The dollar index, which measures USD versus a basket of other currencies, has hit almost 104, its highest level in last 20 years, after dropping to as much as 72 in 2008. This shows that the USD carry trade is unwinding very sharply as liquidity in USD is getting pulled back.
With large hedge funds like Tiger Global under severe performance pressure, we expect that any rise in markets will be used by them as an opportunity to sell. Therefore, this is not a market to go all in with the objective of bottom fishing.
We expect the markets to be very volatile over the next couple of months as they try to find a bottom. At the same time, it is comforting to see long-term investors like Warren Buffet finally starting to deploy their capital. This can be a lead indicator for long-term investors to start investing in tranches without waiting for the bottom.
Do you think Europe could see a recession kind of environment due to the Ukraine war? If yes, then could there be another round of big selling in equity markets in the coming period?
European economies have already been in slump for several years. With an ageing population, restrictions on immigration and the devastating impact of COVID, the last thing Europe needed was a war at its borders. It is unlikely that struggling European economies will be able to bear the cost of massive increase in gas and commodity prices.
With an increase in interest rates, we will see a sharp fall in consumption for the next year or so. However, the markets have already corrected a lot from their top and are now reasonably priced. We do not foresee a sharp selloff in European equity markets unless there are large unanticipated bankruptcies that negatively shock the financial system.
The RBI finally started hiking policy rates. Do you think the RBI could turn more aggressive in rate hikes in the second half of 2022?
RBI has made a surprise U-turn from its last MPC (Monetary Policy Committee) announcement. The latest hike of 40 basis points and the hike in cash reserve ratio shows that RBI is now suddenly targeting inflation at the cost of growth. We believe that this rate hike cycle will run for 2 more years, and the repo rate may increase to as much as 7.5 percent.
Long term interest rates will also rise in tandem. While this is good news for savers who will finally get to make a real return from fixed income investments, equity investors will find it difficult to generate equity premium consistent with equity risk. Equity investors will have to ensure that their portfolio companies are not negatively impacted by rising rates and lack of liquidity.
The sector that outperformed every other sector, as well as benchmark and broader indices, is power. Is it still the right time to buy this space or is it looking overbought now?
Power stocks are cyclical. They were oversold at the beginning of COVID in 2020 since investors believed that power demand will be negatively impacted by lockdowns. However, power consumption has increased to record highs. With old power plants, which were shut down due to bankruptcies, still not coming online the operating power plants have benefitted from increase in power demand and higher rates. However, they seem to have hit a cyclical peak of demand and the margins are also under pressure due to rising cost of coal. The investors looking to buy power stocks are already late to the party.
What are the themes that you want to suggest now, as the market corrected around 10 percent in the last one month?
Investors need to stay with quality stocks, especially ones with stable cash flow and unleveraged balance sheet. The continuous correction in market will see a sell-off of speculative stocks that have weak fundamentals and the damage there will be irreparable.
At the same time, companies that can generate cost efficiencies through product and process innovations to protect their margins in an inflationary environment will be able to use this tough period to increase their market share. There are segments of the market that will see resilience like healthcare, niche financial services, exporters of IT services and pharma, and domestic travel and hospitality.
In an environment where interest rates are rising and capital is becoming scarce, investors will need to stay away from companies that have leveraged balance sheet or need to borrow funds for growth. The strength of dollar and depreciation of rupee will support not only exporters but also companies that substitute imports.Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.