By Unmesh Sharma
The FOMC policy statement and press conference had enough fodder for both the pessimists and optimists. The 75bps hike was communicated clearly and hence well expected and priced in. The commentary and indeed the press conference which followed were yet again a masterclass in communication by the US Fed. The market reaction in the two following days can be seen as a collective sigh of relief. Indeed, there was a risk that the rate hike could have been sharper or the commentary could have been more hawkish. Neither happened.
At the same time, there was also a clear acknowledgement and indeed an implied promise that there is one eye on growth risks. In essence, markets see the re-emergence of the “central bank put” at an appropriate time. And the fact that the next move will be “data dependent” gave participants enough hope that things will at least not worsen from here. Also even as the room to manoeuvre and deliver a ‘soft landing’ has reduced, the worst case scenario may be a shallow recession. This would imply that any popping bubbles would be localised and a near zero probability of a widespread economic dislocation. Indeed, if the data prints do not worsen, this signals a neutral to benign environment till the next policy meet in September. The resulting relief rally in risk-assets should benefit Emerging Markets and indeed India as well.
Is this then finally the point at which we reverse our cautious stance on the market and go ‘All In’? Not yet! We think there are three large factors – none of which are comforting.
3 worrying factors for share markets
Inflation: On Inflation, even as the headline starts to come off due to base effect, a drop from 9% to say 6% will still be way out of the comfort zone of the Fed. Many supply side issues and data from the labour market seem to indicate that the Fed’s fight against inflation will be a long and arduous one. Meanwhile, the current market rally indicates that market participants expect the next rate cycle will be similar to the last one. In that case, we saw a rapid rise in rates and then an inverted V shaped drop as the Fed retreated. We don’t think this is likely to repeat. The Fed Chairman has clearly indicated that price stability is the bedrock of price stability. If he does invoke the inner Greenspan, which we think will be the case as the politics is aligned to this, then we expect a long grind. This would result in elevated volatility and hence a sideways movement in the markets till at least early next year.
Flows: Anecdotally, the pace of selling from FPIs has come off. So far, the heavy selling has been absorbed by the domestic retail and Institutional funds. However we could see this pick up pace again as we experience the unprecedented phenomenon of “Quantitative Tightening”. Do recall that 2013 was tapering and the current bunch of market participants have not experienced this withdrawal of liquidity in their careers. We do not know which way this will fall but there is a more than equal chance that risk assets will see another leg down with profit booking in the next 6 months even as the commentary from the Fed starts to turn less hawkish.
Valuations: The market is fairly priced at best. The usual rule of thumb we use is that valuations should be 1 standard deviation below long term mean. We are not close to that.
What works in this situation for investors
We think Active Strategies work in this environment. The model portfolio by the HSIE (HDFC Securities Institutional Equities) Research Team is skewed towards value – we continue to pick stocks on relative value (low vs high PE stocks). This is reflected in our preference for Large Banks, Real Estate, Cement and Pharma over Non Bank lenders, Consumer Staples, Energy and Commodities and most IT names. We would use the rally to lighten positions at the high risk end of the duration curve (like new-age technology) and add positions in long-term thematics (eg. financial inclusion – Insurance and Capital Markets). The big call for the next 12 months is “Industrials over Consumer”, given the government’s focus and drive.
(Unmesh Sharma is the Head of Institutional Equities at HDFC Securities. The views expressed in the article are of the author and do not reflect the official position or policy of FinancialExpress.com.)