The global meltdown in stocks on Monday was not wholly unexpected given the latest data showing rising unemployment in the US whose economy is clearly slowing. There is now much anxiety about a hard landing with the possibility of a recession not ruled out. There were two other factors: The stratospheric valuations of US tech stocks had become unanchored with earnings growth and the carry trade in the yen was damaged after the Bank of Japan raised interest rates and the yen appreciated. Japan’s Nikkei shed a staggering 13% to hit seven-month lows, a scale of losses not seen since the 2011 global financial crisis. Whether the sell-off across markets is temporary is difficult to guess. For one, the escalating geopolitical tensions in West Asia remain a big concern. While it has resulted in a steep correction in crude oil prices to a seven-month low of sub-$76 per barrel, the consequences of what seem to be prolonged hostilities are unknown. The collapse in prices of metals such as copper — at a four-month low — and also other asset classes such as cryptocurrencies suggest serious risk aversion.
All of this especially the slowdown in the world’s biggest economy — which, even a few months back seemed to be chugging along nicely — could continue to keep investors and markets nervous. Economists at Goldman Sachs put the probability of a US recession in 2025 at 25%, up from 15% earlier. Indeed, there are those who believe the US Fed may be behind the curve and predict an emergency meeting to cut rates before the September Federal Open Market Committee meet. The yield on the 10-year US Treasury is hovering around levels of 3.7% as bond traders bet on larger-than-expected cuts. Citigroup and JP Morgan Chase both expect a series of half-percentage-point cuts in September as well as December. Others point out that while an interest rate cut may be needed to help the economy regain some strength, it might send out the wrong signal creating panic in the markets.
The sentiment in the overseas markets will weigh on Indian equities even if the country remains fairly insulated and the macroeconomic fundamentals are fairly strong. However, it is largely local liquidity that has been pushing up stock prices with foreign portfolio investors not participating meaningfully. Of late, they have turned distinctly bearish, which is one reason for the sharp correction in the past two sessions. That said, the fall was probably expected as the rally to 25,000 levels on the Nifty has been fast and furious. Besides, the June quarter earnings season has been lacklustre. Net profits for a sample of 824 companies (excluding banks and financials) have fallen 5% year-on-year on the back of a sales growth of 7% y-o-y. While lower oil prices are a bonanza, the weaker rupee which is nudging 44 to the dollar will make all imports more expensive, adding to inflationary pressures.
Also, the US is a big market for India’s exporters — especially software services — and any slowdown would hurt exports. The silver lining is that bond yields are falling. However, the Reserve Bank of India might not be in a rush to cut rates since it wants the 4% target to be achieved on a sustainable basis. For retail investors, there is no reason to panic as Monday’s fall is expected to remove a lot of froth from the markets.