*****Is the RBI signalling ‘iceberg’ right ahead? – The Hindu BusinessLine

Clipped from: https://www.thehindubusinessline.com/portfolio/news-analysis/is-the-rbi-signalling-iceberg-right-ahead/article65382150.ece

The Reserve Bank of India (RBI) seal is pictured on a gate outside the RBI headquarters in Mumbai

The Reserve Bank of India (RBI) seal is pictured on a gate outside the RBI headquarters in Mumbai | Photo Credit: DANISH SIDDIQUI

Given the headwinds ahead, getting on to lifeboats appears a more sensible option.

When you are smooth sailing in North Atlantic ocean at full throttle in the world’s largest ship with confidence nothing can go wrong, you might be setting sights on new records. That is of course until you encounter icebergs. The crew in charge of the Titanic, despite warnings on icebergs from other ships travelling in that zone,  continued to throttle at good speed. This was till its own lookouts screamed ‘iceberg  right ahead’,  but by then it was too late.

Is the same thing happening now for markets with RBI, the country’s inflation watchdog, rising rates in an unscheduled surprising policy meeting? Is the country’s own lookout screaming to markets ‘iceberg right ahead’, after clear warning signs from similar trends in developed economies with their central banks turning hawkish?

One can quickly recollect the last time the RBI had an unscheduled policy meet to reduce interest rates, with the most recent one being in March 2020. However, one will have a tough time recollecting the last time the RBI increased policy rates in an unscheduled event prior to today. This is an indication that they too may have fallen behind the curve in controlling the ‘beast of inflation’ and markets may not have prepared for this.

Resilience in the midst of headwinds

India’s benchmark indices till recently appeared to be fixated on setting new records. Despite recent volatility, Indian markets have shown unexpected resilience. DII inflows have cushioned FPI exodus, and the benchmark Nifty 50, prior to today’s correction was down only by around 8 per cent from all time highs reached in October 21. This is a significant outperformance versus global benchmarks and reflects remarkable resilience as during this period many things that were thought to be of lower probability but fundamentally negative for markets, actually materialized.

These include the persistent multi decade high inflation in developed economies, the significant pivot by US Federal Reserve, surge in global bond yields making equities less attractive, and of course the Russia-Ukraine crisis. As compared to Nifty 50, the Dow Jones Industrial Average (DJIA) is down 13 per cent from all time highs, S&P 500 is down by 16 per cent and the Nasdaq Composite is down 23 per cent.  

While one could argue country specific dynamics can result in outperformance in a country’s index, it would be interesting to note that on a five year basis, the correlation between Nifty 50 and the DJIA is very strong for most part with the indices closely tracking each other, till Nifty started outperforming from around June 2021. This may imply while some of the global indices may have started factoring for negative impacts of inflation and Russia-Ukraine crisis, Indian markets are yet to reflect these adequately.

What should investors do amidst RBI warning

With RBI’s unscheduled rate hike and that too by 40 bps, versus the typical 25 bps, the indications are clear we may be set for a stronger than expected rate hike cycle. Aggressive rate hike cycles will impact equity valuations negatively as the discounting rate for future earnings will increase. This will reduce the net present value of future earnings for current investors and pressure valuations downwards. There may also be the case of corporate earnings getting revised downwards –  highly leveraged companies may see reduction in profitability as interest costs increase; and some business that earlier benefited from consumer demand funded with loans will also be impacted. In the end, the purpose of rate increase is to cool demand that is driving inflation.

Thus while it is anybody’s guess whether the rate hike cycle amidst global uncertainties can sink the bull market that started in March/April 2020, investors have two options – either get on to a lifeboat (value stocks and staying in cash/liquid assets to invest later), or be like the musicians of the Titanic – staying put and providing liquidity to those exiting the markets via buying the dips. Given the icebergs ahead, getting on to lifeboats appears a more sensible option. If this bull market remains resilient, one can re-enter when the ship has passed the iceberg zone.

Published on May 04, 2022

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