A perpetual feature of markets is that they never fail to surprise you: both on the upside and downside. S&P 500, the major US stock market index, declined 20 percent in 2022 due to the steep interest rate hikes by the Federal Reserve – the US central bank – to contain stubbornly high inflation. Market participants then anticipated a US recession in 2023. However, to everyone’s surprise, not only did the recession never materialise; rather the economy remained resilient and recently buoyant. The global GDP expanded 3.4 percent in the second quarter of 2023, outperforming forecasts. The US economy expanded an annualised 4.9 percent in the third quarter of 2023, the most since the last quarter of 2021, and above the market forecast of 4.3 percent.
Foreknowingly, stock prices have recovered in 2023 from the decline of 2022. The S&P 500 is up 15.4 percent so far in 2023. The index is still 7.35 percent below the all-time high of 31 December 2021. However, the market sentiment remains tilted towards optimism because the rate hike cycle is believed to have peaked; inflation, though above its target range, is gradually subsiding; and, most importantly, almost everybody believes the US economy has dodged the anticipated recession.
Again, markets can always surprise you. Things can happen when they are the least expected. The recession may not have been dodged, rather just delayed, and may materialize in 2024. If so, this shall have serious adverse effects, not just on the US stock market, but on the global financial markets as well, including the Indian stock market.
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Another possible risk to markets may emanate from China. The credit-driven Chinese real estate industry is presently facing serious problems in the form of debt defaults, liquidity crunch, and stalled projects, among others. The troubles in China may percolate into the global economy, and if so, that will have adverse effects, particularly on economies that are too economically reliant on China. China is a big commodity importer, so naturally, Australia, Russia, Saudi Arabia, Brazil, and other Latin American countries that export commodities to China will suffer disproportionally. Moreover, China is a major buyer of the EU, ranging from cars to capital goods, to luxury items; thus, the EU is exposed to the China slowdown risk.
The Indian economy, compared to other major economies, seems considerably insulated from these risks and uncertainties. The IMF (International Monetary Fund) in its ‘World Economic Outlook (WEO), October 2023’ downgraded global economic output by 0.1 percent from its July 2023 WEO forecast, and the downgrade was more pronounced for China and the advanced economies of Western Europe. However, India’s projected growth rate for 2024 was upgraded and its economy is expected to grow at 6.3 percent in 2023 and 2024. China is expected to grow at less than 5 percent for both 2023 and 2024. The world economy is projected to grow 3.0 percent and 2.9 percent in 2023 and 2024, respectively. These forecasts conjecture a relatively bright prospect for the Indian economy.
Moreover, India could benefit from the fall in commodity prices caused by the slowdown in economic activity, particularly in China. IMF in its WEO, Oct. 2023, projects fuel commodity prices to fall an average of 36 percent with oil prices to decline by 17 percent, and non-fuel commodity prices to decline by 6.3 percent. Historically, India being a net-commodity importer had always benefited from lower commodity prices.
Based on the performance of major stock market indices, the Indian stock market underperformed global markets so far this year. Sensex, the benchmark index of the Bombay Stock Exchange – is up 5.99 percent so far in 2023. In Asia, the Japanese stock market is the best performer with a gain of 26.64 percent so far in 2023 – outperforming by a wide margin. South Korea, the second-best performer in Asia, gained a much lesser 9.05 percent in the same period. In Europe, the respective benchmark indices in Germany, France, and the UK returned 8.28 percent, 6.83 percent, and -2.56 percent, respectively, so far in 2023.
In the US, the performance is highly divergent and thus quite perplexing. The S&P 500 is up 15.46 percent so far in 2023. However, the Nasdaq 100 index – largely constituted of new economy technology stocks – gained 32.84 percent during the period. Meanwhile, the Dow Jones index – largely constituted of old economy industrial stocks – gained only 3.46 percent. There is a general opinion among investors that a few large technology stocks mostly drove the gains of this year. Usually, such narrow-based rallies are seen with scepticism because, anecdotally, such rallies have an ominous nature.
India’s 10-year government bond yield (%) rose from 6.00 percent to 7.5 percent between June 2021 and June 2022: The Indian stock market underperformed during this period with Nifty50 remaining unchanged. Since then, the yield has consolidated between the 7.00 – 7.50 percent range: the Nifty50 gained 22 percent during this period. A breakout of yield out of this range – whether on the upside or downside – is a matter of significance. Whether the breakout will have an adverse or favourable impact on markets depends on which way the breakout happens: a downside breakout is favourable whereas an upside breakout could have an adverse impact. Presently, the 10-year government of India bond yields 7.30 percent.
The 3-month, 6-month, and 1-year treasury bills yield 6.92 percent, 7.10 percent, and 7.15 percent, respectively. The differential of these short-term yields with that of the long-term yield (10-year GoI bond yield) is less than 0.5 percent. Such low differential signifies tight liquidity in the financial system: such conditions act as headwinds for the market and economy. A yield differential greater than one percent between short-term and long-term yields had previously played well for both markets and the economy.
The recent underperformance of Indian markets and its reasonable valuation – Nifty50 trades at 20 times earnings – will provide support to stock prices if they come under selling pressure due to any unanticipated rise in risks or risk perception in markets. Nevertheless, as we have said many times previously, markets never fail to surprise you. So, how do we deal with this consternation? Personally, an appropriate way to deal with the market’s occasional unforeseen behaviour is to cultivate a sufficient degree of intellectual humility and malleability in ourselves.
Meantime, the Sept. 2023 results season is largely over, and our analysis shows more misses than hits. You can read (if you haven’t already) our analysis of CSB Bank post its Sept. 2023 quarter results here. We will update you with more post-results analysis of stocks in our watchlist in the coming days.
AMN CAPITAL 