It has been a good year and it looks like it is set to turn into a big year with the rally that we have seen in recent days both locally and globally. What’s in store for 2022?
Yep, it’s been a pretty decent year. The last time I saw the Nifty was up around 22% and the NSE 500 was up 28%; of course we’re up 52% ââfor the year so it’s definitely been a great year for us. But going forward, it looks like a pretty decent year, even in terms of numbers, given the news about the virus.
As I said before, normally the apprehension is whether there will be a big crash and normally the track record of any market is that this big crash happens when one is way above the market. trend line. We’ve had two pretty decent years. Looking back, 2019 was not great, 2018 was actually a declining year and even looking at the 10 year period from 2010 to 2020, we only dialed about 8.5%, which was the fixed deposit rate at that time. . So there was this room. We were way below the trend line. We’re still not at the trendline, let alone very, very high. So the big risk is not there when it comes to the market numbers.
There are risks elsewhere, which are more related to the macroeconomic front. There are currency inflation risks for India and in various ways, at least globally, on the inflation front for the first time developed markets have had to deal with inflation. Otherwise, inflation was a bottom line for them.
Of course, this is not the case for emerging markets, nor for India. Inflation is very often the center of attention, but where we are today I would keep my eyes on the macroeconomic numbers and, of course, within India, sectorally itself, let alone of actions, there is a lot of dispersion. The FMCG index is up 8% over the year. Nifty Bank is up about 11% while a bunch of industries like IT, metals and some other commodities and materials are up 50-60% or even more. I am only talking about sector indices. In 2022, it will depend on where we are in terms of sectors and companies.
So where do you think we should be? Also, if I’m going to push trendline theory forward, I’m sure for IT and metals the trendline needs to normalize downward rather than upward?
Mid-2020, we brought in IT at a time when FMCG stocks were very popular. It’s not just the trend line; you have to look at a lot of things. There my call was that there was this sector – IT – that has pretty decent returns like FMCG and is predictable in a very uncertain world and yet the valuations were a fraction of what FMCGs were trading at. It was a story of reassessment.
In macroeconomic variables, on the side of the government, the central bank or any other policy maker, one would like to have high growth, low unemployment, low inflation, low interest rates and a strong currency. These are the goals, but it is not possible to pursue all of these goals at the same time. It’s like trying to put five things in a box that can only hold three things and when you fill everything, something comes out from the other end.
What is happening now is that the RBI has decided to focus on growth because economic growth, especially below the top level, is still suffering. Even when it comes to citizens, in terms of whether they have a job and what their income is, the situation below the top rung is not so good. The wholesale price index is around 20 years high and yet we have decided to hold the interest rates. It has not yet appeared in the consumer price index but it is done with a lag. So we decided to keep the interest rates going and the people sitting in India think we are hanging on to the interest and the whole world has not raised the interest rates either because for us the only two markets that we let’s look at are India and the United States.
Neither the Fed nor India have hiked rates yet. But if you widen the horizon and look at all emerging markets or the rest of the developing world, central banks have raised interest rates not once but twice, three times, even five and six times. From Brazil to Russia, we’ve seen rate hikes everywhere. India is actually an outlier in the emerging markets pack. As we have not raised interest rates despite high inflation, the currency is under pressure.
The third factor is if we look at the long term chart of the rupee against the dollar. Either you depreciate slowly – 2-3% every year – or you have periods where for years it’s in a band, and then there’s a sudden drop when the rupee depreciates. We’ve been in the 73-75-75.5 band for a long time. All of these things indicate possible stress on the currency, I mean all things are just in terms of probability, but I would say this is a year where I would expect the rupee to depreciate. Therefore, it is a good place to be in an export oriented industry or some kind of import substitution. So we continue to love IT as a sector for now.
Like I said, I never do a one-year projection, but while metals and elsewhere the power and energy has been great throughout the year and we’ve been riding that, the story started to fade a little while ago. Right now I would say they’re like better performing types of sectors in the market rather than being very good. Computing continues there. Selectively, one has to consider the export or import substitution sectors, in particular according to the PLI scheme. There will be pockets in chemicals, automotive and automotive components. We don’t like two-wheelers, for example, but there will be pockets in the automotive sector and we have to be choosy now.
You have always advised against putting all your eggs in one basket and mentioned that limiting investments to one country is extremely risky. First Global is a global investor. Besides India on a relative basis. What other markets do you find attractive at this stage?
Before getting to the heart of the matter, I would like to caution that this is changing and therefore not a one-year view. To this day, the United States, especially some of the tech pockets, still looks relatively better than the rest of the world and that is partly due to the currency as well. We are keeping an eye on China, where we significantly reduced our exposure around February-March. Now we think this is a market where there may be some changes, but of course this year we have to watch macro variables which are difficult to predict.
For central banks like the Fed or the ECB, inflation is a factor. So what are they doing? Inflation is not just a number. There is inflation, inflation expectations, the central banks’ point of view on inflation. It’s like a nested loop and at the moment the most likely outcome seems to be probably two or three Fed hikes over the course of the year and possibly towards the end of the year. Markets are also valuing in that they might have to backtrack as the impact on growth and markets would be negative.
You have to see how it goes and there are a lot of uncertainties. If you look at inflation in Europe, power and energy inflation is off the charts. Some of the electricity costs in some countries are four or five times higher for industries. Thus, some industries have become unsustainable; aluminum, for example, has an energy cost which is now higher than the selling price of aluminum. This will again have a second order effect on metal prices. It’s been quite a big news for two years now and it could continue with this extra thing of what policymakers are doing in one of these markets. But these are the two markets that look interesting now.
While the dot plot has given us plenty of clues as to when and how many rate hikes will take place, won’t the market respond with a knee-jerk reaction because markets usually don’t like money? it’s expensive ?
Yes, this is the reason why the Fed has pursued its loose money policy for a very long time and the rate hikes still have not happened, especially with the previous idea that what happened the last time in terms of typing tantrum and all that. But like I said, for the first time, inflation is becoming a factor.
As central banks the point is that for a while inflation was classified as temporary and only because of supply constraints and if I were a decision maker the hard part would be that at least one part of the inflation comes from the supply side – whether it is bottlenecks in shipping and ports, or because of certain climatic events in Brazil that have pushed up the prices of agricultural commodities. So it’s not just demand-driven inflation, although in the West there is a component of demand-driven inflation as well, given all the government support that had been given to citizens.
So this is a difficult situation because if you go by macroeconomic theory and let inflation run for some reason, inflation expectations go up and it becomes a self-fulfilling prophecy and the worst case scenario is. stagflation. It’s not my high probability outcome at all, but I’m saying these other things central banks should be dealing with. The expectation, even to this day, is that after the hikes they might need to backtrack, so we’ll have to see how the story unfolds.
You can move the portfolios you manage from one sector to another, but the message is that the allocation to equities as an asset class is not going to change significantly for 2022?
Not yet and part of the reason is that the uncertainty over fixed income is likely even higher. This is the reason why we might consider other smaller asset classes, but fixed income as an asset class faces great uncertainty. In fact, until 2021 I found out that in our global fixed income portfolios we had to manage it much more actively than we had to manage the equity side and we did extremely well for the year.
That aside, on the fixed income side, as a strategy we had to revisit it every month, month and a half and made a lot of changes along the way. As we sit today, all the uncertainties we are talking about are magnified for fixed income, because when you talk about macro, the impact of policy on fixed income is even more direct than for the actions.