Making sense of financial turbulence

Watching the markets is easy. Predicting outcomes is the hard part. As they commonly say for economists – For every opinion, there exists an equal and opposite.

This week US Federal Reserve increased interest rates by 75 basis points taking it to 3.25 per cent, which is the highest in 10 years. Host of other countries followed suit. Switzerland broke a 7 year streak of negative interest rates by a matching raise.

An inflation rate of 8.3 per cent, highest in 40 years, has forced the Fed’s hand. Inflation has become a global problem with all top economies experiencing record highs. The Euro area is afflicted with an inflation rate of 9.1 precent. The UK also breached a 40 year record with a high of 9.9 per cent. Canada and Australia have also reported figures of 7.6 per cent and 6.1 per cent, respectively.

The primary reason for high inflation is the populist choice of printing currency and infusing liquidity to first overcome sluggishness and later combat the economic aftermath of Covid-19. During the pandemic, G-7 countries infused $8 trillion into their economies. American households added $38.5 trillion to their wealth, between 2020 and 2021, as estimated by the Federal Reserve. Of this, top 1 per cent households cornered $12 trillion. During this time, the share of stocks in portfolios went up from just under 40 per cent in 2007-08 to well over 60 per cent, according to Bank of America. And US Stocks multiplied by 8 times. One cannot help but reserve mention of the millennials, meme stocks, and social networks to the meteoric fuelling of the markets. This new generation of investors poured money into markets seeing it as a one-way street which goes up & up.

In fact, many a fund manager were left devastated by gravity defying growth in stocks propelled by investors empowered with Reddit Message Boards and Brokerages like Robinhood. The asset bubble was all too familiar and reminiscent of the period leading to the sub-prime financial crises of 2008.

With the infusion of liquidity and protracted near zero interest rates, US inflation rose rapidly. From acceptable level of around 2 per cent, US inflation jumped to an annualised rate of 7 per cent in 2021. A small section of market pundits warned every now and then about the Fed reacting too slowly.

Democratically elected governments are known to be wary of making harsh moves which may cause recession, unless a force majeure event is thrown up in their face. Such a situation arose with the Russian invasion of Ukraine on February 24, 2022. Around the same time, China commenced with its zero Covid policy locking down city after city on the emergence of slightest of cases. Both of these developments fuelled supply side disruptions and accelerated inflation.

Finally, in March 2022, US Fed raised interest rates by 25 basis points. It shook the markets. Bloomberg reported a $11 trillion wipe out in the following two months. In recurring moves, US Fed raised rates, taking it to the present level of 3.25 per cent. The aftermath is before us. S&P 500 having hit a high of 4,766 points on December 31, is down to 3,656, when markets closed on Friday, a fall of over 23 per cent (officially termed, a bear market). S&P 500 is regarded as the best single gauge of large US companies and covers 80 per cent of market capitalisation.

Despite the beating, the index is still trading at 18 times earnings, implying there is room for further correction. Technology heavy NASDAQ is down from its high of over 16,000, in November 2021 to below 11,000, a drop of over 31 per cent.

The NYSE FANG+ Index (Facebook, Apple, Amazon, Netflix, Google) has fallen from a high of over 8,000 to 4,788, a decline of 40 per cent. Clearly, investors’ over infatuation with Big Tech, Space Tech, Green Tech, EVs, Cryptos and even more so with start-up technologies is not holding up.

Bitcoin’s value has hurtled from $67,000 to a low of $17,601 by June 2022. In a space of just seven months, the world witnessed a $2 trillion wipe out, affecting millions holding crypto currencies.

Year-to-date losses from the likes of Amazon (-34 per cent), Meta (-60 per cent), Zoom (-73 per cent) and Shopify (-80 per cent) have fundamentally altered investor perception. High-profile collapses, such as the blood-testing Theranos or the co-working space sharing supernova WeWork, or a $23 billion write down by Softbank, have been a wakeup call for funds.

The US housing market, which is a big driver of the economy is reported to being seriously impacted with mortgage rates finding a new high of over 6 per cent.

Monetary medicines are always a painful treatment for which currencies, commodity prices, capital flows and trade have to brace for impact.

With rising interest rates, the US dollar has strengthened leading to world’s currencies being tossed around. The euro, British pound, yen, yuan, Indian rupee, and Australian dollar have all sunk.

The euro slid to its weakest since 2002, while pound sterling hit its lowest in 37 years. Last week, Japan had to intervene in currency markets to defend the yen for the first time since the Asian financial crises of 1998. The Indian rupee breached 80 this week, a big psychological resistance level.

In commodity markets, the rout has been no less. Oil (Brent) after touching a high of $128 in March is hovering at $87, a fall of 32 per cent. Gold crossed $2,050 in March 2022 but has fallen to $1,664, down 19 per cent. Metals – copper, aluminium, iron ore, tin – are all down since April of this year.

Iron ore,on which India imposed steep duties citing domestic availability, has fallen by 33 per cent over the last four months. Similarly, fertilisers (DAP & Urea) have dropped sharply in last four months but remain highly elevated when compared to prices a year earlier, while phosphate and potassium remain more than doubled.

Food and grains have also tapered, of which edible oil most so, though they remain higher by double digits year-on-year, causing continued concern to policy makers about food inflation.

The Baltic Dry Freight Index, which is a bellwether for international trade, had raced to over 5,600. London’s Financial Times said in an article published on September 8, that in just last three years, the container shipping industry has made as much money as in the previous six decades! In the last few months, this index has tumbled to a humbler 1,550, down by 64 per cent.

Neither is the war over and nor are China’s intermittent lockdowns. Shipping freight rates are a pure play of demand expectations.

By now, the question in every reader’s mind will be – whether India’s booming economy and stock markets will be impacted and how? In an opinion published in FT on May 23, Ruchir Sharma, Chairman of Rockefeller International said: “Fed tightening has led to a range of outcomes for the economy, from hard to softish landings, but has always led to financial crises somewhere — including every major global crisis in recent decades.”

So the answer is an emphatic yes, but how profoundly, only next few weeks will reveal. The immediate impact of the current adverse global developments is going to be on the Indian stock market. Sensex declined by over 1,000 points on Friday.

With rising cost of capital and “risk-off” sentiment amongst money managers, financial markets will witness a “flight-to-safety”. To the extent that Indian stock market is dependent upon foreign flows, Sensex stands vulnerable. A decline in FDI can also be anticipated because rising interest rates and depreciating exchange rate, both will affect returns in dollar terms.

India’s IT sector is particularly vulnerable to overseas economic environment. NIFTY IT Index has fallen from a high of 39,447 to 26,592, a decline of 30 per cent. Next in line would be the funded start-ups. Going by recent press reports, for instance, around Byju, Oyo, Urban Company or on the stock price performance of Zomato(-56 per cent), Paytm (-48 per cent), Nazara Technologies(-36 per cent), Nykaa (-38 per cent) indicate that the days of astronomical valuations, even in face of runaway losses, and bottomless funding are over.

(Sadhika Kumar is an Alumuni of UC Berkeley and an IT entrepreneur based in Delhi)




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