Global
The US 10-year-bond yields spiked over #1.5% last month, as inflation fears rose. But more than that it was real yields which contributed to overall yields. Hence, we believe that the recent increase in yields is largely a function of improving growth expectations. Nevertheless, inflation risk should not be discounted.
The fear of inflation is largely stemming from (i) higher commodity prices (ii) temporary disruption to transportation (namely container shortage) which is pushing costs higher and (iii) President Biden’s proposed stimulus package. We believe these factors are transitory in nature, and the first two will ease as the global economy opens more and companies increase their capacity. In the short term, therefore, we feel bond yields should settle around current levels.
That said, market volatility around inflation concerns will remain. We believe the real test for inflation rise may happen towards the summer if (i) the success of the vaccine leads to the full re-opening of economies and as this occurs people start pent-up spending from their savings (ii) unemployment falling as companies start to re-hire, again leading to additional spending and (iii) the full impact of stimulus packages feeds through to more spending. All of this could push up prices and therefore would be viewed as more “sticky” inflation going ahead. Inflation with improved growth is always equity positive, though value and cyclical sectors tends to do well.
We do not expect central banks to react by raising interest rates, but the markets will try to price in when rates might rise and hence volatility may remain high.
Thereafter, focus will be on the good news that the global economy is on the growth track, and the markets can live with higher rates in the future. So higher inflation does necessarily lead to markets performing poorly in the long term ( as in 2004-2007).
However, any misstep by the FED could lead to problems in the credit markets where borrowings are huge and any slight uptick in real interest rates will have a significant negative impact with many companies falling into bankruptcy. That would lead to a risk-off trade with currencies weakening in emerging markets.
India
GDP growth turned positive in the 3rd quarter after registering 2 consecutive quarters of GDP contraction. Growth, though marginal, was driven by manufacturing, construction, and financial/real estate sectors. After a long hiatus we are seeing signs of real estate recovery with registrations improving and cement demand also improving. We are closely monitoring real estate recovery and currently not calling it a big cycle ahead yet.
Last earnings season was better than estimates and, most importantly, it was a broad-based performance. The outlook shared by most corporates was pointing towards demand sustaining into the recent months. However, few sounded out risk to margins due to rising input prices and logistic costs. While inflation is a near term earnings risk, this could be long term positive if demand remains strong despite high inflation.
The pandemic risk is ebbing globally, UK talking about reopening, but we have seen instances of second tide (not wave) in India. Hopefully, it should be contained and not lead to strict lockdowns.
Portfolio Stance
From near term perspective, we turn neutral on broader market as the volatility may remain high. Inordinate movement in commodity and bond prices may impact equity valuations in the near term. In this context we maintain our positive view on cyclicals, especially on financials, industrials and global commodity plays. We maintain a neutral view on IT and Pharma sectors.
Significant market liquidity, lower interest rates and improvement in growth outlook makes us positive in the medium to long term perspective.
#Sources: Bloomberg