Dear Reader,
Just a few weeks ago, the markets were fixated on inflation. The story was that the waning of the pandemic together with the rapid pace of vaccination would lead to an upsurge in growth, as demand came roaring back. Since supply would take time to adjust, this would lead to high inflation, central banks would have no alternative but to hike rates, bond yields would rise and the rally in equities would fizzle out.
That narrative has now been turned on its head. The question du jour in the markets is: If the markets are going up because of the reflation trade and if US growth is so strong, how come US bond yields are falling? That niggling doubt has led to the latest bout of nervousness in stocks. Robin Brooks of the Institute of International Finance tweeted, “We’re in a growth scare, with real 10-year yield down to -1.0%, where it was in 2020 during peak COVID. This is “risk-off” for EM.” Nobody seems to be talking of President Biden’s huge push to infrastructure now.
What do the data say? The JP Morgan Global Composite PMI for June showed strong overall growth in both manufacturing and services, albeit it has lost some momentum, primarily due to lower growth in Asia, which bore the brunt of renewed infections. India’s Composite PMI for June, for instance, indicated a contraction in economic activity from the previous month. For the US, though, the PMI survey said “the rate of growth in activity was substantial and the second-fastest on record”.
On inflation, the Global Composite PMI press release said, “Capacity issues across global supply chains meanwhile resulted in increased costs, with input price inflation staying close to May’s near 13-year high. Output charges also rose at a near-series record pace.”
The data, therefore, seem to suggest that the strong growth and inflation scenario continues to hold. Why the scare then? There are several explanations. One could be that markets are buying the central bank line that any rise in inflation will be temporary. Bond markets are looking through current inflationary pressures. Another is that current growth is just due to pent-up demand, with some saying that growth has peaked — as the stimulus cheques stop, the argument goes, demand growth will slow down. A third explanation points out that nothing much has changed in growth or inflation data, so the fall in US bond yields must be technical in nature. Another says supply chain difficulties are getting resolved and inflation will soon start coming down — China has very recently signalled that they may cut the amount of cash that banks are required to hold as reserves to support growth as inflation fears dissipate. And then there’s the worry that the Delta variant of COVID-19 poses a threat to the recovery. This FT story lays out some of the explanations.
Back home, RBI Governor Shaktikanta Das has said the rise in inflation is temporary. Nonetheless, he has his hands full in keeping bond yields down despite the large fiscal deficit. Our Recovery Tracker shows that growth is coming back rapidly, although there are headwinds from higher oil prices, while the monsoon has hit a dry patch and our Herd Immunity tracker shows a slowdown in the vaccination drive. Nevertheless, robust earnings expectations could cause a melt-up in the markets, although it may finally end in tears.
The melt-up will be a bonanza for a set of financial services stocks that will benefit the most from the increase in market capitalization. In a melt-up scenario, US SPACS may well become the instrument of choice for Indian start-ups.
The IPO frenzy continues and we analysed the prospects of Clean Science and Technology and GR Infrastructure. The India Pesticides IPO reflects the success of India’s chemical industry. Even the government is losing no time in cashing in, as its NMDC offer for sale shows. The proposed Zomato IPO is making waves and we took a look at what investors should track in the food delivery business.
There are, of course, ample opportunities for bottom-up stock picking. Among banks, loan growth at both HDFC Bank and CSB is far above the industry average. Some stocks may face near-term pressures, but have a good long-term story, such as Gujarat Gas, Hawkins Cookers, TCS and Ujjivan SFB.
Improving growth prospects is the theme for stocks such as Titan, Godrej Consumer and Bharat Dynamics. But we did take into account some of the concerns on inflation in our analysis of Marico and on the chip shortage for Tata Motors, while we advised investors to keep a watch on prices for Tata Steel. Sumitomo-Mitsui’s acquisition of Fullerton tells us the worst is over for NBFCs.
Apart from the pandemic, there are several other disruptive forces that will change the face of business. The most obvious of these is climate change, which has led to the greening of business — 128 firms with $ 43 trillion assets under management have now pledged to meet climate change goals. A group of fund managers in charge of $ 6.6 trillion of assets believes that nations should have a common range for the price of carbon. In our Green Pivot series, we looked this week at EV batteries and at Amara Raja’s plans. Another huge disruptive force is the Cold War between the US and China, of which Didi Chuxing is the latest victim.
Which camp is right? Those who see higher inflation, or the deflationistas? A year ago, we had written a piece titled, ‘Inflationary fires or deflationary ice?’ on the theme. The reference is to a poem by Robert Frost that starts with the lines, ‘Some say the world will end in fire/Some say in ice’. It’s possible, of course to have both fire and ice, which is stagflation. The best case is that central banks will be able to deftly steer a course between the two.
As for the markets, perhaps they have run up so fast they are searching for reasons to correct.
Cheers,
Manas Chakravarty
