Sahil Kapoor is the Head Products and Market Strategist at DSP Investment Managers
The once-in-a-generation rally in US dollar against a basket of major currencies in 2022 has caused unintended mayhem in global financial markets.
The US Dollar index, which measures the currency against a basket of other major currencies, has soared to its highest levels not seen since George W Bush’s first term as the US President.
The index is currently perched at 112 after having fallen to multi-year lows of around 89 in 2021. The strength in the US Dollar has seen the Indian rupee sink to record low levels of more than 82 per dollar while other emerging and developed market currencies have also taken a beating.
“When you look at all the data points, you know that we are at an extreme, the dollar rally is unsustainable,” Sahil Kapoor, head of products and market strategist at DSP Mutual Fund told Moneycontrol in an interview.
Kapoor believes that the current macro-economic set up in terms of rising US interest rates and shrinking global liquidity that is favouring the dollar’s ascent is most likely to flip going ahead.
“I don’t think the status of the dollar (as world’s reserve currency) is under threat but what’s happening right now is that US dollar is overvalued on all historical parameters,” Kapoor said.
Edited Excerpts:
How are you assessing the current global investment set-up? Are there signs or signals that are making you a little worried?
Kapoor: So let’s look at it in two parts: one, what’s happening with the economy and the other is what is happening with the markets. When you look at the economies, globally, specifically the developed world, about two-thirds (US, EU and China) of the global economy is either slowing, or is already slow. For example, in the US, half of the economy is already in recession, which is the goods part whereas services side is now slowing.
When you look at the Eurozone, it is already in recession while China is already very slow, but it’s trying to reverse course. So from a global economy standpoint, it’s very clear that the world economy is in a stage of neutrality-to-slowdown. But when you look at the rest of the world, largely you are seeing that very few countries are able to withstand this slowdown. And when you look at India, the Indian growth story appears to be much stronger and much more resilient than other countries.
Historically, we haven’t seen Indian economy decouple but I don’t think there is any reason to say that it cannot. There are reasons to believe that India will have its own path. We will slow down along with the world economy, but our slowdown or the growth that we give up will be much less in comparison to what the world is doing.
The other aspect is markets. I think they are very different from what the economy’s doing right now. The reason for that is that, globally, when you look at stocks, they have given up a huge amount of valuation premium over long-term averages. When we entered 2022, for example, the S&P500 was trading upwards of 25-26 times earnings and India was trading at 24 times. Today, US small cap index is trading at 13 and a half times trailing earnings, which is a 40-year low. However, S&P500 is today trading at 17-17.5earnings, which is at its long-term average. Indian stocks are trading at about 20-20.5 times earnings, which is again near its long-term average. We are no longer expensive. We have given up the expensive valuations and, therefore, I think the risk in entering the market is much less than it was a year ago. We are more comfortable with where valuations are, and any market which is trading at average or below-average multiples and exhibits growth in earnings, I think they will continue to do well.
Dollar’s strength seems to have taken many by surprise. Are you concerned by the persistent strength of the dollar and what could be the long-term implications of it for our economy?
I think we are at an extreme right now in terms of the US dollar’s strength. The most important reason for the dollar’s strength is that currencies are not priced in what a country is doing, they are priced in what the competitors are doing.
What has happened with the dollar right now is down to weakness in the other three major economies, that is, Europe, the UK and Japan. Also, these three regions have no major technology companies and, lastly, they have been so far away in terms of real interest rates to the US that even fixed income money has moved to US bonds.
When you look at flows, US Treasury Bonds received net inflows of $ 880 billion in the last 12 months, which is the highest 12-month investment inflows into US bonds even at time when US bonds are falling. US stocks over the last 12 months have witnessed $ 248 billion in outflows. This is called ‘flight to safety’. And this is something which has supported the US dollar to a very large extent.
Also, the real effective exchange rate for the US is at 111-112 level. Right now it is higher than it was in 2000-2002. So when you look at all these data points, you know that we are at an extreme, the dollar rally is unsustainable.
What do you make of these theories around dollar’s demise as global reserve currency?
I am not a fan of these conspiracy theories about dollar losing its status as the reserve currency of the world. For now, there is no global competitor to the US dollar. No country in the world can absorb as much trade deficit as US does and there is no bigger naval power in the world which can challenge the US right now. I don’t think the status of the dollar is under threat but what’s happening right now is that US dollar is overvalued on all historical parameters. Over the next year, there is a possibility that the current global setup, which is favouring the US dollar, will slowly go away.
How does the ongoing global energy crisis feed into this dollar shortage issue?
I think the energy crisis is ebbing. First, there are no shortages, which are not followed by gluts. So there is going to be a glut of energy supply going ahead. And largely, it’s getting reflected in how OPEC is now behaving. It had a very small 100,000 barrels per day cut in output earlier and now another cut of two million barrels per day. This shows that OPEC is concerned about the imbalance of the oil market.
About two months ago, I was struggling to tell people that the energy market wasn’t tight, even though everybody on the Street was saying that energy markets are too tight. The supply did not ever go away. It was expected to go away but it did not.
And just before the Ukraine war broke out, I said that it’s very difficult for oil to enter the $ 120 per barrel zone because there is no extraordinary demand for oil. You will be surprised to know that in the last five years, the absolute demand for oil has not gone up by even one million barrels a day and, in fact, it’s actually falling. So I think there is a case for energy prices to cool down. What’s happening right now is that there is a supply chain change occurring and it is very painful. And that’s what we are seeing in the natural gas market. I think the supply chain issues in the oil market will get resolved in the next few quarters.
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