Talking Points This Week: Is It Safe To Swim In This Storm?

In ‘Talking Points This Week’, Niraj Shah studies how top business leaders and market makers are navigating the fast-changing financial landscape.

It is imperative to ask if this is a recovery from a dip that you have to buy right now. Yes, all past dips have been bought into, but can this be different, and can it be prolonged? Multiple factors are at play, which I write about here. The point is, the war has left serious damage on the markets, even if ceasefires are being attempted. Some commodity costs are projected to damage many countries' GDP, as cost pressures force newer modes of spending that take budgets away from planned expenditures. Weakening currencies don't quite help either. Here are the key talking points for this week.

DIIs Emerge As Tugboats

Foreign institutional investors have exited positions in the Indian markets in droves, especially if one looks at the secondary markets over the last 11 months. The selling pressure has intensified in 2022, with FIIs selling stocks worth around $8 billion in the current year. Historically, the relative performance of India's stock prices to emerging markets would have turned adverse in reaction to oil price increases caused by supply outages. This time, the Nifty has corrected around 5.5% year-to-date, while the Kospi is down over 10%. Among advanced economies, the DAX is down 16% YTD.

This relative outperformance can be attributed to many hypotheses. A Morgan Stanley note last week details factors like policy certainty, declining oil intensity in GDP, calm in the currency and rates basket, and a rising share of FDI in external balances.

Another obvious factor seems to be the strength of domestic institutional investors as well. The same note shows how DII flows have been on an upward trajectory since June 2015. After a bit of a pullback in the aftermath of initial Covid-19 uncertainty, DIIs have shaped up very strongly even as FIIs continued to sell. Can this continue? No one knows.

The trends are strong and it doesn't seem like the domestic investor is buckling down in a hurry. But do remember, the new breed of investors has not seen a prolonged dip. Most dips in the last 18 months have been swiftly bought into. Will that new investor continue to stay put with existing investments/SIPs? A behavioural question that is not an easy one to answer. The bigger question is whether this resilience is the calm before another storm or is it a new growth paradigm?

Surfing The Commodity Price Wave

Oil was on the boil. And as rapidly as the commodity rose, its cool off was as dramatic, when Ukraine and Russia announced a ceasefire on Wednesday, to allow the evacuation of civilians. It has since continued to cool off and is now trading at levels below $110, especially after Russia assured that it will fulfill its supply obligations. The larger point that remains is Ruchir Sharma's assessment of the world having underinvested in energy. That may bring about sharp spikes in the oil complex.

Wheat prices touched all-time highs and its price surge has been swifter than oil. The breadbasket of Europe being attacked has led to supply disruptions and fears of more to come, leading to the basic commodity having a run unlike it has had in many years.

London nickel prices soared as much as 30.7% on Monday in one of the most extreme price moves ever seen on the London Metal Exchange, as fears over Russian supplies leave buyers exposed to a historic squeeze. The moves were so severe that it prompted the LME to halt trading in its nickel market. The metal is used in stainless steel and lithium-ion batteries and Russia accounts for around 7% of its global production. While prices had cooled off, they may remain much higher than before, on average.

All of these point to probable high inflationary pressures. And the U.S. CPI print, while predating the above factors, is starting to look ugly.

Defence Rush: A New Anchor?

Germany announced Sunday it was committing €100 billion ($113 billion) to a special armed forces fund and would keep its defence spending above 2% of GDP from now on. It was one of the most significant shifts in European security policy over decades.

China's defence budget rose by 7.1%, the fastest pace in three years. Observers say China's actual defence spending is far higher than obvious, as several key projects are accounted for under different heads in the budget accounting, such as the space and nuclear programmes, the stealth fighter, as well as construction of ships and aircraft carriers.

Even smaller economies like Denmark made their largest defence investment in recent decades. Andrew Holland of Avendus believes that if an investor were to be investing in Europe, the top sector would be defence. Back home too, a recent flurry of notes on defence sector stocks seem to suggest that the sell-side is bullish on defence spends in the country. Some of the production may even be for exports, says Holland. Note that before this situation unfolded in Ukraine, Budget 2022 allocated Rs 5.25 lakh crore or $70.2 billion, an increase of almost 10% over the budget estimate for Budget 2021. The allocation is equal to about 13% of the government's total expenditure for the year. With these jumps in defence spending, every nation wants to be as atmanirbhar as possible following Ukraine's experience.

U.P. Elections: Passing By Unnoticed

As the BJP won Uttar Pradesh, Yogi Adityanath was set to become the first Chief Minister to return to power in the state after completing a five-year term, and the BJP was the first party to retain power in the state since 1985. From a markets perspective though, this may not have made too much difference because of the global landscape that we are amidst. In normal times, multiple clients would call to ask about the impact of the outcome, says Manishi Raychaudhari, Asia equity strategist at BNP Paribas. But in the current times, he has not received even a single call from a global client to discuss what the results mean from an Indian investment perspective, Manishi adds. That said, key state elections going in favour of the incumbent at the state and centre may indicate political stability going into 2024. Will that help the BJP take policy decisions without resorting to populism for votes? That one negative cog going out of the equation is a good thing. The point about these election results is not whether they make investors happy, but that an uncertain result may have added to the stress.

All in all, volatility has come back with a capital V. Market dynamics were becoming significantly more complicated and the degree of difficulty around money management, whether individual money or investor wealth, has appreciably risen. The geopolitical conflict has opened up tail risks that a lot of people cannot even comprehend, let alone analyse. Maybe, as advised by a veteran trader, amidst a period of potentially epic volatility and risk transfer, an investor's instinct should be to approach the path ahead with a high degree of both humility and simplicity.

Niraj Shah is Markets Editor at BloombergQuint.