The Week’s Talking Points: Look East. Wait, Look West.
In ‘The Week’s Talking Points’, Niraj Shah studies how top business leaders and market makers are navigating the pandemic-altered financial landscape.
The big week for global markets got off to a messy start with stocks plunging around the world. Safe to blame China Evergrande Group’s woes, which added fuel to the fire. Sadly for the bulls, the endgame for creditors to the Chinese property giant arrived just as traders got in a state of alert before the U.S. Federal Reserve’s meeting midweek. Both fear and greed, but largely fear, ran amok in the trading fraternity. While easy money and assurances of central banks provide liquidity and in turn greed, it is fear that has led to varied hypotheses about what Evergrande does to China, but also to the rest of Asia. As Bloomberg’s John Authers asks: “Will it be a Minsky Moment, akin to the Lehman collapse? Or will it be more akin to the LTCM Moment? Or might it just be altogether less momentous?”
The answers will only come in the future, but it was the biggest talking point at the start of the week, and brought Hong Kong Realty Shares to their knees, as shown in this chart.
Evergrande Fallout, Potential For Contagion
On Talking Point this week, James Sullivan of JPMorgan analysed how severe a backlash this event could have on the Asia-Pacific region. Sullivan believes that the issue is China-specific, and the risks of a very severe contagion are not high if there's orderly restructuring. That is the base case for JPMorgan. Views from Nomura, too, echoed that sentiment. The deeper insight from the conversation with Sullivan is what he sees as a long road ahead for China in the event of a property price cool-off. It seems by design, of course. The current reforms are oriented to deliver an affordable economy to commoners and in that setup, education and healthcare become trusteeships. Property assumes a utilitarian role and is not a speculative asset. Will it impact commodities, which feed off a property boom? Read here.
The U.S. Federal Reserve has adopted an affirmative position on the trajectory of monetary policy normalisation. The insistence on the supposedly ‘transient’ nature of high inflation has waned considerably. While Chairman Jerome Powell did not spell out a fixed timeline explicitly, one can expect the taper to begin in November with the whole package being wound down by June 2022. Over the last few months, the Fed has prepared the financial markets for this eventuality so thoroughly, that the soft manner in which the taper is likely to happen will presumably not hurt equities. Hopefully, the same can be said for the rate increases when they start to happen. Do note that the Fed’s policymaking committee indicated that it expects to start raising its benchmark rate sometime next year—earlier than the members had envisioned three months ago—and only after the Fed had ended its bond purchases.
Is the FOMC concerned about inflation? Yes. But enough to cause ripples in the calm pond of investing—maybe not.
Value Vs Growth In Event Of Swift Taper
On the larger point of the Fed taper, higher rates, higher cost of capital and its impact on stocks of emerging markets like India, Sanjay Mookim of JPMorgan is skeptical about value stocks outperforming growth in the times to come, unless the cost of capital rises dramatically. And his base case is that the cost of capital will not rise dramatically.
“The persistently low overall level of interest rates that our economists expect, and their forecast for real GDP growth that should decelerate to a below-trend pace of 1.5% by the end of next year, should continue to support profitable long-duration stocks with high-quality attributes.”
Leveraged Long On Indian Markets? Words Of Caution
“Markets may not stay immune to global volatility even if strong retail flows (direct or through DIIs) distort the speed of response: links exist for both earnings (e.g., exporters or commodity producers) and multiples (21% FII ownership). We would fade a rise in relatively safe IT, pharma, and buy if domestic cyclicals (financials, industrials) correct.”
“While India is viewed to be a beneficiary of the China turmoil, India's Nifty has already outperformed EM benchmarks by 19-33 percentage points on a 3/6/12-month basis. From such levels, Nifty performance has been weak historically. Also, over the last 6 months, India has received only $1.5 billion of net inflow from foreigners despite the China problems. We see rising equity supply & peak valuations as risks. We further reduce portfolio beta by cutting weight in Tata Steel, SBI, and adding ITC.”
And If You Are Long-Term Long...
There is one more voice in the chorus which believes that Indian markets are slated to become larger. Goldman Sachs, over the past weekend, put out this note that says India will become the fifth-largest equity market by 2024.
“We estimate nearly $400 billion of market-cap could be added from new IPOs over the next 2-3 years, that could drive India’s aggregate stock market value to increase from $3.5 trillion currently to over $5 trillion by 2024.”
That’s likely to make India the fifth largest in the world by market capitalisation, surpassing the U.K. and the Middle East. The big question is, will this eventually bring in the long-spoken-about—but not materialised meaningfully—change in foreign flows, with India being the beneficiary of India-dedicated flows and not EM-dedicated flows.
I’d like to stick my neck out and say, it should.
Niraj Shah is Markets Editor at BloombergQuint.