The Week’s Talking Points: Multi-Speed Lanes... In Monetary Policy, Earnings, And Equity Buckets
In ‘The Week’s Talking Points’, Niraj Shah studies how top business leaders and market makers are navigating the pandemic-altered financial landscape.
It was a big week, with multiple central bank meetings and a storm of data releases that revealed how major economies performed amid paralysed supply chains.
The Bank of Canada signalled that rate hikes are coming and ended its bond-buying stimulus programme amid worries that supply disruptions are driving up inflation. Meanwhile, the European Central Bank pushed back against speculation of early tightening as Europe grapples with the energy shock. Brazil made the largest move, with the central bank hiking rates by 150 basis points, the most in 20 years. And the curve between U.S. 20- and 30-year yields has inverted for the first time since the American government reintroduced a two-decade maturity in 2020, a clear sign of the global bond markets getting whipsawed.
Meanwhile, in India, RBI Governor Shaktikanta Das got reappointed for three years, in a sign of continuity that should please the hawks and doves alike. In America, the first estimate of GDP for the third quarter, which was released Thursday, showed a sharp slowing down, even though there were a few markers that were better than what they appeared at first sight.
Inflation Tantrum Ahead, If Not A Taper Tantrum?
Including what follows in the piece below, enough has been written about the rising commodity prices and rising wages due to apparent labour shortages, augmented this time by supply-chain problems which are creating inflationary pressures. While companies may selectively combat inflationary pressures, the question is whether global equities will continue to range-trade below recent highs without going into a full-fledged bear market as a result of this inflationary threat in an opening-up world. Sadly, even that's not clear, considering the rampage that the variants of the virus are on currently in some parts of the world. Hence, a stuttering start to a post-vaccinated world recovery accompanied by a possible rise in inflationary pressures may not augur very well for equities. Time will tell if we do indeed hit stagflation or not.
Locally, Margins Are Not At The Margin Anymore
Investors are counting on earnings to support equity prices and globally, the reporting season has been pretty okay. But worries remain that, over time, rising raw material and wage costs and supply-chain snarls could crimp margins. Locally, we are starting to see signs of this. Be it in chemical companies (Deepak Nitrite Ltd., Tata Chemicals Ltd., and Navin Fluorine International Ltd. showed chinks in their armour), pharma companies like Lupin Ltd. and Laurus Labs Ltd., or FMCG companies at large. And margin worries are impacting insurance companies as well, where reinsurers have indicated another price hike, and negotiations are on between the two. Clearly, margins are not the peripheral argument in the results, but taking centre stage as the most important metric in quarterly numbers. On their part, corporations are doing all things possible to combat that. HDFC Life Insurance Co. says it will follow a risk-based pricing model to protect margin across segments, Asian Paints Ltd. has announced a 7-9% price hike and Persistent Systems Ltd. has announced giving ESOPs to 80% of its employees to contain attrition and, thereby, costs. Will that help protect margins and, therefore, earnings? That’s a million-dollar question. But we are already seeing that the world over, the earnings estimates are being reviewed. This chart says it all:
EM Equities Stuck In Slow Lane Of Underperformance, But...
It can safely be said that 2021 is a washout year for emerging market equities as a group. Largely. While the MSCI EM index is now poking its nose above the zero line in recent days, the underperformance is high. This point is a stark contrast to what was happening at the start of 2021 when the reverse was true. Three factors can partially explain why emerging markets might be underperforming the developed peers: i) China's reset; ii) the strong dollar and iii) rising U.S. market rates and yields. All three are still at play. If anything, ravaged by the pandemic, the growth scenario in emerging markets looks particularly vulnerable.
Yes, there are outliers. India has performed very well, and while growth may not be as much in question, inflation hawks will tell you that things are not looking as strong on that front. Yes, Russia has done very well too, and the natural resource pricing suggests that the country will have a hot winter, but the coronavirus is a menace again there. In such a scenario, when one is looking at a U.S. Fed taper come November, is it plausible that the global investor will think twice before investing in any emerging markets? Within that, can India be an outlier? Subject to some domestic factors, the answers to those questions could be... yes, and yes.
Geopolitics Is The Joker In The Pack
From an international perspective, the U.S. cancelling permission for China Telecom Corp. to operate in the country, or its Secretary of State Antony Blinken calling for countries to join the U.S. in pressing to give Taiwan a greater role at the United Nations are clear signs. Add to that, Taiwan President Tsai Ing-wen confirmed U.S. troops are training soldiers on the island and expressed the belief that the U.S. will come to Taiwan's rescue if Beijing were to attack Taiwan. But what is front and centre for Indian markets is India deploying recently acquired U.S.-made weaponry along its border with China, hours after testing a nuclear-capable missile. Rajeswari Pillai Rajagopalan, director of the Centre for Security, Strategy, and Technology at the Observer Research Foundation, asserts that India’s border buildup shows frustration with the lack of progress on talks with China and that there’s not much hope that things will be resolved anytime soon.
If there is one thing that stop-start economies don’t need amid broken supply chains and rising inflation, it is a military confrontation between large powers like China and the U.S. or India.
May the period of the festival of lights ensure that the diplomatic equations don’t stumble, and there be peace across regions. Let there be light!
Niraj Shah is Markets Editor at BloombergQuint.