Four weeks ago, the market narrative was that inflation is back and bond yields will go above 2%. But in the last couple of days, the narrative has reversed. Why are the markets changing their orientation so rapidly?
I have to admit that this bond market rally is very weird in the sense that it has taken place in the context of very high inflation numbers. The bond market rally kicked off in May when we had the biggest inflation number in America for many years.
But then last week, we had another June CPI report in America which was above expectations but the bond market kept rallying. So I have to admit that I am somewhat mystified by the scale of the bond market rally. Many people are attributing it to technical factors like investor positioning, algo trading, etc, but it seems to me that the bond market is taking a very bearish view on this delta variant which started in India and is surging in the Western world. The bond market seems to be worried about renewed lockdowns.
So are we in a repeat of what we saw at the beginning of 2019?
Maybe. The key issue right now is whether the bond market is correct because this delta variant is extremely infectious. So far, hospitalisation and fatalities (numbers) are lagging dramatically in the UK, which suggests vaccine efficacy. The more we see this lag between cases and hospitalisations, it suggests vaccine efficacy. The delta wave in India was dramatic in the way the cases soared, but then there was a big plunge in cases.
Do you think that eventually US bond yields will cross 2%? There is a rally in the bond market, but do you think we could see a selloff also?
We discounted a lot of bad news on inflation and so it was not surprising that the bond market went from 1.7% to 1.3%, but this week we broke key technical levels. We are signalling an inflation, a growth scare. In the long-term, bond yields are at risk of going higher because I am assuming monetary policy and fiscal policy will remain very expansionary. But there is also a possibility that in the coming months the Federal Reserve may do what the BOJ has already done – locking in of bond yields. But for now, that is not the issue that the markets are focussing on. The bond markets are signalling a growth scare and that the economies may not reopen as quickly as previously thought because of this renewed COVID wave. This is all about the pandemic issue and not about monetary and fiscal policy. But you are absolutely right. Four weeks ago, people were talking about inflation and tapering and now the bond markets are acting like the Fed is going to resume balance sheet expansion.
The markets are waiting for clarity on whether the delta variant is going to impact global growth or not. Hopefully by October-November, we would know whether there is a third wave or not. So what happens after that? Do you think that the markets will remain nervous in the next two or three weeks?
If the precedent holds true for the West, then you could be buying cyclical stocks today. But the Indian government did not lock down the economy nationally and there was no political pressure to keep the economy closed. The big difference between the Western world and India is that in the West people are receiving welfare payments for doing nothing. The pressure to reopen the economy is not the same.
So what happens to growth stocks? Typically, growth stocks do well when interest rates are low. Do you see outperformance coming back in growth stocks, whether it is US tech stocks or Indian growth companies?
That is why FAANG stocks have resumed their rally with this bond rally because lower US bond yields are beneficial for discounting the cash flows of companies like Amazon and Facebook that generate a lot of cash.
You have been a long-term India bull and consistent with your view. So given where the growth dynamics are moving, the valuations and crude oil rates, what is your current India positioning?
My Indian positioning always had a growth bias simply because there are many cyclicals in the Indian market. My Indian portfolio is doing fine. But India is different from the rest of the world. India did not shut down at the national level due (during the second wave of the pandemic). My only concern about India is simply a tactical one that the Indian market has done extremely well and valuations are high. We are going to get some big IPOs coming to the market which will generate a lot of interest and they may take some liquidity out of the existing stocks. But any meaningful correction in India, in my view, should be bought into. So I am remaining overweight on India.
So are you making a case that we are still in the early stage of this equity bull market?
Yes, in India. I do realise the risk of a new variant which can be as infectious as the delta variant but more lethal. In the meantime, the good news is that the vaccination rollout is accelerating in India.
