It was a tough Monday but I guess that was necessary. Are we in for a tough quarter or a tough second half?
We must remember that we have had a dream run. From Covid bottoms, the market has rallied almost 130% plus. It has been a crazy, unbelievable one-and-a-half year and this has not just happened in India, it has been global in nature. All country world index, global markets have had a 100-110% kind of move. India has been the best performing market. Whether it is from the Covid bottoms or whether it is on a three-month or one-month basis, we have been a spectacular outperformer as far as the whole global market scenario goes.
Now we went back and realised that this is something which we have not seen before and we realised that whenever markets crash — whether it was the 2000 IT crash where the market fell 50% or 2008 financial market crash when the fall was 60% plus — the markets always recover in this spring like fashion. So in 2003-2004, we had a very big bull market when the rise was about 120%. Then in 2009, post the crash led by the Lehman crisis, the market went up 180%. So in the first phase after a big crash, the market always has a similar spring action but we all know that this momentum or this kind of action cannot continue.
Post these, we observed that the markets take some time. They have a consolidation and they may spend a few months sideways and the index levels that we have seen earlier, may take some time to come off. I personally feel that we are getting into a consolidative phase. There is no massive negative news. There is the Evergrande crisis, but the market always throws up something when the days are down and throws up something good when the days are up. But as long as there are no big triggers, global markets and more so India, would go into a phase of consolidation and this will be more of a time wise correction. After the 2004 pullback, we realised that. After the 2009 move, the market spent about three years sideways.
So post a very big rally, markets need time to consolidate. They need time to correct and I personally think that we will have a time-wise correction. However, the interesting part is that when markets go through time-wise correction, that does not mean stocks do not do much. In fact, in the first stage, everything goes up. The more beaten down sector or a stock is, the more it tends to do better in percentage terms. But post that, when we go into a consolidation, the markets tend to bifurcate and some sectors, some stocks do very well and some do not do very well.
I guess we are heading into that stage where the market will start having a differentiated character, rather than everything going up together. Some sectors will do well and some will not do well. There are three stages in a bull market – a vertical climb, a consolidation and then the next rally continues. I feel we are ending the first leg and we should get into a phase of consolidation. However, there is still money to be made because stocks and sectors will show differentiated character and this is where stock picking skill will help.
There are two popular sectors – one which saw a fall yesterday and the one which has not seen a fall – IT and metals. What should traders who have made money in metal stocks and in IT stocks or maybe both should do now?
IT has been a rank outperformer and not just in India, but globally also. Nasdaq has outperformed the S&P500. Technology sector indices the world over have outperformed and this has been the big trend. Again, the risk is that because they have run up, they will correct. Yes they will, but early leaders or early breakouts which technology has shown, very often become the mega trend of the rally. I personally think that for a trader, there are always stop losses and levels which are fair enough but if you are a strategic investor and looking for the longer term, one has to be overweight on IT. Maybe the fall can be used to accumulate into something and see how stocks are behaving. Of course, they are getting into the number season and we will get much more clarity in the next few weeks.
Metals, on the other hand, are subject to global prices. It is not that anything specific happens in India. It is actually the movement of the underlying commodity globally. More than metals, one should look at commodities as an asset class, because commodities have an influence on inflation and so on bond yields. When I look at the commodity index, which is the CRB index, I personally think that this is just a correction in a bull market.
Since 2008, commodities had a singular downmove all the way to 2020. We had almost a 12-year bear market in commodities and commodities have broken that trend line. In the bull market first phase, any asset class or any tradable stuff tends to move fast. Commodities also doubled. The CRB went from 100 to 220 or thereabouts, another 120% return. It cannot keep up that pace but I feel that just as we have ignored commodities for the last 12 years because they have been in a bear market, we cannot ignore commodities now. They have broken the trend and there will be cycles. Metals and crude are no longer going to be asset classes you can ignore. So, for a trader, I still feel that commodities will be an interesting place. The only problem is that commodities unlike IT, are very fast moving and chop both ways very fast.
So one will have to be a very skilled trader. But in terms of asset allocation definitely IT is a place I would like to be overweight. The volatility in metals probably is a bit too much for me and so I will avoid that. But it is great for traders. So, each one can use whatever strategy they want but the longer term trend is definitely in IT.
On a scale of 1-10, what are the chances that we have seen the best for the year, for the index?
I would not call the kind of number that we have seen the best of the year. I feel that at an index level, we may not do substantially unless we have some fantastic triggers. But at the end of the day, we are not invested in the index, we are invested in stocks and sectors.
I feel that a lot of sectors will continue to make new highs. The risk is that also on the flip side, the index is going to be in a range. Something is going to gain and then something has to give away also. A lot of sectors may also give way and that is where the risk is because a lot of people get sucked towards this level. One gets a rotation trade like someone is underweight autos but from time to time, when there is a story, an auto stock moves and people get sucked into it. We cannot expect what happened last year to continue. It may be range bound but within that, for investors and for traders, there is money to be made.
Look at those spaces where there are trends. We spoke about some sectors. There are many other themes also that we can discuss which will make money. But use this opportunity of a very inflated market to get out of stocks which may not be very good. How does one differentiate between good and bad? I think earnings is going to be the differentiator of outperformance of portfolios and stocks in the next phase which is a consolidation phase. We will get into a phase where the market will have a K-shaped recovery. Till now, we just had a V-shaped market which just went up. I feel the market will now start differentiating and that has been the nature of consolidations in 2004-05 and 2010-2013.
Given that the froth has begun to come off and historically, even in the raging bull markets, we can fall 10-15%, how steep could the fall be from these levels?
There should be triggers. We had a raging bull market in 2003-2004. We had a change in government in 2004 and there was a change in stance where the whole divestment process was supposed to be stopped. And if you go back, in 2004, the fall was just for two days when the market hit circuits and after that it recovered. So, there have to be triggers, markets will just not collapse or fall. Markets at the moment are set to go sideways. I do not see any triggers per se. If one is in a range, one needs triggers on both sides. There has to be some massive upside surprise for these ranges to get broken out of or there has to be something very negative.
If I look at the markets right now, I do not really see much and that is why I feel it will go sideways. The market will have a time wise correction rather than a very big price wise correction.
Could the trigger come from something global? The riskoff is back in US equity markets. Then there is Evergrande which led to the fall in Chinese property stocks. Plus the all important FOMC meeting will be kicking off. Many believe that come November, taper will be back. How do you read all this?
I think the global triggers are not going to be in equities per se. Yes, the Dow and the S&P are all going to correct and so that is fine. You have an overlap of good days, bad days, pullbacks. Those are normal day-to-day things which go on but the big thing that really matters to me is inflation because in the US and even in India, the whole discussion is whether the inflation is transitory or structural. The Fed feels it is transitional and that has been their stance and that is how they have been handling monetary policy.
A lot of people, especially some of the economists, feel that inflation is structural in nature. In case inflation tends to be more sticky or tends to be more aggressive and violent, that could affect the bond market. One has to remember that for the last decade or more, the single cause of the rally in global equities has been in bonds. So, if the bond market has been vertically downward for almost 12-13 years, in equity markets there is a very good inverse correlation on a decadal basis.
So the big risk to the market is obviously going to be bond yields but in all these problems — whether it is Evergrande or whatever — the one thing that I keep noticing every morning is that the bond yields have been fairly well behaved and hovering around 1.34% in the US; 1.74% was a recent high and 2% would be a very big number to play with.
I think that this is the kind of a range that could play out — tightening, no tightening and Fed statements, But the bond market is going to be the clear lead indicator. If there is one single data point I need to look out for, that is going to play out in bond markets. So, the commentary will happen, narratives will come and opinions will come but ultimately the market speaks. The bond market is very intelligent, probably one of the biggest markets in the world is the US bond market and the US bond yield is a very big influencer. If that remains tame, equities as an asset class would not have any major risk. But yes, the big risk is inflation which will lead to bond yields spiking and that is the time when I would be worried about the asset class or the need to move into cash and things like that. We will have some good days and bad days, some good sectors and some bad sectors, some good stocks and some bad stocks.
What happens to defensives like IT and pharmaceuticals? Will they also have a big impact?
I do not think that you are going to have it all happen suddenly in a day. These are pretty self correcting mechanisms. It is not like bond yields will go from 1.34% to 2% in a single day; it is a very gradual process but even the move from asset classes is not a one-day or a single point decision. It is going to be more gradual and definitely the market will move on to the risk off trade if there is a bond yield risk, So that would be step number two. The bigger step or the bigger issue is inflation.
I feel that if inflation remains and demonstrates that it is transitionary, bond yields could actually have a leg down and that could fuel another big rally. But the question is whether inflation is transitionary or structural. Once the Fed answers that, we could have much more clarity. Every morning when I wake up, I do not look at the Dow or I do not look at the Nasdaq; I look at bond yields because that is going to be the single variable that is going to drive other asset classes and definitely equity is in that.=
