In my previous letter I had made three important suggestions: One, remain invested in this bull market preferably in high quality large-caps in financials, IT and construction-related segments; two, book some profits and move some money to fixed income and three, increase the exposure to gold. The suggestions to move some money to fixed income and increase the exposure to gold were based on the simple logic that markets were over-valued and therefore vulnerable to corrections. I never thought that the Russia-Ukraine tensions would lead to war. But the unexpected happened.
Stock markets, globally, turned weak after the outbreak of the war. There have been sharp corrections of above 10 percent in most markets and some like Nasdaq and Dax corrected by 20 percent from the peak indicating weakness. Nifty corrected 15 percent from the 2021 October peak.
During a war, unexpected things can happen. The situation is very fluid. The immediate economic impact of the war has been the surge in the prices of commodities, particularly in crude. Crude has shot up around 60 percent from 2021 October levels. If the war continues and crude price remains elevated, it will impact the economy.
When the RBI projected 7.8 percent GDP growth and 4.5 percent CPI inflation for FY23, the central bank assumed crude to average around $80 for FY 23. This assumption is now way off the mark. GDP growth can be lower and inflation higher than projections. Unless there is a dramatic end to the war, crude price will be a major macro headwind for the Indian economy. FPIs may continue to sell in India and move money to commodity-exporting emerging markets, which are likely to gain from the price surge in commodities.
Since the element of uncertainty is very high, it is very difficult to anticipate the likely market trend. A quick de-escalation of hostilities may bring cheer back to markets. Elevated gold prices would come down. But we don’t know how the situation will evolve.
Investors should follow a cautious investment strategy. A Bottoms-up approach would be the right strategy now. There are segments and stocks that would be unaffected by the war, and even gain from the war. Such segments like energy, metals, IT and pharma/health care stocks have already appreciated. But when the war ends, energy and metal stocks are likely to correct. IT is likely to remain resilient.
There is a major market mispricing happening now. Sustained FPI selling has beaten down high-quality financials and their prices are attractive. Leading private sector banks, couple of PSU banks, housing finance companies and the leading Fintech companies offer value-buying opportunities. When the situation normalizes, this segment is likely to give the best return in the medium term to long-term.
