Market bracing for 75 bps-Fed rate hike: Time to fish in troubled equity waters?

0
543
1137346743

With May inflation in the US coming at 8.6 per cent against expectations of 8.3 per cent, the Fed is likely to take a relook at its 50 bp rate hike guidance. The market is now bracing for a 75 bp rate hike by the US central bank. The present trends indicate that the Fed will have to continue with its aggressive tightening, taking the terminal Fed funds rate to 3.5 or 3.75 per cent by mid-2023.

Global stock markets have turned distinctly weak. The mother market on Wall Street is in bear market territory with the S&P 500 falling more than 20 per cent and Nasdaq over 30 per cent down from their respective peaks. The dominant trigger for this weakness is the rising inflation in the US and a hawkish Fed expected to get more hawkish to sound more credible in its fight against inflation.

With May inflation in the US coming at 8.6 per cent against expectations of 8.3 per cent, the Fed is likely to take a relook at its 50 bp rate hike guidance. The market is now bracing for a 75 bp rate hike by the US central bank. The present trends indicate that the Fed will have to continue with its aggressive tightening, taking the terminal Fed funds rate to 3.5 or 3.75 per cent by mid-2023.

Will the aggressive tightening tip the US into recession?

The probability of an aggressive Fed pushing the US economy into recession has increased to around 60 per cent. The US economy is strong now and the labor market is tight; but a 3.5 percent terminal rate has the potential to push the US economy into recession, impacting global economic growth. Markets have not yet discounted a full-blown US recession and its impact on corporate earnings. So, unless inflation shows signs of peaking and then declining, the bearish trends may persist.

FPIs will continue to sell in India

FPI selling which began last October, gathered momentum in 2022, and is high and persistent NSE -1.23 % now. FPIs have already sold equity worth Rs 1,91,000 cr in 2022 till June 13. With the dollar index above 103 and the US 10-year yield at 3.36 per cent, the global macro construct is conducive for further FPI selling. This is the major drag on the Indian market.

It is important to appreciate the fact that FPIs are selling in India, not because they are negative on India, but India is one of the few EMs where they are sitting on good profits and valuations in India are even now much higher than that of EM peers. They have been selling aggressively in financials and IT because these are the segments in which they are sitting on profits.

Opportunity in crisis
FPI selling has opened opportunities for domestic investors in select segments. With Nifty at 16,000 trading at above 18 times FY23 earnings, the overall market is even now expensive, compared to the long-term PE of 16. But there are segments of the market which are attractive and buyable now.

Financials, particularly leading banks, top the list. Valuations of leading private sector banks are depressed, not because of concerns regarding their fundamentals, but because of relentless FPI selling. In fact, fundamentals of this segment have improved and are further improving. India’s industrial output, as measured by IIP, has improved to 7.1 per cent in April indicating robust economic recovery. This augurs well for the banking sector which is now in the pink of health with falling provisions, declining NPAs and rising credit demand.

The rising interest rate scenario is another tailwind for banks since it will boost the margins of banks aided by deposit rates lagging lending rates. In brief, the leading financials, particularly the big private players are good buys for the medium to long-term. For investors with a one to two-year investment horizon, this is a good investment opportunity with low risk.

Safe bets
FMCG and pharmaceuticals are relatively safe in turbulent markets. High quality names in this segment have been resilient even during recent sharp downturns in the market. This segment has the potential to outperform during a global market sell off.

IT can bounce back
IT has corrected significantly with the IT Index down by 22 percent in the last 6 months. The order pipeline of IT companies continues to be robust, and earnings visibility is good; but the market is concerned about a possible US recession impacting the tech spend in the US and thereby the earnings potential of Indian IT. Investors can wait for the Q1 FY 23 results for clarity on this.

In brief, even though there is a high level of uncertainty and equity waters are troubled, there are opportunities for smart investors to catch some big fish.

First published in Economic Times.