Prioritizing value stocks over the growth stocks, which have performed well in the past four years, may be more prudent. Going forward, sector rotation will be important for achieving returns in the current market environment.
The global market is witnessing a rally today, marking a recovery after the carry trade that shook world stock markets last month. While this relief rally may persist in the short term, its momentum could be tested if there are no further strong triggers. The belief that the carry trade issue is behind us is justifiable in the near-term. However, given the substantial size of the strategy and the potential for the Japanese yen to appreciate in the long term, driven by hawkish monetary policy, the risk remains.
Importantly, the ongoing rally is also driven by the anticipation that the Fed will start cutting interest rates in its September policy meeting. The BoE has already taken a step in this direction with a 25-bps cut, lowering the rate to 5%, historic high. It’s crucial that these rate cuts be substantial and implemented promptly. Otherwise, the stock market may struggle to sustain its current momentum, as a slowing economy and declining corporate earnings could weigh on investor sentiment.
In the last 4yrs, the global economy has been propped up by expansive fiscal policies, with governments ramping up spending, resulting in high fiscal deficits. Notably, the stock market benefited from the dual effect of low interest rates and robust government spending. Now inflation and interest rate are high reducing expenditure. Furthermore, loose fiscal policies are expected to reverse, as governments face the challenge of sustaining high deficits. This is expected to trigger a slowdown in economy & earnings growth. Meanwhile, given high inflation and fiscal deficits, market yields are not expected to decline significantly. Given that the world is trading at high valuation, a time and price correction is due in the short to medium-term.
Regarding the carry trade, now the market is trading safe assuming that the issue is done for the time being. However, given the varied differences between the policy views of FED & BoJ, it is possible that the spread between the US and Japan bank rates will reduce. Which will impact medium to long-term carry trade positions and new FII inflows, especially Yen denominated. FED is expected to cut the rate from 5.5% today to 3.85% in CY25, while BoJ is expected to increase from 0.25% today to 0.5%.
Asian markets
Last month, carry trade problems affected Japan, Taiwan, South Korea, and US tech companies. It did not affect India much. Data indicates that India did benefit from the carry trade, which bloomed from January 2023, as Japanese currency depreciated from 127 to 162 to USD. India is estimated to have received 23% of yen-denominated inflows, with 25% of this amount invested in midcaps. It makes India vulnerable if Yen based selling comes back in the future. However, the impact is likely to be limited as Japan asset under custodian in India is low at 3%. While influence on midcaps may be high, but the most impactful factor for India is that the trend of the global stock market and inflow from domestic investors, both institutional and retail, should sustain.
Given the risk that the global economy may slow in CY25, FII inflows get grounded due to high inflation and interest rate. It is prudent to be cautious on the market in the short to medium-term. Prioritizing value stocks over the growth stocks, which have performed well in the past four years, may be more prudent. Going forward, sector rotation will be important for achieving returns in the current market environment. Sectors which are presumed to be safe, like FMCG, Consumption, Pharma, IT and Telecom may have an edge, as the market lacks steam in new growth areas due to elevated prices. Manufacturing based sectors are the long-term maker of India story in which stock specific approach and valuations should be reviewed by adopting an accumulation strategy.
First published in Mint
