Stock markets, globally, are interestingly poised. Fears of a likely US recession have led to sharp corrections in markets; but hopes of a lower-than-expected growth slowdown are triggering fresh buying. The heightened volatility in the market indicates that the trend is unclear. The biggest unknown in the market now is that we don’t know how intense the ongoing global growth slowdown would be. It is probable that the US might tip into a recession. It is also probable that the Fed might succeed in engineering a soft-landing for the US economy. What should investors do in these uncertain times?
Undoubtedly, the strongest headwind for the global economy and equity markets is the surging inflation, particularly in the developed markets (DMs). US inflation is at a 41-year high and has been rising steadily: 8.3 per cent in April, 8.6 per cent May and 9.1 per cent in June. Inflation in the UK is 9.1 per cent in June and in Euro Zone inflation is at 8.6 %. Central banks are tightening monetary policy; bond yields are rising and growth is slowing down. Dollar – the safest asset class during uncertain times – is surging (Dollar index is above 108) and most currencies are depreciating against the dollar.
Has equity markets discounted a US recession?
US tipping into recession by end 2022 or early 2023 is bad news for the global economy. If the $25 trillion US economy tips into recession, global growth will be impacted. Global trade, too, will be impacted adversely affecting exports from emerging markets (EMs) like India. Equity markets are discounting these concerns. S&P 500 has corrected around 20 percent from the peak. Nifty corrected around 18 percent from the peak. Have the markets discounted a US recession? Partly, ‘yes’. But, have the markets discounted a severe US recession? The answer is ‘no’. A severe US recession, along with the ongoing slowdown in China and Europe, can severely impact global growth and corporate earnings, which is not yet reflected in global equity prices.
That said, our base case is a soft landing for the US economy. Even if the worst case scenario of a US recession materialises, it is likely to be mild rather than severe. US economic growth continues to be strong and unemployment is surprisingly low at 3.6 per cent. Therefore, Jerome Powel in 2022 stands a good chance of doing what Allen Greenspan did in 1994: raising rates without tipping the economy into a recession.
A mild US recession is good for India
CPI inflation in India, though higher than RBI’s upper band, is lower than inflation in the DMs. More important, inflation is trending down, though mildly. CPI inflation has declined from 7.79 per cent in April to 7.04 per cent in May to 7.01 percent in June. This downward trend can sustain, given the recent sharp decline in commodity prices. But inflation will remain elevated till December 2022 and decline thereafter.
The decline in commodity prices from their recent peaks has been sharp: crude is down 30 per cent; aluminium by 36 per cent, copper by 21 per cent and steel by 19 per cent (as on 16th July). Crude palm oil price is at a 1-year low and soyabean oil is at 23-month low. If the US goes into a mild recession, crude prices will decline further. Citibank has projected Brent crude at around $ 60 if US tips into recession, say, by the end of 2022. Such a sharp crash in crude would be a blessing in disguise for India. Indian economy had bounced back smartly after every US recession.
First published in Economic Times