What the wild swing in global markets last week means for investors

Usually, it’s the US Fed and Jerome Powell who hog the limelight when it comes to markets during the week of monetary policy. This time Xi and Putin were on par.

Even before the Fed moved the markets post its monetary policy on Wednesday, optimism on Russia-Ukraine delegate levels talks were buoying markets. Further a surprise move by Chinese government sending across a strong message that they will support the markets resulted in wild up moves in shares in Hong Kong and China with positive sentiment spilling over to rest of the world.

Domestic markets were quick to join the party during the week with the Nifty 50 up 4 per cent for the week.

What should investors make of these?

Russia Ukraine talks

While the week started with hopes of some level of de-escalation in the near future, nothing much has materialized. While no one knows what the future course of this war will be, it would be reasonable to assume that even if talks result in an agreement and there is de-escalation, the punitive sanctions imposed on Russia will remain. Thus, the risks of contagion from any stress in Russian economy impacting counterparties across the globe and impact of higher commodity prices may linger.

Portfolio podcast | Where is crude headed post recent volatility  Portfolio podcast | Where is crude headed post recent volatility  

China U-Turn

The China and Hong Kong markets had one of their best rebounds ever after their respective benchmark indices – SSE Composite and Hang Seng fell by around 10 per cent intra-week. Both indices rebounded from their lows by over 7 and 17 per cent by the close of the week!

Even before recent events, Chinese markets have been roiling for months under regulatory pressure since President Xi began his crackdown on China’s tech industry and entrepreneurs last year. Markets were getting further routed on concerns of potential delisting of Chinese ADRs in the US due to regulatory issues, compounded by fears of sanctions on China if it were to aid Russia in its war against Ukraine. So much has been the pain in Chinese markets that at their lows this week, SSE Composite was at levels first seen in 2007, and Hang Seng close to levels first seen in 2000.

The pain in the markets however reached a level threatening economic outlook, and the Chinese government machinery had to intervene to calm markets and make a U-turn on its earlier regulatory crackdowns

Fed rate hike

Not to be seen as distant second to the Chinese government when it comes to U-turns, the US Fed in its monetary policy last week, further doubled down on its complete about shift in recent months on prioritizing inflation fighting, over placating markets with loose monetary policies.

Only as recently as December, the Fed’s dot plot which summarizes the outlook for the federal funds rate, indicated that majority of its members at max expected the Fed Funds rate to be at 0.75 per cent by end of the year. Now a miniscule expect it to be below 1.75 per cent by end of the year! Quantitative tightening is also expected to follow soon as the Fed will aim to reduce its balance sheet size to stem inflation.

What was more interesting was that this aggressive monetary stance came at the same time when the Fed also reduced its expectations for US GDP growth in 2022 to 2.8 per cent versus expectation of 4 per cent growth in June.

While normally one would expect markets to react negatively to such data, the US markets and global indices reacted positively. Their likely rationale could be that aggressive monetary stance was already factored in ; Comments from Fed Chairman that US economy was strong enough to grow in the midst of monetary tightening could have also found favour. The other view to explain this market reaction is that, some investors believe the economy cannot handle these rate hikes and hence the Fed will be forced to go slow on rate hikes versus what has been projected now.

Takeaway for Indian investors

Markets globally are an interplay of fundamentals, liquidity and sentiment. It does appear the market recovery post recent correction is driven more by sentiment rather than fundamentals, which have deteriorated since start of the war. Continuing sanctions on Russia could still challenge fundamentals (as mentioned above) though peace talks can bring an end to the war in the near term.

The Fed’s aggressive stance is a clear indicator now that liquidity is going to tighten for the foreseeable future. A tightening liquidity scenario will be unfavourable for flows into India as global investors will reallocate more to China where the index is trading at around 50 per cent discount versus India.

With fundamentals and liquidity panning out worse than what was foreseen at the start of the year, it does appear sentiment is the variable driving markets now. Either the sentiment will have to down draft and converge with fundamentals, or fundamentals will have to improve to justify the sentiment. Investors need to note that U-turns in sentiment can be swift and can be sharper than what has been demonstrated by the Fed or Chinese government. For investors, it is better to err on the side of caution at this point. It would be ideal to book profits in excessively valued stocks, reallocating to value and quality within equities and allocating some portion to gold which has negative co-relation with equities.

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