Talking Points This Week: Tops And Bottoms

Every week, Niraj Shah studies how top business leaders and market makers are navigating the fast-changing financial landscape.

This week, there have been a number of developments across financial markets that took the conversations among participants to talk of tops and bottoms. Views around peak interest rates in the U.S. are getting firmed up. Weakening economic data has sparked speculation that the Federal Reserve, whose actions are followed by many other central banks, may not need to raise rates to the levels previously anticipated. But rates may not be the only reason why asset managers and owners are worried. Supply chain snarls refuse to die down, with Xi Jinping asserting that Covid Zero is the correct policy for China. The availability of energy continues to remain a headache for the world. In light of these, it becomes important to look at tops and bottoms across assets.

Could Equities Have Made A Bottom?

“Recent positive news on (1) recovery in monsoons, (2) decline in crude prices and (3) collapse in metal prices raises hopes about domestic inflation peaking over the next few months and trending down in H2FY23,” says a Kotak note.

It is easy to now predict that inflation remains the key variable for global and domestic markets. As the note says, any signs of easing in inflation will likely provide a cap to bond yields and a bottom to markets. Taimur Baig of DBS cautions that markets would not likely price in this immediately and that it would be a courageous call to call a bottom in equities, currently. Baig does predict that U.S. real interest rates may see an increase of 600 basis points in the span of half a year, reverberations of which will be felt in financial markets as that is an extraordinary amount of delta for the global economy to absorb. Suffice to say that it is impossible to even attempt to predict any equity market bottoms currently.

Bottom On Japanese Rates? Why Do They Matter To Equities?

Rising rates in Japan, home to millions of savers who invest in bonds around the world, would quickly ripple across financial markets. Yields nearly everywhere could dart even higher say experts like Mihir Vora of Max Life. That would, in turn, push up borrowing costs for companies, consumers and governments.

Rates in Japan are important consideration from another perspective as well. The low cost of borrowing in the Yen makes it an attractive vehicle to fund investments with higher interest rates and yields, popularly known as the 'Yen Carry Trade'. Some would argue that one of the components of the 2007-2008 global market turmoil was this trade. Before the financial crisis, there was a strong risk appetite with money provided by selling yen flowed into risk assets like subprime residential mortgage-backed securities and collateralised debt obligations. In time, mortgages went under, the carry trade unwound, and financial markets swooned.

Fast forward to today, if Japanese rates rise and the Yen appreciates, many global markets in equities and fixed income can see unwinding. For a set of market participants already reeling from sharp losses, this would be a very unwelcome development.

Have Crops And Intermediates Topped Out?

International crop prices registered significant drops in important pockets in the past week. Egypt lowered imports, leading to a sharp crack in wheat prices. Vegetable oil prices corrected on Indonesia's return to export markets. Growing fears of a U.S. recession exerted pressure on cotton, which has seen the worst rout in a decade in the recent decadal top. Fertilizer prices have also revealed some weakness, with U.S. prices of ammonia, urea and diammonium phosphate correcting by double-digits in the past month, presumably due to weak demand. Indian companies catering to the domestic market, including Dhanuka Agritech and PI Industries, have guided to a subdued performance for Q1FY23. Kotak Securities notes BASF's global CEO Martin Brudermiller warning of a “considerable downturn early in the second half of the year because inflation will begin to weigh on consumer demand and competitors are expected to reinstate crippled supply chains.”

The management of Indian surfactants producer Galaxy Surfactants voiced volume growth pressures, even as the company maintains margins.

A large part of the investing world is struggling with uncertainty around tops and bottoms. It has been a period where investors have lost money to crypto, startup valuations, equities or inflation. Let's see if H2FY22 brings about a change.

Niraj Shah is Markets Editor at BQ Prime.