The ongoing global equity market correction was long overdue, as we had seen 310 consecutive days of stock market rise without a decline of more than 3%, which is the longest streak since 1980, Sanjay Guglani, chief investment officer, Silverdale India Equity Fund, and chief executive officer, Silverdale Capital Pte. Ltd, Singapore, said in an interview. But he pointed out that the equity sell-off does not change the big picture, which is that the widespread global growth is intact. “After almost half a decade of negative surprises, since June 2017 there has been the positive earnings surprise—further more than two-thirds of S&P 500 companies that have declared results to-date, have beaten the consensus forecasts,” Guglani said.
With the Indian markets too in a free fall, mirroring global trends, Guglani said that the BSE blowout does not change the country’s economic outlook. “India continues to be the fastest growing large economy, the impact of structural reforms unleashed by the Modi government will be evident in the coming quarters, and the demographic dividend is still intact,” he added.
There has been meltdown in equity markets globally. Do you think this is start of another financial crisis?
For those worrying about potential financial crisis, may we point out that for a significant financial crisis the meltdown should be in multiple asset classes. We do not see the rout in equity being mirrored in the fixed-income market. The G-spread (i.e. the spread between corporate bonds and government bonds) has not widened significantly. There would be a bit of rub-off impact wherein investors would sell in fixed income market to fund equity losses, but it is unlikely to be significant by itself.
The equity market correction was long overdue. We had seen 310 consecutive days of stock market rise without a correction of more than 3%, which is the longest streak since 1980. Technically, the correction could take the market to its trend line, which is further down by about 6% for S&P 500 Index, and which is also close to its long-term support - 200-days moving average.
However, given the sharp fall in prices, the technical indicators have already hit the oversold zone. Hence, there could be dead cat bounce, within a day or two; with market falling (again) after that.
The equity sell-off does not change the big picture, which is that the widespread global growth is intact. After almost half a decade of negative surprises, since June 2017 there has been the positive earnings surprise; further more than two-third of S&P 500 companies that have declared results to-date, have beaten the consensus forecasts.
So, what happened? This is the first time in history of mankind that we have passive funds—ETF, Trackers, Index Funds, etc.—larger than active funds. Most of the passive funds are algorithmic, driven by looking in the rear-view mirror, that is, based on history—whether few (nano) seconds or few hours or few days—hence are predominantly, trend driven. The Index goes up, so you buy Index ETF, which buys more of the index stocks, which pushes up the Index, and there you have a virtual cycle. The same happens on the downside, with more velocity since you don’t need to put moneys on the table to sell and stop-losses trigger massive trades. Humanity is witnessing the after effects of the largest ever misallocation of capital through pump-priming of central banks.
Is this drop in global equity a flash crash?
The current meltdown is further accentuated by massive increase in volatility (VIX) trading. The amount of investment (AUM) in volatility (VIX) related products shot from $2 billion to over $5 billion in the past five years.
The VIX, which was stagnating around 10 for several months spiked to over 35 practically overnight. Credit Suisse is closing its volatility-based investment product (VelocityShares Daily Inverse VIX) as it lost 93% value as of 6 February, it was $2 billion as in late January. ProShares Short VIX ETF plunged 83%. Horizons ETF fell by 84%. Nomura announced shutting down Next Notes S&P 500 VIX ETN. The unwinding of these VIX-related products could trigger $225 billion of equity sales, as per Barclays.
We believe massive spikes of volatility and “flash crashes” are here to stay, and it never hurts to play safe by sticking to quality fixed income securities and diversifying well in case of equities.
Which sector looks to be more promising for medium-term investors?
The technology sector was and continues to be the maximum wealth creator.
Despite the run-up in technology stocks, many quality tech names continue to be reasonably priced with PEG being half of old tech stocks and about one-third of industrials.However, given rapid growth and shift in technology, it would be better to stick to Fund of Funds.
Indian markets are also falling based on global cues, could you share your views?
There is no change in economic outlook, India continues to be the fastest growing large economy, the impact of structural reforms unleashed by the Modi government will be evident in coming quarters, and the demographic dividend is still intact. While the fiscal leeway in the 2018 budget is not significant, oil and inflation need to be watched. Given accelerated adoption of alternative fuels globally, US becoming significant producer of crude at 10 million barrels a day —with shale gas break even below $50 bbl, etc— we do not see a major spike in oil price. Inflation would see a seasonal uptick with the onset of summer and pulled-up by increase in MSP (minimum support price) of agricultural products. According to the RBI study the impact of increase in MSP on inflation is much lower since, despite 150 products being under MSP, the market price is lower than MSP only in handful of cases and active intervention is required sporadically for a few of those. Further, the agility of the Modi government in using food grain reserves and imports has made food price spikes very muted. From investor perspective, given the vast diversity of the Indian economy, it would be preferable to diversify much more through Silverdale Fund of Indian Equity Funds.
In view of equity meltdown, do you think US Fed would continue with its guided rate hike?
We continue to expect Fed rate hike in March 2018, despite the Bloomberg expectation having fallen from 99% in January end to 80% (Feb 6, 2018) in less than one week. Typically, the market prices the fed rate hike before the actual hike. Given the strong uptick in payroll data, the market has priced-in March 2018 rate hike as well as increased the probability of three rate hikes in 2018. We believe the strong uptick in US non-farm payroll to 200,000—against consensus of 180,000—is due to idiosyncratic factors, and shall get normalized in the next month data release. Since US Federal Bank has embarked upon marginal rate hikes with tightening of the balance-sheet —i.e. stopped buying $30 billion of bonds every month—as expected the interest rates have started looking up. The 10-year treasury broke the minor resistance level towards the upper bound of 30-years channel, which resulted in 10-year treasury yield spike.
As a bond fund manager, any change in your investment strategy?
We continue to focus on short dated, emerging market, investment-grade names which has historically played well for us (2017 return to investor: 9.02%). We look to add high-conviction names during such times of turmoil and market dislocation. While we did expect increase in volatility, it came in a bit too quick; however, our discipline in bond quality selection and our tactical view of keeping higher amount of dry gunpowder—unutilized credit limit—has put us in an advantageous position.