Are Indian markets glossing over a major double whammy?
For Indian markets, the government’s choice of timing for its demonetization move couldn’t have been worse. Investors had to grapple with the aftershock of the move—one fund manager estimated wealth destruction to the tune of at least $100 billion as a result—at a time when global markets were pricing in greater uncertainty that came from the election of Donald Trump as US president.
Early in the day’s trading session, a mere indication of a Trump presidency had been enough to send global equities and currencies in turmoil. Dow futures had fallen by over 700 points, or around 4%, in intraday trading. Trading in S&P 500 futures even had to be halted at one point. Global equities were in disarray, just as equity strategists had predicted.
But in the end, things worked out fine. After the final election results were announced, the markets experienced an unusual calmness. At the time of writing, Dow futures were down just 1.5%.
In India, too, the Nifty 50 index had fallen well over 4% in early trading, but ended the day only 1.3% lower. Are the markets glossing over two major disruptions?
According to the fund manager, investors in Indian markets haven’t fully appreciated the impact of the demonetization process. According to him, around $100 billion worth currency would end up as worthless, and will in turn impact economic activity. The amount is an estimate based on how much of the over $200 billion in demonetized currency is legitimate and how much is unaccounted for or black money.
Besides, a number of industries still depend largely on cash transactions for sale of end-products, and this can get disrupted in the near term, even for those with legitimate sources of cash. The multibillion-dollar question is how quickly this stock of cash is replenished by the banking system. In any case, there will be pain in the short term.
“Short-term liquidity squeeze could be severe and hence economic activity could suffer. Can last up to two or three quarters... Further, with the eventual design of the GST looking more complicated than originally envisaged and with the timelines getting shorter, uncertainty could be compounded. That risk is non-trivial,” V. Anantha Nageswaran, a Singapore financial markets consultant and a Mint columnist, wrote in a blog post.
It’s true that real estate stocks fell heavily and so did stocks of finance companies and those who depend on consumer discretionary spend. But overall, investors in Indian markets seem to be fairly sanguine about the impact of the demonetization process.
The reaction to the Trump verdict is even more surprising, especially given how markets had reacted to the mere possibility of his win earlier. Some investors appear to be relieved that the uncertainty owing to the change in leadership may cause the US Federal Reserve to further postpone rate hikes. According to a Bloomberg report, the market-implied chance of a December rate hike fell to as low as 47%, based on US overnight indexed swaps. That compares to 82% at 5pm in New York on Tuesday.
But investors seem to be just clutching at straws. Since Trump’s inauguration is only in January, the Fed may well go ahead with a rate hike in December. But whether or not the Fed raises rates, the uncertainty related to the Trump presidency hasn’t gone anywhere. Citigroup’s global macro strategists wrote in an early morning 9 November note, “Near term we expect yields to fall, equities and emerging markets to sell off. Markets will likely focus first on economic policy uncertainty, rising geopolitical risk premia and threats from Trump tariffs to global trade. To us all negative risks.”
According to market experts, the biggest risk related to the Trump presidency is uncertainty, and investors hate uncertainty. “Uncertainty alone could hit the economy. Global growth will also be impacted if uncertainty rises,” Citi’s strategists said in an earlier note.
Of course, not all investors are as sanguine as broad indices suggest. India’s IT stocks fell further after the election results came in. And the Mexican peso fell to a seven-year low against the dollar. Trump’s win is expected to result in weaker relations with Mexico and hurt its economy.
According to the fund manager cited above, investors are learning to overcome fears about the unknown sooner after the Brexit experience.
“After the Brexit vote, markets fell sharply, but recovered after a few days. Now, the recovery has happened in a few hours,” he said.