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If you followed business news over the past 2 weeks trying to figure out how the markets would react on fed rate hikes, I can assure you that you've wasted time.

I've seen multiple market cycles, but it's futile for someone like me to figure out the implications of the US Fed on the markets.

Television pundits (or as I like to call them stock market astrologers) would tell you that a 75-basis point hike was priced in the stock markets as the Dow Jones had already fallen going into the event.

However, the US and other global markets have fallen a further 5% post the hike.

Well, the reason apart from thefed rate hikewas the speed at which the rate hikes will happen. In fact, some optimists were hoping for a rate cut in 2024. That is clearly out of question with the hawkish fed commentary.

Probably that is what has spooked the market.

The reason why I started with this analysis of the US Fed's monetary policy is because I'm going to present a contrarian view.

To start with, the US Fed in my opinion has lost all credibility. Its actions these days are more indicative of a rear-view mirror observation, rather than a deep understanding of the problem.

Now I'm not making a point about the stock markets having bottomed or not. I'm saying if the negative news flow continues, then the markets could head substantially lower from here.

Here's what I've observed...

The most important observation is related to inflation.

Inflation is historical data while investment decisions are forward looking.

So why is it that when the world is so negative on Inflation, I'm hopeful?

The main reasons are this...

1) US Home Prices have started its downward trajectory

If we analyse the US Inflation components, the devil lies in housing which is nothing but a reflection of commodity prices.

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In the US, housing, which is the core inflationary component, was extremely hot till April 2022.

However, the rise in median housing prices have started to moderate. In fact, prices for August 2022 have declined for the first time in a decade.

This will lead to inflation moderating faster than expected, as the housing market is a major fuel for red hot inflation.

From the chart below, we see US home prices are in a downtrend.

Increase in US Median Home Prices

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A combination of weakening demand, improving supplies, a mean reversion in commodity prices and 'base effects' are all likely to cause inflation to peak in 2022.

US real estate contributes to 18% of US GDP. If you compare it with the world GDP, it's a massive 4.5% of the global GDP. It's no wonder the 2008 crisis was catastrophic.

2) Commodity Prices are Softening led by Crude Oil

Who would have thoughtcrude oil priceswhich fell into reached negative territory in May 2020 for the first time in history would rocket to US$ 130 in less than 2 years.

While the cause was geopolitical tensions and free money effect driving demand, the outcome wasn't favourable.

Now withinterest rates on the rise, crude prices have fallen by 30% from its recent peak. I believe this will substantially reduce inflation going ahead.

Agri commodities and the metals have seen substantial cuts in prices. The agri index is down by 37% this year while like copper and aluminium, which stoke inflation in consumer durables and capital goods, are down 35-40%.

What about inflation in the future?

I believe commodity prices will weaken further.

⦁ The China Factor

China is the largest consumer of most commodities. It's the world's largest consumer of steel and copper. It consumes 14% of total oil produced in the world.

The Chinese economy is slowing down and is unlikely to grow at 9-10%, which it did in the past decade.

The question to be asked is, how can commodity prices rise if the big dragon slows down? Also, the export market for China is expected to slow down due to environmental restrictions.

Also, inventories are rising, indicating the supply glut is over.

⦁ Freight rates have fallen sharply and are expected to fall more

Global Freight Rates have Fallen More than 40%


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In a nutshell with major constituents of inflation expected to go down, inflation can't be as sticky as what people fear. Inflation is likely to be far lower in the coming months.

So, in that case, where is India placed?

India is in a perfect blend of the following factors...

Consumption demand + Rising disposable Income + Capex cycle

Now picture these tailwinds with crude falling down to US$ 60.

Also, with a strong monsoon, cash flow for farmers will be strong, which means rural demand is going to be robust.

48% of India's CPI is food, while 15% is energy prices. With about 60% of inflation constituents expected to be under control, wouldn't you say inflation has peaked out?

In my opinion, yes.

Does this mean 'all is well' going forward?

Well, life and stock markets are not binary.

While inflation might have peaked, the problems induced by the US Fed's 'helicopter money' are still lurking.

The concerns could be any of these...

⦁ What if the Fed goes overboard with rising interest rates?

⦁ What if defaults in the US housing markets rise due to rising interest rates?

⦁ What if geopolitical issues flare up leading to rising energy prices especially in Europe,

⦁ resulting in inflation coming back hard?

Apart from all this, the biggest risk is the currency. The Indian rupee is falling against the dollar. Money flowing back to the US hurts all major economies, including India.

I believe the one thing which investors should track is currency. For Indian markets to go up or even remain stable, the currency should stabilise.

Once that happens and there are no major financial or geopolitical disruptions, I'm sure India will outperform.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com

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