Vladmir Lenin, Russian communist revolutionary and head of the Bolshevik Party, had once famously said: “There are decades where nothing happens; and there are weeks where decades happen.” It took Vladimir Putin, the spy-turned-president, to show the world what the quote meant.

A world that was coming out of a virus-induced crisis is now engulfed in a geo-political conflict that is no longer confined to Russia-Ukraine borders. The misadventure showed fragility of global economic inter-linkages. Supply chain disruption and commodity price flare-ups have got global central banks fire-fighting their way to tame inflation that is ravaging economies, both developed and emerging. India has been at the receiving end as it imports 85% of crude oil it consumes, resulting in inflationary pressures clouding prospects of a robust growth recovery.

India’s vulnerability to crude oil is well documented with the central bank estimating that a 10% spike in oil prices can tear down the country’s real GDP growth by 20 basis points over the baseline. The worry is that if prices average $100 per barrel against the Budget estimate of $75 per barrel, GDP growth will be slashed. According to ratings agency Icra, current account deficit could widen by $14-15 billion (0.4% of GDP) for every $10/bbl increase in average price of the Indian crude oil basket. Thus, if the basket averages $100 in the current fiscal, the deficit is likely to widen to $85-90 billion, that is, 2.4% of GDP.

The crude oil spike coupled with U.S. Fed rates hikes have led to exodus of foreign investors. In just six months, rising bond yields in U.S. and strengthening of the dollar saw ₹2.10 lakh crore being pulled out of Indian equities. The outflows are nearly four times the annual flows seen in 2008 when the U.S. credit crisis resulted in equity outflows of ₹52,987 crore.

Jamal Mecklai, founder of Mecklai Financial Services, a firm focused on treasury risk management, believes the Fed is already late. “Unlike the Volcker era when in the 70s Fed aggressively hiked interest rates, the Fed of today is molly-coddling markets by assuring participants about a quarter-to-quarter basis points hike. The Fed is way behind the inflation curve and will have to aggressively hike much beyond what it has budgeted.”

In CY2022, 26 out of 34 major global central banks have administered 124 rate hikes already. According to Amish Shah, head of research at Bank of America Securities, tightening of liquidity is negative for equity markets as G4 central bank balance sheets have a correlation of 0.97 with global equities, while G3 balance sheets have a correlation of 0.95 with Indian equities.

What’s rather interesting is that over a 52-week range, the Sensex has just fallen 1.46% from 52,588 on June 22, 2021, to 51,822 on June 22, 2022, while the Nifty fell 2.2% from 15,772 to 15,413. But from the high of 62,245.43, hit on October 19, 2021, the Sensex has collapsed 20% (10,422.9 points). Similarly, the Nifty has fallen 17.2% (3,191 points) from 18,377. The sharp fall in past eight months, accentuated post the Russian-Ukraine conflict since February this year, is what has roiled investors. The carnage is evident from the fact that BSE and NSE combined universe of 530 stocks have seen a cumulative decimation of ₹78 lakh crore market cap from 52-week highs.

Earnings Shock

Global profit expectations have fallen to their weakest since September ’08. Though inflation is expected to cool off, relative to history, it will remain at elevated levels, prompting 73% global fund managers to believe that global growth will fall to a new low. The percentage is the lowest since 1994 when BofA began its annual survey exercise.

Shah says that despite several negative shocks, consensus estimates for Nifty earnings for FY23/24 have surprisingly been raised by 4% since January with consensus expecting 24% growth in FY23 and 15% growth in FY24. BofA has estimated FY23 EPS at ₹732 vs Street’s expectation of ₹850. Shah believes consensus has been lulled into believing that the companies will weather the storm because of the relatively resilient Q4 FY22 performance “The worst is clearly not over and there is more pain to come. Cheaper inventory buffers had mitigated the impact of high commodity prices on margins. Hence, we expect earnings cuts in the first two quarters of the current fiscal, especially, in consumer discretionary and industrial sectors,” says Shah.

Tightening liquidity impacts earnings as well. “Historically, whenever central banks tighten liquidity, its impact on earnings comes through with a six-seven months lag,” says Shah. The Nifty is now trading at 17x one-year forward earnings, closer to its 10-year average, and the multiples could contract amid earnings cuts. “Pricing in these negatives, we believe the market could likely bottom out by September 2022,” says Shah.

The only positive that is coming through the period of turbulence is that domestic retail flows have managed to offset the impact of massive FII selloff. In FY22, flows through systematic monthly investments touched a record ₹1,24,566 crore, and despite the fall, flows in first two months of the current fiscal stood at ₹24,149 crore. Dinesh Thakkar, founder and managing director of Angel One, believes the trend will continue. “In 2008, the selloff had pulled down indices by 50%. Though the outflows are four times of CY 2008, indices have fallen only 10%. That is largely because of strong retail participation, and I see the trend continuing,” says Thakkar. Shah agrees with Thakkar by stating that correlation of equity outflows & debt inflows even when 10-year yields were as high as 8% was very low at 11%.

While so far, domestic equity flows have shown resilience, which way the wind blows will hinge on the narrative post Q1 results.

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