The Fed continues its promise to fight against inflation until it brings the
core inflation down to 2%. Based on the most recent estimates, the Fed
sees the federal funds rate moving to the 4.5-4.75% range by early 2023.
This may lead to some pain in the economy, perhaps recession. Also, this
involves some risk that the Fed's aggressive tightening may potentially
destabilize the financial system in the process.
Volatility has spiked across asset classes, raising concerns about the ability of the global economy to cope with sharply higher interest rates. If volatility in the financial market continues, the Fed may end up moderating
The Fed was late to tighten monetary policy, allowing inflation to rise, but they have made up for lost time since its first-rate hike in March 2022. The federal funds rate has increased by 300 bps at an accelerating pace, one of the fastest rate-hiking cycles.
The impact of rate hikes has started working its way through the economy. GDP growth has slowed, led by weakness in housing and manufacturing. Moreover, commodity prices have fallen sharply from their peak levels. The Fed's effort to slow down the demand side of the economy seems to be working.
We believe market pressures may force the Fed to slow with future rate hikes. Also, the Fed’s attempt to bring inflation back to 2% could increase the stress in the global financial market.
PACE OF FED RATE HIKES HAS BEEN RAPID IN THIS CYCLE COMPARED TO PREVIOUS ONES
After witnessing significant earnings growth in the first half of 2022, all
eyes are now on the third quarter earnings season. Markets are heading
into the earnings season on poor footing as US stocks are witnessing
heightened volatility amid concerns that the Fed's aggressive rate hikes
will result in a possible recession. Analysts will track EPS and guidance in
each sector and will likely adjust the earnings and revenue estimates for
the next few quarters.
At the end of June, analysts expected third-quarter EPS for the S&P 500 index to be 9.8% higher than last year's third quarter. However, there have been a series of earnings downgrades over the previous three months. For Q3 2022, analysts expect EPS growth to be just 2.9%, as they believe it would be difficult for businesses to maintain profitability given the current economic environment. Labour costs, supply chain disruptions, and
unfavourable foreign exchange rates are some of the major concerns negatively impacting earnings. From an earnings contribution perspective, we expect companies within the energy and industrial sector to be the major contributors toward overall growth in the earnings for the index. Currently, markets are looking at companies to provide forward guidance for the last quarter of 2022 and CY2023. Given the host of worries, we may see an increase in companies either withdrawing forward guidance or lowering forward guidance which will bring further downward revisions to earnings and revenue estimates.
Indian market was no exception and witnessed elevated volatility in Q2FY23 triggered by global and macro headwinds. Rupee depreciated 2.3% against
the US dollar in Sept 2022 even as Forex reserves decline $96 bn in CYTD. By the end of the quarter, the RBI hiked repo rate by 50 bps to 5.9% and revised
GDP growth forecast down to 7.0% from 7.2% earlier.
While the Indian economy faces several headwinds, the corporate India is confident about margin expansion in H2FY23 owing to recent weakness in commodity prices. The lean balance sheets of both corporate India and Indian Banking sector are encouraging corporates to kick start their capital expenditure plans after several years of indifference. The aggregate earning of Nifty 50 companies is expected to remain flat in Q2FY23 after eight quarters of growth.
The Indian stock market has surprised everyone by its resilience in the face of bearish sentiments across the globe. The outperformance of Indian markets vis-à-vis other emerging markets has led to expansion in the valuation. Valuations are at a multi-year high premium vs EM countries and thus could induce volatility on the back of any major global developments.
For the last quarter (Q2FY23), our Tactical Intervention Approach (TIA) model recommended going underweight on the markets. While the market ended the quarter recording positive gains, it witnessed heightened volatility on the back of several global and macro concerns. For Q3FY23: Our model suggests continuing the Underweight stance on the equity markets A quick recap on our model: We give distinct 15-18 input factors to our program, broadly classified into macro (market capitalization to GDP), valuation (P/ E, P/B, etc.), momentum indicators, trends, volatility, liquidity, and so on. Besides their absolute value, we take the first derivative (implying % change and direction of the change) for some parameters. The model identifies a pattern in the data set and produces market predictions without following instructions coded by humans. It helps us remove all biases and prenotions developed by humans on the markets.