Dear Friends,
The four most dangerous words in investing are “this time it's different” according to John Templeton, one of the most renowned investment gurus. It is seen that investors consistently use this rationale to justify their emotional and greed-driven decisions as stock market tops and bottoms. However, “this time it’s different” is actually true and I believe it's not investors alone who are responsible for large corrections in global markets, the central bankers and policymakers have also played the part by overshooting their actions. It can be named after a pandemic or GFC but there is undoubtedly a significant role played by policymakersin adding up to the bubble.
Fed fund rates are currently running at 700 bps negative (around 8% inflation and 1% Fed Rate) on a real interest rate basis, which should at least come to zero or slightly positive. I honestly don’t remember when we heard 700 bps negative last. In no economics books or normal world do such instances happen. The developed market this time is entangled in what is known to be the developing world's vicious boom and bust cycle and stagflation.
For instance, Turkey has 14% overnight rates and 70% inflation. The UK has a 1% overnight rate and 9% inflation. That makes the British pound the third worst performing major currency this year. The cost of reversing such anomalies can cost policymakers, investors, and normal people a lot more than one can forecast.
It's clear the west is much more behind the curve than most of us realize. There is an index formed by DB called the Fed Misery Index, it tracks the percentage points inflation is above target currently and percentage points the current unemployment rate below the non-accelerating inflation rate of unemployment. On this measure, the Fed has serious trouble going forward. The last time the fed misery index was high was in 1980, implying that the Fed has not been this far behind the curve since that period ever. The Fed tightening on the basis of this index and data provided has to be very aggressive. It can lead to a recession-like feeling but the Fed has no choice. The Fed currently at 700 bps negative should take the Fed fund rate to 6% from currently at 1%. Markets are not even pricing 3% fed rate.
If the Fed increases rates by 200 basis points it will cause shock waves to asset markets and take a 10-year yield to more than 6%. But the moot point is that whether this can substantially reduce inflation. My answer is NO, inflation is here for many more reasons which are beyond the Fed or any central banker’s control. But we know policymakers are data-driven so they will keep hitting the rates hard till they find a solution.
We all know why inflation is so sticky, there are several structural disinflationary forces which have been set are about to reverse. This might be further aggravated by factors such as deglobalization, geopolitical instability, underinvestment in capacities, higher cost of alternative energies to tackle climate change, the rise of the cost of production in China & Asia and importantly, the world has opened after two years of lockdown leading to huge pent-up demand and excess savings coming back to consumption. Overall, this will lead inflation to remain elevated and continue to surprise us on the upside rather than the downside.
The labour markets across the world are tight and will be more aggravated in times to come. Also, most of the labour supply squeeze are structural and will lead to higher wage growth (28% of attrition at Infosys underlines my views). Rental costs inflation and unstable supply chain challenges will continue to trouble manufacturers and end-consumersin the foreseeable future.
Back home we are seeing some relief-rally after major corrections. We believe price correction is yet to get over for midcaps and premium valuation stocks and time correction for high quality reasonably valued large-cap. More earning downgrades are likely in the coming quarter.
We continue to maintain our stance on buying high-quality stocks and following a conservative investment approach in the short term and continue to deploy cash with a sharp focus on the best businesses. The best way to get away from such a difficult cycle is twofold.
1) No left out feeling or FOMO (feeling of missing out),
2) Prudent risk management and staying away from bad quality businesses and promoters. We are doing our best to achieve this.
This is passing clouds and this will get over quickly. As it is said wisely “The bull markets do not last forever and so do the bear markets”.