I wrote the blog Is this time for Mean Reversion? in Jan this year and some of the events mentioned there are playing out. As I write this, NASDAQ is down 30% from its 52 week high, S&P 500 down 18% and Nifty down 15%. The various indices globally are either in bear territory (down 20% from the peak) or are getting close to the bear territory. Investors are not willing to pay any price for the growth – Netflix is down 75% and Tesla is down 41%. The US tech stalwarts have not been spared either – Facebook down 50%, Amazon down 43%, Microsoft and Google each down 26% and Apple down 22%. The investors are now asking “Has the Equity Market Hit Bottom?”
The unprecedented amount of fiscal stimulus and printing of money during COVID has put too much money in the system. The supply-chain woe has created scarcity of finished goods. China’s zero COVID management policy around the recent upsurge of COVID is putting further strain on the supply chain. The Russia-Ukraine war is affecting the price of commodities, particularly agricultural products and oil.
The US inflation has recently inched up to 8.3%, a 40 year high. The UK inflation is at ~7%, a 30 year high. The retail inflation in India has gone up to 7.79%, way above the comfort of the RBI target of 4%. The Central Banks are worried that a sustained level of elevated inflation will put the economies into recession. They are in a hurry to increase interest rates to control inflation. The US Fed increased the interest rate by 50 basis points on 4th May. On the same day, RBI increased the repo rate by 40 basis points in an unscheduled meeting. The next day Bank of England increased the interest rate to 1%.
The Reserve Banks are late in increasing the interest rate. The market is worried that it would be difficult for the Central banks to do the soft landing of economies. The investors are pulling out money from the equity market. Bonds too are losing value because of the sudden large increase in the interest rate. It is rare for both Equity and Bonds to underperform simultaneously. In the US, the mortgage rates have gone up decreasing the affordability to purchase a real estate but the price of the home is staying at the elevated level because of the demand-supply issues. That will change soon.
The most important question for the investors now is “Has the Equity Market Hit Bottom?”
The unprecedented liquidity and close to zero interest rate have encouraged investors to invest in relatively riskier assets at a higher valuation. The good news is that there does not appear to be any systemic problem so far but small shocks cannot be ruled out because of the imbalances caused by the rapidly falling Equity market. We will have to wait to see how the increase in the interest rate is going to impact inflation. There is the worry that inflation could stay at elevated level for a longer time and the Central Banks may overshoot on the interest rate tightening causing recession.
Well, the market has fallen and is close to the bear market territory but may not have hit the bottom yet. The US and the Indian markets are still trading at higher valuations than the historical P/E average. Bull markets typically end with the capitulation where investors lose all their hopes in the market and that has not happened yet. While I do not hope for the capitulation, a capitulation typically cleans the slate and sets the stage for the next Bull Run.
The writer is a SEBI Registered Adviser and Founder of FinMyn (https://finmyn.com). He provides Fee-Only Financial Planning and Investment Advisory services.
He has advised many clients in India, the US, Europe, the Middle East, South East Asia and Australia.
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