Would you term the recent market rebound as a bear market rally or a resilient bounce back?
It’s very difficult to suggest that it is the sign of a longer-term structural rebound. A lot of the issues that face the markets right now and caused the correction in the first place still remain. Some of that is now priced in. The inflation dynamic and the US rates dynamics are generally priced in, barring a major surprise. There is reasonable conviction now that there’s going to be a Fed funds rate somewhere between 325 and 350 basis points over the course of the next 12-18 months.
The uncertainty relates to what’s going to happen to US and global growth. Then there’s geopolitics which is unresolved at this point. There’s a view that we need to see more data, what happens with geopolitics, the early impact of what the Fed has done thus far, and the tightening of financial conditions. I am not of the view that this is a long-term structural change that’s occurred in the last week or two weeks. When there’s a little bit of data that is perhaps better-than-expected, you see rallies. You could call that a bear market rally or opportunistic trading. For a structural shift to occur, we have to see some resolution on growth. I don’t see that emerging in the next one, maybe even two quarters.
What are the chances of a recession in the US?
That debate is the most active. We think it is 20-30%, there’s a group of folks who think that it’s probably closer to 70-80%, and then there’s someone more optimistic who might think it is 0-10%. That’s actually creating a lot of the uncertainty and the volatility in the markets. I don’t think there’s going to be much clarity for at least several months.
Do you see a prolonged spell of monetary tightening by the Fed?
The Fed will continue to tighten till such time as inflation is more manageable. It’s quite clear that it’s unlikely that the 2% target will be achieved anytime soon. Our assumption is that the Fed will continue to tighten in terms of rates and shrink the size of its balance sheet till such time that the objective is achieved. What’s also clear is that other major central banks are going to follow. The one exception is the Bank of Japan. Outside of that, every central bank in the world is going to be tightening.
What does that mean for risk assets like emerging markets, including India?
We have already seen some impact on risk assets. If the Fed actually reduces the size of its balance sheet by $2 trillion, which is the expectation, I can’t see an environment that is good for risk assets. That will have to be offset by some pretty good data on growth and earnings.
Where does India currently stand in your list of investment destinations?
Both on an absolute and relative basis, very positive. Assuming India grows at anywhere between 7% and 9% over the next several years, that’s a complete outlier from a positive perspective.
There is no major economy globally that we expect to be even close. The US and Europe will slow. Growth in China this year is going to be closer to 4%. It’ll recover next year, but it’s not going to hit the 8% or 9% that we’re talking about for India. There’s a whole bunch of risks which apply to India as much as any other place. High cost of energy, food, fertilizer, interest rates and reduced liquidity will have an impact. On a relative basis, that’s offset by the growth profile of the economy. India in the context of other EMs is much better. There are higher foreign exchange reserves and reduced oil intensity of the economy are both very important in the current environment.
What is your assessment of the outflows from India?
That is less a verdict on India and the attractiveness of India as an investment destination. The outflows are a reflection on investors de-risking just given everything that’s happening more broadly. Valuations are stretched. On a relative basis, India trades at 19 times earnings. MSCI EM trades at 10 times earnings, China trades at 9 times earnings.
Are there similarities between the current technology sell-off and the dotcom bust of 2000?
What happened then (dotcom bust) was that the amount of capital that was raised for businesses that were going to potentially profit at a much earlier stage was much more significant. Unprofitable tech is a big segment of the market but these businesses have more scale and are closer to profitability than was the case then. They have a tangible market that is large and they are penetrating that market. But we are going to see business plans becoming a little more conservative, capital becoming more valuable, and spend becoming more reasonable. Compromising longer-term growth for near-term profitability is going to be the thing.
That’s bad news for several new-age companies waiting in the pipeline to raise funds.
It is going to be difficult in the near term for multiple reasons. It is going to be much more selective, at a different price and perhaps, the amount of capital available is going to come down. The focus will have to be on making sure that the business models don’t envisage cash burn indefinitely, making sure that profitability is a key criteria and being more realistic about valuations. In many cases, the public markets will offer a valuation that is lower than the last private round. The private investors and entrepreneurs are going to have to get comfortable with that. This is something that we’re seeing globally.
Do you see the spill-over effects of geopolitical risks on the credit markets?
It’s already happening. We’ve seen credit spreads widen meaningfully, both in the investment grade, the high yield side and the loan market. There’s less liquidity. People are much more cautious than they were last year as you would expect. The US-China relationship has actually been problematic for some time. This most recent deterioration will continue to have an impact till resolution is achieved.