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  • Home » News » Analysis » Markets Boom Amidst Gloom

Markets Boom Amidst Gloom

Indian and US markets have increased by 10% in one month. Is it just a dead cat bounce or is there something fundamental? Let’s try to solve this.

  • Shaurya Bishnoi
  • Publish Date - August 18, 2022 / 06:54 PM IST
Markets Boom Amidst Gloom
Right now, the market has factored all the inflationary headwinds and is in process of factoring these structural changes. Hence it’s on rise. (Photo Credit: www.tv9kannada.com)

Economic data across the world is disappointing but the market is in a mood to roll. Retail sales in China, Europe and US are on a downward trend for the past few months. US went into a technical recession. Manufacturing and services PMI across the globe are falling continuously for quite some time. However, consumer confidence is reviving in India, US and China but is falling in Europe. Now, this revival of consumer confidence is giving hint about market rally.

Well, let’s look at equity markets. Indices like Sensex, Dow, FTSE, CAC, KOSPI all went up by more than 5% in one month. In fact, Indian and US markets have increased by 10% in one month. Is it just a dead cat bounce or is there something fundamental? Let’s try to solve this puzzle.

It’s about what kind of headwind is more prevalent: Inflation or Economic Slowdown. Yes, inflation seems to have peaked. International commodity prices ranging from crude oil, copper, aluminium, palm oil are cooling. Let’s look at commodity indices for an overall picture. Bloomberg Commodity Index declined more than 6% and S&P GSIC is lower by more than 12.5% in the past 3 months. But that’s because we are heading towards an economic downturn. So, we can think of this like an automatic economic stabilizer. This translates into less aggressive rate hikes by central banks.

For equity markets, an economic downturn is a smaller risk than aggressive interest rate hike. We are in a situation of stagflation. Having both high inflation as well as low economic growth. Now it seems at least for one issue the worst is behind us.

While for an economic downturn the question is how deep and long it will be. Right now, consensus is it won’t be that deep. So the biggest fear of inflation is subsiding and the economic downturn is perceived to be shallow. Hence markets are up. Markets know that it is lower due to temporary issues like supply chain disruptions (Improving), lockdown (Improving).

Consumer confidence across the globe fell when commodity prices were sky high. Now fall in commodity prices triggered revival in consumer confidence globally.

On a structural level forces like deglobalization, decarbonization, demographic changes and geopolitical uncertainties brought tectonic shifts in the world. Here 3Ds (Deglobalization, Decarbonization and Demographic changes) will actually pave the road for global CAPEX revival.

With reshoring firms will invest money to set up plants in friendly or nearby countries. With decarbonization, firms will invest in alternative sources of energy. While demographic changes and shortage of labour will induce accelerated investment in digitization and automated production processes to fill up the cavity created by lower workforce.

Now, geopolitical instability has rippled up the stable international business environment. So, to survive high tides firms need to innovate and adapt. All this will lead to higher productivity as well. At the same time, even though trade in goods may reduce, trade in services may continue to rise.

Therefore, transmission of data and knowledge will continue across borders which will propel productivity, innovation and catch-up effect in emerging economies (It can even reduce inequality to some extent).

All this will lead to higher investment and CAPEX despite high interest rates. As anticipation of increase in real capital will drive investment and not the availability of cheap capital (which was the case in the last decade).

Right now, the market has factored all the inflationary headwinds and is in process of factoring these structural changes. Hence it’s on rise.

However, near term risk can emerge from labor market. Workers are demanding higher wages and given the tightness of the labor market in developed countries coupled with deglobalization (lower access to cheap global labor). Bargaining power of workers in developed countries has increased.

So, if inflation expectation of workers is not anchored then inflation can spiral upwards. Hence central banks need to specifically focus on not just controlling the inflation but also on clear communication with common folks.

Other short term risk is supply glut as firms may over compensate for the recent supply shortage.

However, given the contrasting nature of these 2 risks only one of them will prevail and in the current scenario supply glut is more likely than wage inflation spiral in near term.

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