Be choosy of what to own during an inflationary & valuation transition

When inflation is at decade high it is advisable to choose what you buy, hold, and sell in the market. Some sections of the economy have benefit while some are negative to neutral. These prices move in tandem in a cycle of lows to highs. Usually, it moves due to disruption & mismatch in supply & demand, which could be short or long-term in nature. This time it was initiated by the pandemic which firstly affected demand leading to low inflation followed by disruption in supply & transportation to high inflation. Today’s hyperinflation it is due to the war and further slowdown in capacity utilization and logistic crackdown in some parts of the world.

Undoubtedly, this inflation will not stay elevated for a longtime. A change is expected from hyperinflation to normal inflation in the short to medium-term. Forecast expects a drop in economy prices in the next 2-4 quarters with hopes of the war coming to an end, opening of capacity and transportations.

This transition will influence the performance of stocks & sectors. Today’s beneficiaries will not be able to sustain in the future while the ones that have been negatively impacted will gain in the future due to cost reduction & improvement in demand. This anomaly will persist if the weekly & monthly inflation data points continue to be elevated. The sectors that will directly benefit from these disruptions are energy, metals, mining, agriculture, realty. If the issue escalates to the long-term, it will start to affect long-term private spending, which is not anticipated today. Negatively affected in the short-term are largely discretionary & non-discretionary consumer sector and logistics. The sectors which were neutral about hyperinflation were IT, Pharma/Chemical (marginally impacted) and Banking (due to accommodative policy).

In the last one-month global markets have moved cautiously in context to inflation data release, uncertainties of war development, volatile crude prices, hawkish FED policy and mixed quarter results. Similarly domestic market has been volatile with hawkish RBI policy and negative start to Q4 result season by IT and mixed results by the banking sector. This has led to heavy selling in heavyweights by FIIs. Weak IT results has prompted the market to be worried about the headwinds like attrition, wage inflation, lower utilization, and possible cut in IT spending by industries due to geopolitical and macro issue. The degree of downfall is high because the sector is trading at high valuation and risk of downgrade is increasing, affecting the short & medium-term performance.

If we look at the broad market, it is trading at the upper band due to the mixed rally. Nifty500 index is at 14,895 near an all-time high of 16,000. In the short to medium term, we can anticipate a transition in the performance of sectors which will have an effect in the trendline of the broad market. One reason for the main market to sustain will be to trigger a risk-on strategy in the global market as FII selling is a concern. For this the global bond and commodity markets must normalize which is currently at an elevated trend due to rate hikes, supply constraints and geo-political tensions. In context to the consolidation of the domestic market, I think we are in the last phase of the consolidation which has been happening during the last 6months. If inflation risks start to subside which is possible in the next 2 to 4 quarters, we can assume it to be worthwhile for medium-term investors with focus on such stocks & sectors.