InvestorQ : If the stock markets correct sharply on Monday 29th August due to the Powell speech, should you suggest buying into the markets?
Arusha Ray made post

If the stock markets correct sharply on Monday 29th August due to the Powell speech, should you suggest buying into the markets?

diksha shah answered.
2 months ago

The Fed chair, Jerome Powell, has hinted that the Fed would stay hawkish on rates till inflation retreated closer to 2%. That also underlines the possibility that there could be 75 bps rate hike in September 2022. However, the Fed has stuck to its interest target of 3.75% to 4.00% range as the terminal rate. Nearly 90% of the rate hikes could be front loaded in 2022 itself. Opening would be weak for Indian markets and we have seen that on Monday. However, there several positives for the market if you consider a longer term perspective.

a) Remember, market reactions tend to be knee-jerk in nature and are not conclusive. Sooner, rather than later, investors will digest the real story. The good thing is that the Fed is absolutely unambiguous about its choices. It has hinted that if it had to choose between growth and inflation control, it would prefer to control inflation, even if that meant sacrificing growth to some extent. That is actually a positive for the markets.

b) The Fed has rightly indicated that the best way to boost growth in the current context is by containing inflation. How is that? If you look at the US real GDP data, it contracted by -0.3% in the June 2022 quarter. However, the nominal GDP growth is 8.5% so inflation has done most of the damage. Even a 200 bps reduction in inflation is a direct 200 bps boost to the GDP growth rate. That sounds simple right?

c) Will the Fed and RBI kill consumer demand by being hawkish. In reality, the reverse could happen. It is not just inflation but inflation expectations that really sets the tone. If people expect higher inflation, they become cautious about spending money since savings will erode. The Fed hawkishness has actually reduced the inflation expectations in India and in the US and that is likely to give confidence to consumers to spend.

d) Won’t higher rates hit valuations and solvency of companies? That argument is only partially correct. Let us look at valuations first. When rates go up, the cost of capital goes up and so valuations go down since cost of capital is used to discount future cash flows. However, the historical experience has been that rising rates hurt in the short run but are actually beneficial for markets in the long run. Regarding solvency risk, rising rates do pose a risk, but that is offset by the falling leverage among large Indian corporates in India in the last 2 years.

Selling into a market due to rising rates seems to be the low-hanging fruit or the mug’s trade. The real trade would be to take a contrarian approach and accumulate stocks for the long term. More than anything, clarity helps markets more than anything else.