Market divided over interest rate outlook, tightening: Andrew Holland

The main worry for the markets remains a policy misstep by central banks in not tackling inflation or being too aggressive, leading to a sharp economic slowdown, says Andrew Holland

It has been a topsy-turvy road for the markets over the past few weeks as they grappled with multiple headwinds. Andrew Holland, chief executive officer at Avendus Capital Alternate Strategies, tells Puneet Wadhwa that as a fund, Avendus Capital has kept its hedges and cash high which provides it with the flexibility to move back into the market more constructively once uncertainty is over. Edited excerpts:

To what extent are the markets factoring in what the US Fed and other global central banks will do over the next few months? Any worrying points?

The market remains divided about the outlook for interest rates and tightening. On one hand, there are still forecasts for 5-7 interest rate hikes (by the US Fed) over the next year, and on the other, any tightening will lead to a possible downturn in the global economy, which can lead to a possible recession and as a result global central banks will quickly move back to easing interest rate hikes. The main worry for the markets remains a policy misstep by central banks in not tackling inflation or being too aggressive, leading to a sharp economic slowdown.

Will the remaining part of 2022 be as choppy for the markets?

Before the Ukraine-Russia conflict, we were expecting a very volatile first half of 2022 as the markets grappled with interest rates rising around the world, and especially the US Federal Reserve (US Fed) reducing its bloated balance sheet. The likely unintended consequences of this tightening had, in our view, not been factored in by the markets. One just has to look at what happened in China when it tightened last year – the property market virtually collapsed with many well-known construction companies facing liquidity issues.

The conflict in Ukraine and the ‘economic war’ being waged against Russia has only added to the volatility. Apart from a ceasefire, the outlook remains uncertain and fast-changing. We believe Europe is heading towards recession and the US is towards stagflation; both are yet to be factored into earnings forecasts. The recent rise in commodity and food prices is already squeezing companies’ profit margins.

Would you term the Indian equity markets as buy-on-dips or sell-on-a-rally? Are valuations in any sector(s) compelling enough to buy?

While the volatility will provide good entry points, sitting on the sidelines a little longer may be prudent. The US Fed has dug itself into a hole. It has made a policy mistake with respect to inflation being transitory; and with the spectre of stagflation hovering, the US central bank cannot be too dovish. The next few weeks may also give more clarity as to where the conflict in Ukraine is heading and how long the economic sanctions may last. The one potential positive for inflation is that at some point, higher commodity prices will lead to demand destruction, thus lowering commodity prices sharply.

What has been your strategy amid the recent market correction?

As a fund, we have kept our hedges and cash high, which provides us with the flexibility to move back into the market more constructively once some of the uncertainty has cleared.

What are the key triggers that can change foreign investors’ stance on emerging markets and India?

It is usual for foreign investors to take risks off the table if their belief is for rising interest rates globally. Typically, emerging market currencies, equities, and bonds are the first to face selling pressure. For India though, it has also been impacted by: (i) its weighting in emerging market indices, (ii) investors enjoying strong returns over the past year and therefore given higher relative outperformance and high valuations, are taking gains off the table, and (ii) the big fall in China’s indices causing redemptions in emerging market funds. So, it’s not an Indian problem per se. We are confident that the same investors will come back to India once the above events are out of the way.

Have you trimmed your estimates for corporate earnings growth for FY23?

We have downgraded most earnings estimates, apart from the commodity sectors. While there are many negative factors impacting the markets at present, we feel more optimistic going ahead. Undoubtedly, the best-case scenario would be for a ceasefire to hostilities in Ukraine and in the short term. Overall, we would expect a big capex cycle globally, and therefore it could well be a whole new set of sectors that outperform, especially those which may benefit from a new capex cycle.

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