How roller coaster ride in global yields is leading to carnage in stocks

Last month has seen a carnage in the bourses globally, with the World MSCI Index falling 6%, MSCI China 8%, and MSCI Emerging market and India too relatively outperforming but in absolute terms down ~5%.

The last month itself had two swings in the Global Debt Market – firstly the Fed suggesting possibility of even higher rate rises due to inflation numbers of January coming in higher at 5.4% as against 5% and strong labour market data of unemployment levels down to 3.4%. Investors started getting concerned about the interest rate moving to even 6% levels as US Media suggested. Additional uncertainty was due to the Biden administration proposing raising taxes for the corporate and the higher income bracket households.

The news of failure of Silicon Valley Bank and two other regional banks with FDIC taking control of those to safeguard depositors led to severe risk off in the markets and the small financial space. This episode highlights the mark to market driven stresses building up in the corporate and financial sector. The U.S. authorities launched emergency measures shore up confidence in the banking system after the failure of Silicon Valley Bank threatened to trigger a broader financial crisis, ensuring depositors would not lose their money. This lead to yield both for the 2-year and 10 year which had peaked to over 5% and 4% to almost 4.2% and 3.6%, with the inverted spread narrowing from -1% to -60 bps

The markets now believe the hike in US interest rate may be not as much as expected earlier and probably be around a peak of 5-5.25%. Seeing the collapse of SVB and issues cropping out in Credit Suisse, one cannot rule out the possibility of further rate hike by FED in the short term and a probable requirement of cutting the rates in the second half to curb economic slowdown. However, the spread between junk bonds increased and the consensus view is now of Big getting bigger in Banks both in US and domestically.

The consequences of the above action would be falling inflation and falling Global demand and cut in earnings estimates which has already started. Though arguable our analysis suggests, global earnings have already been cut by 4-5% this and probably another similar no. is left to be cut in the remaining part of the year India could shine again, like in last year.

RBI has raised India’s interest rate by 2.5% almost half of that of US and we believe a max of 0.25-0.5% hike is possible largely to prevent the Rupee not to depreciate versus the US$.

Indian Earnings to beat global earnings F22-F25

Indian earnings estimate will have limited downside risk as against global estimates largely due to the Index composition and skewedness to the financial sector. The Nifty 50 had a contribution of almost 44% in 3QF2023 emanating from the Financial sector, and we believe the Banking sector is in its “Golden Age”. In India we are in a benign asset quality cycle with a downward trend in NPAs and credit costs across banks, making it one of the best times for earnings for the banking sector. The 15-16% loan book growth currently is being contributed by Retail India and once the capex cycle starts, the Corporate growth could also contribute to a robust loan book growth.

Thus If banks earnings grow by 30-35%, they themselves will contribute to a 10-12% overall growth in India Inc. earnings and at least lead to sticky 14-17% earnings cagr next two years, making India a relatively lower risk trade than the rest of the world.

Why we believe SVB crisis may not impact Indian banks?

RBI’s strict supervision has done a magnificent job in building our confidence in the banking system.

This is evident from the fact that the Gross NPA Ratio has come off to ~5% for the banking system from a peak of ~12% in FY18 and the capital levels are healthy at ~16%.

Today Indian banks are much more resilient due to the various clean-up measures and discipline enforced by them with respect to risk management. These measures included Stricter provisioning norms, Mandatory public disclosure of deviation in NPA’s between reported non-performing assets (NPAs); Tightening of risk thresholds under the Prompt Corrective Action (PCA).

Indian banks have also Increased emphasis on technology enabling them be better equipped in Risk management and managing yields. These measures have made the Indian Banking System structurally sound.

(Vinay Jaising in MD, Portfolio Management Services, JM Financial Services)

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