investment strategy: Sell rallies in growth stocks in short term; own oil stocks to

“I am not bothered about this peaking of inflation in India. The inflation issue we have right now in world markets is primarily centered on the G7 economies, most particularly America. In casw of the Indian Budget, as the deficit spending is going into investment, I am relaxed on the fiscal deficit,” says Christopher Wood, Global Head of Equity Strategy, Jefferies.

By now, you must have digested the Budget. What do you make of it?
Well to me, this is a pro-growth Budget where the key takeaway is more of the same of what we saw last year where the government seems to be focussing on driving infrastructure capex. As the deficit spending is going into investment, I am relaxed on the fiscal deficit.

If one tries to generate growth in a world where supply disruptions and logistics issues are large, could that stoke inflation and really backfire?
I am not bothered about this peaking of inflation in India. The inflation issue we have right now in world markets is primarily centered on the G7 economies, most particularly America. It reflects the huge monetary and fiscal stimulus implemented in the US, UK and the Eurozone in response to the pandemic. Demand was artificially stimulated because people were paid money to do nothing. In Asia, governments have not paid lots of money to people to do nothing – be it China, India, or Southeast Asia. As a result, we have not had demand artificially stimulated and so the inflation pressures are much less.

We have seen intense selling in US technology stocks. Except for Apple and Alphabet and Microsoft, everything has come tumbling down. Meta was down 25% last week, Netflix has got spooked. What do you make of this selling?
If the Fed proceeds with its stated policy of seeking to tighten monetary policy to combat inflation, the stocks remain at risk. We have seen in the last two months the most dramatic U-turn by a central bank I have ever witnessed. I call it the Jekyll and Hyde Fed. Back in late September, more than half the Fed Governors said no rate hike at all in 2022.

In the last two months, we have had Fed Governors competing to sound more hawkish and we have had economists doing the same. We are now looking at three-four rate hikes at least and also very important for the markets is that the Fed is discussing balance sheet contraction called quantitative tightening. And there are concerns in the market that the Fed may start contracting the balance sheets at the same time as they do rate hikes. If they did that, it would lead to more market nervousness.

While we have discussed a lot about US internet stocks, what about this entire debate on how much of the Fed move of 2022 is in the price? Is it three, four or more?
Three or four rate hikes are priced in, but the Fed has not clarified what is its policy relating to the balance sheet. In my view, markets are more nervous about balance sheet contraction and rate hikes. By the way, the Fed balance sheet will be nearly to $9 trillion when they complete the asset purchases at the end of March ideally. When the pandemic began, the Fed balance sheet was $6 trillion.

But can the Fed really go aggressive on the rate hike because if interest rates go higher, the Fed will have a bigger problem because they will have to deal with the cost of rising debt?
That is true but we have to ask ourselves why has the Fed done this astonishing U-turn. There are two reasons in my view; one reason is they simply got it wrong. So they had a new strategy, they completed the strategic review in 2020 and that strategic review gave them the license to overshoot that 2% target.

Their view was that the inflation pickup was transitory last year and so we had the CPI report coming up at about 7% and that prompted Fed Jerome Powell to do his reversal, saying inflation is not transitory. I think the Fed was forced to do that because inflation is coming up 5% above the target. Obviously 5% is a big miss, but there is another reason why the Fed has started to be focussed on inflation and that is political pressure from the Biden administration to tighten because the Biden administration is polling very badly on the economy.

They obviously have lost control of inflation and that is a big negative with the midterm elections coming up. So there is a political need on the part of the Biden administration for the Fed to seem to be doing something about the inflation.

We understand that the prime minister has written a personal letter to you and this in a sense is an endorsement from the prime minister and his office the fact that you have been a long- term India bull and a call which is now just getting recognised and rewarded.
Yes that is true. I am very honoured to receive this letter and I definitely remain consistent on the Indian story. I believe a lot of important reforms have been implemented during the term of the current government, the current Prime Minister and I am hoping India is set up for an extended investment cycle similar to what we saw between 2002-2003 to 2009.

I continue to draw comfort from the evidence that the housing cycle picked to a significant degree last year after a seven-year downturn. I am assuming that recovery continues this year even if we get some rate hike by the RBI which is likely and I am hoping as are my colleagues in Jefferies India, that the residential property cycle will be followed by a lag by a broader capex cycle. The government by doing all this in capex in infrastructure is definitely creating an environment which should make the private sector more willing to invest.

In the second half of 2021, your view was that Indian markets were trading at a premium to Chinese markets and Chinese markets had fallen a lot in 2021 because of regulatory issues. Now that China is easing interest rates while India is going to be increasing interest rates, is there a case for global investors to put money into China? What will it mean for a market like India? December and January were months of outflows as February has been volatile so far.
I have not reduced my weighting in India but yes you are absolutely right. What I said in the greed and fear is that in the short term India is vulnerable because one, it has done very well; two, it is expensive and three, we now had this external Fed tightening risk. So I am not surprised see India correct and with that actually quite significant selling of Indian equities by foreign investors in the first few weeks of this year. None of that surprises me but what is very encouraging is that inflows into Indian domestic mutual funds remain strong and in my view, corrections in India are buying opportunities if corrections are triggered by concerns about the Fed or concerns about RBI tightening.

The Indian market can be resilient in the face of a rate hike just as it was back in 2003-04-05-06. However, this year China is easing policy. Last year, China was tightening. So it definitely makes sense for equity investors to increase their exposure to China. But the two are not mutually exclusive.

Do you see India or the Indian business cycle moving independently of the world?
India is a domestic demand story and falls are just buying opportunities. Apart from the obvious risk of a new more damaging Covid variant, which will hit all markets including India, the two big external risks for India which can definitely create selloffs and opportunities for investors in India to buy more equities are; a) Fed tightening. The inflation problems in America are not in India. b)Oil price is a real risk. Oil has already gone up a lot. I have been telling investors to own oil stocks over last year and this year. I believe there is a real risk that oil can go significantly higher because of these artificial situations which are being created by the environmental attack on fossil fuel. That has had the paradoxical impact of raising the cost of energy because the attack on fossil fuels has discouraged corporates from investing in oil while the world continues to consume oil.

So we have growing supply constraints and what is interesting is that oil prices have already gone up a lot today. A lot of Asia including China remains closed and that means if China opens this year, oil can go significantly higher. My message is to own oil stocks to hedge this risk.

Indian markets have historically done very well when the first rate cycle starts because it is considered to be pro-growth and not so much so pro-inflation. Do you think the same factor will be at play? While we can argue about the implications of the cost of credit going higher, in the short to medium term, markets are likely to endorse rather than running away from it?
Yes I do believe that, particularly domestically. There the risk is these externalities from Wall Street fundamentally. As long as we have evidence of the investment cycles picking up, I definitely believe that. The other interesting point is that this time around, even if oil goes to $120, India will be less hit by higher oil than before because India has much higher foreign exchange reserves than in the past.

While cyclicals, industrials and financials are a play on mean reversion, what about IT? IT is in linear trend, stocks are at an all-time high. There is a rupee tailwind. There is a business tailwind and there is a headwind of wage inflation. What is your view on IT?
Yes, definitely one should be looking at those areas. Right now these companies have been dramatically successful. The FAANGs have been phenomenal places to invest for the last many years although the FAANGs market share as percentage of S&P peaked out in the summer of 2020 and in my view has registered an all-time peak.

So long as these higher inflation pressures are visible, global investors and investors in the US need to own big weight cyclical stocks. One can no longer just own growth stocks, tech stocks, which is what one could do for the last 10 years. The best performing sector in S&P last year was the energy sector not the FAANGs. The best performing sector year to date in the S&P when I last checked is again the energy sector.

So is the entire move from growth versus value and a mean reversion in value a multi-year decadal trend where we will see value stocks outperforming?
That is a very good question. If inflation remains structurally higher after the pandemic which is my base case, if inflation settles in the 3-4% range, that definitely means that cyclical stocks should become the more stable part of the portfolio. However, growth stocks will get another bid if it turns out that the Fed will not ultimately be as hawkish as what markets are now worrying about.

In my view, it is quite likely that at some point, we will see another U-turn by the Fed as big as the one we just witnessed in the last two months. Because the American economy cannot really deal with very significant monetary tightening because of the high levels of debt, the same applies to the European economy.

What is the middle path then? Where do you see things settling on the inflation and growth front? Rates have to go higher, there is no argument on that but it cannot go up endlessly. Growth is here and for real, even high interest rates will not puncture growth completely?
Well no basically the Fed needs to re-impose real interest rates. We are looking at the most negative interest rates in America since the 1950s. But the question is whether the Fed is really going to do that. Let us say the Fed raises rates four times this year, then we still have a significantly negative real Federal fund rates.

Has the Fed lost its credibility? Do you think they will be much more aggressive now to keep their nose ahead of inflation?
Yes, I agree that is why in the short term I will advise investors to sell rallies in growth stocks.

We have seen a shakeout in crypto, a reversal in some of the US tech stocks; NFT valuations which had gone crazy are now coming back. Could there be a risk-off moment if there is a further meltdown in crypto or US tech stocks because the world is very leveraged because of low interest rates?
There has been a lot of leverage in the crypto markets. Crypto as a class remains a very interesting long term story but so do a lot of these biotech stocks in other areas of technology, all of which have been performing very well until the last three months. I would have to say all these forms of investments remain vulnerable to renewed selling pressures so long as the Fed is tightening and there are concerns on contraction. So I am not surprised to see profitless tech stocks get hit badly.

I am not surprised to see biotech stocks get smashed and I am not surprised to see the crypto asset class get smashed. So for people with the holding power, this is a long-term opportunity.

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