The strange ties of stocks and bonds, New and Old Economy, oil and demand, and the US dollar with recovery
The tussle
for supremacy between stocks and bonds is one of the many paradoxes of
investing. Both are dependent on each other for survival but feed on each
other’s misery. Equities and fixed income securities are chased on signs of the
economy blooming but for contrasting reasons: one for capital appreciation and
the second to capture the prevalent rate-bearing instruments on expectation of
borrowing costs sliding further. The mark-to-market value of a portfolio
comprising loans taken by the private sector and the Union government and the
central bank improves as lending cost looks set to tumble. A rate-hike cycle to
pull back assets from entering bubble territory caps consumption. The
valuations assigned to companies based on their projected north-bound trajectory
on low-cost money go over the top. There is exodus from debentures and
government securities in anticipation of future issuances at higher coupons and
yields. The playbook is becoming increasingly visible of late. The rapid
rollout of vaccines and a third fiscal stimulus in the US even as interest
rates are near zero are sending yields soaring and correcting shares. The
return of demand is triggering commodity inflation. Producers are ramping
prices, setting the stage for a lingering inflation unlike the flare-up caused
by the temporary bottlenecks in getting food and non-food supplies. Snapping up
the diving counters is fraught with risks. They might turn dud if the drop
continues. Locking funds in NCDs and treasuries might be lost opportunity for higher
returns going ahead.
The ties of
sustenance and destruction are not only between two types of investment vehicles.
They exist even between opposing segments and within a grouping with similar
characteristics. The shift of inflows from tech stars to Old Economy scrips is
a reaffirmation that the regime of soft borrowing is beginning to end. The bout
between growth stocks, requiring cash infusion to take off, and value stocks,
languishing due to slump in usage during a period of pessimism, is yet another
irony. The two categories thrive at the expense of each other. In the absence
of opportunities for higher earnings in a low-cost environment, funds gravitate
towards emerging areas because of their ability to expand rapidly in short
periods. Traditional sectors start attracting attention only when they can
reclaim their pricing power. Oil sprang 175% from a bottom a year ago as global
economies clawed back to normalcy. The commodity has become a proxy to gauge
the health of the global economy. After plunging in April last year as nations
hunkered down, prices scaled back after a rapid rise due to renewed shutdowns
in the European Union on resurgence of covid-19 infections. Fall in upstream sales indicates trouble for
both the explorer-refiner and consumer. Softness at pumps at the height of the
pandemic provided no solace to the grounded aviation players. Prices rebounded
when airlines were permitted to undertake flights with certain
limitations.
Industries
with low raw material and intermediary expenditure should be a cause for alarm
rather than satisfaction because of the transitory nature of the benefit. The
initial bounce-back of polymers and paints was based on rural markets, buoyed
by good monsoon and cheap credit. These sectors might not be able to maintain
their margins with the bubbling of input costs. The recent upward direction of
petrol and diesel inhibiting buying of automobiles is one side of the story.
The other is the disruption in transport affecting delivery of semiconductors.
The problem will resolve as soon as the threat of coronavirus is under control.
The smooth resumption of transport will no doubt enable acceleration in output.
The outcome will be higher prices of chips as logistic providers re-work their
bill. Another confounding benchmark is the US dollar. It weakens, rather than
strengthening, during a bullish phase in the US economy, coinciding with loose
monetary and fiscal policies. Inflows into the world’s convertible suggest a
difficult period ahead. Investors departed
from risky assets for a safe harbor in the greenback during the initial
periods of the lockdowns. A strong currency complicates US recovery as its
exports become uncompetitive. The Federal Reserve had to pull down lending
rates to near zero to diminish the appeal. Those who prefer to stick to their
comfort zone, own rather than lend to businesses, or have a long-term horizon
usually sit out during one of the alternate phases. Institutional investors,
who face redemption pressure at the slightest souring of the mood, rebalance
their portfolio to make the best of the two cycles. Volatility is the consequence
of such transition.
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