The defining characteristic of mid-cycle is the withdrawal of monetary policy stimulus. Volatility rises during the period of transition, with equity returns being more modest during this phase, mirroring earnings growth.
The US Fed and the Reserve Bank of India (RBI) have raised policy rates by 175bps and 90bps in H1 2022 respectively, to curb record-high inflation.
The extremely hawkish pivot by central banks accompanied by a surge in bond yields has driven significant volatility in the risky assets.
Though volatility is a feature of mid-cycle transition, the current pullback (i.e., peak to trough fall of about 18%) has been longer both, in duration and quantum than previous historical pullbacks.
Going ahead, the macro-economic environment and earnings trajectory in the second half of 2022 will determine if the mid-cycle transition is successful like in 2004 – where markets recovered after the initial fall to hit a new all-time high over the next 6 months – or unsuccessful like in 2011 – with equity markets entering a 3-year long bear phase.
We expect India’s economic growth to remain above its long-term trend in FY 2023 amid a low base, broad-based economic recovery and a revival in consumption and private capex.
The earnings cycle remains robust, with the likelihood of a third consecutive year of double-digit EPS growth for the Nifty Index after over 35% and 15% EPS growth registered for FY 2022 and FY 2021, respectively.
In addition, India’s economic and earnings growth remains much ahead of its major peers. The above macro-economic conditions are similar to the 2004 mid-cycle.
However, inflation and bond yields are significantly higher compared to 2004, indicating the possibility of more policy tightening going down the line.
Nevertheless, the current domestic macro-environment is much better than 2011 and the terminal policy rate is likely to be lower compared to 2011 cycle as both current and future inflation is likely to trend lower than the 2011 period.
Overall, in our view, given strong macro fundamentals and resilient earnings growth, the current mid-cycle transition is likely to be a minor setback and not a roadblock. Thus, we believe equities are likely to outperform other traditional asset classes over the medium term.
However, the probability of strong outperformance, is declining gradually, especially given key risks – slowing global economy, hawkish central banks, and India’s higher valuation premium to peers – is likely to keep volatility elevated and future returns modest.
(Saurabh Jain, Head, Wealth Management, Standard Chartered Bank, India and Vinay Joseph, Head, Investment Products and Strategy, Standard Chartered Wealth, India)