Markets: Stop watching the clock!

Source: EM

“Hickory Dickory Dock,
The bee buzzed around the clock.
The clock struck ‘five’,
She went to hive!
Hickory Dickory Dock.”

Read no error in this replication of the good ol’ nursery rhyme. Not many know that this is exactly one of the stanzas in the same. However, here we shall not elaborate more on rhymes and rather concentrate on the ‘five’ word that has been the main perpetrator of the global asset ‘meltdown’ that has shaped up in the past four weeks or so.

Now, the ‘five’ here refers to the US Federal Reserve’s short-term rate of interest, which current stands (or hovers) at the 5% level. When, on May 11, the Fed raised this benchmark rate from the earlier level of 4.75%, it had indicated of further firming up (increasing rates) in order to address inflation issues in the US economy. And then, as the ‘bee went to the hive’ i.e. as the clock struck ‘five’, something similar has been the situation with participants in the global asset markets (for the time being, we shall stick to equities).

What more, the US Fed was closely followed (less than a month later), in their rate hiking campaign, by 4 emerging market central banks of Turkey, Thailand, Korea and India. What was more similar was that 3 out of the 4 raised short-term lending rates by a similar 25 basis points. So what has led to this situation – the central banks acting and equity markets reacting?

In wake of rising pressure on central banks to tide in inflationary pressure arising out of higher asset and commodity prices, worries of higher interest rates have fueled a drop in stock markets around the world. The fear is that if interest rates go too high, it could consequently lead to deceleration of the global growth engine, or even lead to a worldwide recession.

Now, as far as the Indian markets are concerned, it is pertinent to note that this decision (of hiking repo and reverse repo rates) by the RBI reflects the upside risks to price stability (inflation) over the medium term. Thus, the consequent hike in interest rates will contribute to ensuring that long-term inflation expectations remain anchored at levels consistent with price stability.

Long-term investors need to appreciate the fact that such an anchoring is a prerequisite for monetary policy to make an ongoing contribution towards supporting economic growth, which is a pre-requisite for sustenance of strength in the equity markets. So, let the clock strike ‘5.25’! You, the investor, only need to keep tab on your risk-return profile and invest in sound and strong companies for the long-term.

What we mean ‘sound’ in a rising interest rate scenario are companies, which are relatively insulated i.e. lower debt burden. Commodities may not be necessary a good investment avenue, as has been the case historically, when rates have risen.

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