The detection of the Omicron variant of the coronavirus in the last week of November caused a bloodbath in global equities, taking complacent equity market investors by surprise. Major markets in the United States, Japan, India, Russia, Korea and Brazil ended November on a negative note, down around 1.5-4%, according to Bloomberg data.
While the seriousness of Omicron is still unclear, it surely cooled the feelings of participants in global stock markets, who were gearing up for a Santa Claus rally. With the increasing pace of vaccinations around the world and the gradual reopening of borders, global stocks were expected to rally towards the end of the year, a trend commonly referred to as the Santa Claus rally. But hopes quickly fade and fear sets in.
Over the past month, according to the Fear Gauge, the CBOE Volatility Index (VIX) has risen 53%. In comparison, the Indian NSE VIX saw a more moderate increase of about 23% over the same period. But that doesn’t mean all is well. Analysts warn of increased volatility in global and Indian stock markets going forward.
âSpeculation that Omicron could prove to be more contagious than previous variants, and possibly resist vaccines, has seen a sharp deterioration in risk appetite,â said Thomas Mathews, markets economist focusing primarily on emerging markets at Capital Economics in a December 3 report. And Omicron isn’t the only factor that could pull markets down. Loose and accommodating monetary policy, generous budget support, and subdued inflation are all turning from tailwinds to headwinds.
According to Mathews, Omicron could increase inflation in the medium term and pave the way for rate hikes. âAfter all, supply chains are much more stretched than they were even during the Delta Wave, and any further restrictions would only hamper them further. Meanwhile, we already thought that expectations for policy rates seemed too low, and Omicron-linked inflation over the medium term may well be a catalyst for them to rise. “
As inflation creeps in, many central banks have started to raise their interest rates. For example, Brazil raised its key rate for the sixth time since March and by 150 basis points in October. A basis point is equal to one hundredth of a percentage point. Russia, Hungary and Chile are other examples. As for the main US Federal Reserve, the central bank has already indicated that it will withdraw stimulus soon and start raising rates by mid-2022. For Indian investors, the next Reserve Bank of India (RBI) monetary policy meeting on December 8 is crucial in terms of the interest rate decision as well as inflation commentary.
âThe jury is still out on whether RBI will follow in the footsteps of its emerging market peers with its interest rate decisions. As inflation wreaks havoc on corporate balance sheets, we believe the RBI may not be able to maintain the status quo on rates for long. Thus, volatility is set to increase in the coming weeks, “said an analyst from a national brokerage house, on condition of anonymity.
Simply put, the downside risks to stocks are on the upside. Yet valuations remain expensive, especially in the case of India.
The MSCI India Index trades at a one-year futures price-to-earnings (PE) ratio of approximately 22 times. This is a steep premium over the MSCI EM Index which trades at a multiple PE of 14 times, according to Bloomberg data.
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