Market to be very weak ahead of Fed meet, don’t expect big selloff: Ajay Bagga

The biggest event lined up for the coming week is clearly the Fed meeting, what is your expectation?

Well looks like a 75 basis point hike, the third in a row. Market is a bit vary that it will be 100 basis points but there is a low probability, one-fourth of a percent probability of 100 basis points. The key part of this Fed meet will be that dot plot will again be released after June. We will get the new dot plot so that will give us an idea of the terminal rate. Right now the market is discounting about 4.25% as the terminal rate for this Fed rate hike cycle so let us see what the FOMC members come out with.

The second part will be their take on growth and inflation. We had recently had a lot of brokerages and the World Bank and IMF all expressing doubts about global recession. We had the FedEx CEO come online yesterday and talk about shipments falling off and global recession looming so their take on that. But I fear that this time around they will be very afraid of doing the 1970s Arthur Burns or Wheeler kind of Fed and they will be more like a Volcker to see through rate hikes and break the back of inflation. I think that will be the key message from the Fed.

A good thing is that the market is going very weak into the meeting so we do not expect a big selloff, in fact there could be a slight rally based on that but overall the situation is deteriorating. The third quarter S&P 500 revenues are down, earnings are sharply down where on July 1 the street estimate was 11% year on year growth, it has gone down to 5.8%. So the earnings estimates are going down, valuations have gone down and we expect markets to continue to go down.

Indian markets have not gone anywhere, I was just looking up the September 16 number and it was about 17,629 on September 16, 2021. We have closed today below that, let us see the adjusted close but I do not think we will be higher than that. So clearly for a year our index has given no returns, of course, there pockets, there are sectors, there are individual stocks which have done very well but overall, we have managed to just stay flat.

In India, we are seeing the markets outperforming in comparison to the global markets but what I remember is that you were expecting the Indian markets to hit a bottom maybe around September and October, do you still stick to that view?

Yes I had hoped you would have forgotten that because Kunal and I were arguing on that. He was saying there will be a new lifetime high first. I was remembering that and I said I should follow Nooresh and Kunal now and stop talking but clearly the situation is bad.

I am seeing an earnings recession looming and there is no easy way out and the kind of interest rate hikes that we have seen along with the quantitative tightening that is happening, the European Union is not able to do quantitative tightening. But the US is taking out some amount of money, they have not been able to meet their objectives because that would really just flatten the markets but I do not think we are out of the woods. The good thing is three-fold – one, in this midterm election year. On average you have the worst year for the markets going into October and then October to next October it is the best year of the four-year cycle so that is one good thing.

Second, Fed rate hike only 60% of the time leads to a recession, normally from the start of a Fed rate hike12 months, 24 months the markets tend to do well, in fact the market peaks around the 24th month and on average in the 30th month is when the recession strikes. So by that logic on average there could be expectation of a 2024 recession not for next year which is good news. So let us see if these averages work out or this time it is one of the markets which we also had a recession within 11 months of a Fed rate hike in the past.

There are cycles like that but on average it tends to last for 30 months so let us see how that works out but I think with two or three assumptions we must understand what the market is still complacent about.

First, this rate cycle will not end very soon, they will make sure that they are on a trajectory to bring down inflation. Second, if you plant this into the

curve on the unemployment versus inflation, you need to lose about 5 million to 6 million more jobs in the US, you need to see the unemployment rate go to about 6.7% from the present 3.7% so a lot of pain ahead if they are really going to tackle the inflation number. If they are not, if they are going to increase their target to 3%, 3.5%, that will be a positive surprise, otherwise just wear your helmet and be ready for lower markets for a few months at least.

How should one position themselves when it comes to the IT pack ahead of the earnings?

I think staying away becomes the thing given the amount of under ownership that is coming in and given the performance. I think there is going to be a lot of margin pressure still coming through. Attrition issues might be getting sorted out to some extent given that now there is some amount of layoffs happening in the rest of the industry so hopefully IT will see some of the attrition issues start to go away but margins will be under pressure.

As you said the management commentary is mostly optimistic but the market is looking beyond that. So I would say maybe three months we give a rest to IT, no new investments in IT, let us watch for the management guidance and then how does the European winter go through, what happens in the European industry that will be critical. I am not expecting a recession in the US this year at least so those numbers should be okay but what will be the cutbacks. We are seeing an earnings slowdown coming in the US also. All that will impact our IT and I treat most of these sell side reports as lagging indicators so now that all the big foreign brokerages have called a sell on IT it might be a good time to start looking at it but I would wait for the results because there is too much that is unknown right now, wait and watch and then maybe after three months we can look at it.