Mounting risks for stocks, most particularly highly valued growth stocks, says Chris Wood in his note.
The possibility of inflation turning “sticky” and not being “transient” -- as most experts had earlier hoped -- may dent equity market sentiment across the globe, warn analysts.
The cautionary stance comes on the back of rising commodity prices, especially those of crude oil, which went past $84 a barrel this week, its highest level in three years, and have gone up a massive 96 per cent from a year ago.
“All this means mounting risks for stocks, most particularly highly valued growth stocks. If the trigger for the anticipated sell-off is to be rising inflation concerns and related Fed tightening concerns, a further major rise in the oil price continues to have the potential to aggravate the current inflation scare dramatically,” Christopher Wood, global head of equity strategy at Jefferies, wrote in the latest weekly note to investors Greed and Fear.
The easy money policy of global central banks, especially the US Fed, against the backdrop of Covid-19 to help the economies navigate the uncertain phase, had triggered an up move across most asset classes, especially equities, in emerging markets.
The Indian frontline indices -- the S&P BSE Sensex and the Nifty50 -- have gained 28 per cent and 31 per cent, respectively, thus far in 2021.
The rally in mid- and small-caps has been sharper with the indices surging over 50 per cent and 65 per cent, respectively, during this period.
Besides oil, the surge in coal and gas prices has become a sore point for most economies, including India, which relies heavily on the “black diamond” to meet its power generation goals.
Rising inflation, according to Wood, is not the only risk/negative for equity markets. “There is also the issue of souring input costs and whether corporates can pass them on,” he said.
A similar view on inflation has been echoed by analysts at Nomura.
“What has become a series of supply-side shocks -- from shipping to semiconductors to now energy -- combined with still-significant policy stimulus and the reopening of the US economy could push the unemployment rate low enough to boost wage inflation and de-anchor longer-term inflation expectations. If the Fed is wrong on transitory inflation, hold on to your seats as financial markets reprice the Fed’s conundrum of no easy policy options,” warns Rob Subbaraman, Nomura’s head of global macro research and co-head of markets research in a report coauthored with Rebecca Wang.
The US five-year, five-year-forward inflation expectation rate is now 2.36 per cent, only 2 basis points (bps) below its 2021 peak of 2.38 per cent reached in May. Wood says a move above 2.5 per cent will put more pressure on the US Federal Reserve (US Fed) in terms of being more specific about how much it is willing to overshoot 2 per cent.
The Indian markets, according to Milind Muchhala, executive director, at Julius Baer, still continue to display strong buoyancy despite the gyrations seen in the US markets on account of the hardening of US bond yields, concern on peaking growth, and the building up of inflationary pressures with a sharp increase in energy costs.
From an asset allocation perspective, equities, according to analysts at Credit Suisse Wealth Management, still remain a preferred asset class from a medium- to long-term perspective, as real interest rates globally are expected to remain in negative territory.
“In the near-term too, as the inflation pressure rises, the shift to equities from bonds may support buying interest in equities, albeit in select sectors that thrive in an inflationary environment or are less susceptible to input cost pressures and supply chain disruptions,” wrote Jitendra Gohil, head of India Equity Research at Credit Suisse Wealth Management in a note coauthored with Premal Kamdar.