A note from the founder - Feb 22

The US Federal Reserve has raised interest rates and promises to raise them even more in coming year. This significant piece of news was the topic for my last note where I had presented it as a big threat to the equity boom seen over last 2 years. Well, the speculation is now reality. Rising interest rates will affect flows into equity markets and that will in turn bring correction in share prices and mutual fund NAVs. We know that shares have been trading at high Price/Earning ratios and this high optimism (P/E ratios) should not be assumed as an inevitable reality. Scenario can and will change.

One good trend for the equity investors has been the robust growth of Earnings (net profit) of most large companies in FY21-22. We hope we see that trend continue when we read the annual results coming up in Mar22. The large, organised sector has seen demand recover and also captured market share from the unorganized sector that was hit by Covid.

On 1 Feb, the Finance minister Ms. Sitharaman will present her 4th budget. The exercise of budget is given too much importance by the media and many pundits. I have no expectations from it. Fundamentally, 40-50% of the Government’s revenue goes in paying interest alone. Add Defence and subsidies, which can’t be cut. Add inflation of the salaries and benefits of the large Government staff. This means that the Government is surviving its increasing expenditure by increased borrowing every year. Government borrowing has reached a historical high of ~ 90% of our GDP. This deficit cannot come down unless taxes rise. The Government has therefore very small levers to stimulate growth in economy. Nevertheless, we expect it will try through capital (infrastructure) spending. The other factors of growth in GDP - Private consumption, Exports and Private investment continue to show pessimistic rates of growth.

Overall, it appears that we will see increase in fixed income rates (bond rates) and perhaps a nil or small growth in equity markets. This looks like the trend for the year ahead.