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Emkay Global Voices – A Dialogue with Samuel Rines

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Madhavi Arora

Lead – Economist

15 Mar 2022

We hosted Samuel Rines, Cross Market Strategist and Marketing Director, Corbu LLC, to make sense of the current uncertain environment and volatility gripping global markets. Here are the key takeaways: ü Uncertainty around the Russia-Ukraine conflict is set to carry on well into the summer months at least, and probably longer. However, markets are beginning to factor it in and look past it, with the focus shifting to the upcoming Fed monetary policy decision and the China story. ü We are set to enter a prolonged stagflationary cycle – these risks were a lot lower at the start of 2022, but the conflict has exacerbated them. Semiconductor shortages are looming again – Odessa (Ukraine) alone supplies over 60% of neon, which is a key part of the semiconductor manufacturing process. Russia and Ukraine are also two of the largest wheat exporters in the world, and with semiconductors, gasoline and groceries all in short supply, higher inflation is inevitable. ü As a result, the policy response is likely to be painful in the short term. The ECB is tapering bond purchases, but rate hikes do not look imminent, while the Fed seems determined to break demand if needed to dampen inflation. ü India has seen FII outflows, but it remains the only attractive demographic market globally. India offers a better story than China in terms of stability. One sign of returning flows will be if FIIs start buying Indian consumer stocks – but that is probably a sign to watch out for toward the end of Q1FY23. ü China has had disappointing numbers recently, and given the state of its real estate sector and poor performance of tech companies, it is difficult to invest in the near term. ü Oil & gas will stop being relevant once the Ukraine crisis is resolved. ü Cryptocurrencies are a solution looking for a problem, but CBDCs have merit. Geopolitical uncertainty is likely to persist, but markets will move on quickly Rines believes that while uncertainty around the Russia-Ukraine conflict is likely to persist for quite some time, especially if Ukraine continues to resist fiercely and in the absence of a peace deal, markets are beginning to factor this in, and the focus will shift to other events by the end of this week. Among other major events, the foremost will be the upcoming Fed monetary policy decision, while China’s need to pick up the pace on growth will also be a key story that markets will keep an eye on. Stagflation is here to stay The risk of a stagflationary environment had abated at the start of the year – most global markets, including China, had begun to open up, while supply chains were also getting back to normal. However, the Ukraine situation has upended those dynamics. One of the key issues dogging markets over the last 18 months has been the semiconductor shortage, which is likely to continue since Ukraine is a major supplier of many components needed for semiconductor manufacturing. Ukraine produces over half of the world’s neon, a key input for making semiconductor chips, and exports have halted completely. There are only around eight weeks of neon stock left, which could be stretched to 12 at the most, but you are then looking at a significant chip shortage again. Another problematic area is food as Ukraine and Russia are two of the biggest wheat exporters globally, and thus this crisis will continue to push food prices up. Thus, with groceries, gasoline and semiconductors all in short supply, inflation is pretty much guaranteed, and stagflation is embedded into any forecasts for 2022. Policy response could be painful, but smart positioning can benefit The policy response from G4 central banks will be a key driver for markets. According to Rines, the ECB does not need to be as hawkish as the Fed, since growth seems to be relatively stable, while European economies, especially Germany, are now pushing for fiscal stimulus as well. Additionally, Europe’s energy dependence on Russia also makes it difficult to raise rates substantially in the current situation. European manufacturing also has significant ties to China, and so an uptick in China will flow through as well. Overall, the Euro could see a surprise upside to the dollar this year due to these dynamics. As for the Fed, Chairman Jerome Powell has made it clear that he is willing to ‘break’ demand to control inflation, at the cost of growth, and follow the steps of Paul Volcker. This is not a typical Fed cycle as the Fed is hiking rates due to inflationary pressures as a result of supply problems, and at this point, a tentative pivot to value stocks vs. growth could be beneficial. A general US vs. Europe play in portfolios is also interesting, and within Europe, Germany is the most attractive. Rines goes as far to say that buying German stocks is the best option globally – buy the DAX and call it a day. This is also aided by the Euro having a significant upside.

India remains extremely interesting for global asset allocators While India has seen significant FII outflows recently, it remains the only attractive demographic environments globally. From a long-term perspective, India looks better than China due to its demographics and economic stability. One of the signs that long-term flows are beginning to return will be if FII flows begin to hit Indian consumer stocks, but given the current scenario, that is a sign to watch out for toward the end of Q1FY23. In terms of risks, muted growth in China will keep the dollar strong and act as a hindrance to EM flows. One of the kickers to investing in India is that the rupee can move significantly during a risk-on move. And if this happens, flows will not come back before late Q2 and Q3. The China story is not as appealing in the near term Recent numbers out of China have been very disappointing. The remnimbi, however, has stayed resilient compared to other Asian currencies over the last two months, in large part due to China’s commitment to accumulate commodities, while it also has the monetary firepower to keep the currency stable for some time. However, China remains extremely difficult to invest in at the moment due to the state of the real estate sector, which was a large part of most asset allocators’ positions. Secondly, Chinese tech firms have seen disappointing growth recently, which has further impacted flows. Commodity supercycles are done, with oil & gas only of interest due to the current crisis There was a supercycle in industrial metals in 2020-21, driven by a global buildout of electrification via renewables and batteries, which needed a lot of copper and lithium, among other metals. This was also a large risk-on driver for EMs, since some of the larger allocations in EM funds tend to benefit from commodity supercycles. At the same time, oil & gas was written off, with no new investment in production. Despite the current elevated state of commodity prices, that is set to continue – there is no oil & gas supercycle, as once the Ukraine situation abates, investor interest will begin to wane rapidly. Gold could be an interesting asset to watch, as it is still only around $2,000 despite 7% inflation (in the US) and a war. However, sanctions on Russia will have a large overhang, since the only way now for the country to raise funds will be by selling its gold reserves. Cryptocurrencies are a solution looking for a problem, but CBDCs have merit It is interesting that even in such a volatile scenario, cryptocurrencies have taken a beating, when they were being called ‘digital gold’. One reason could be that 20% of the global hash rate is in Russia, and with Russia threatening to restrict access to the global internet domestically, it automatically reduces the efficiency of global crypto networks. Another major issue is that crypto mining continues to be very energy intensive, and Rines struggles to see how it can be a solution for anything before becoming more energy efficient. Central bank digital currencies (CBDCs), however, are extremely interesting, especially for efficient banking. In that respect, India’s mooted CBDC again makes it a significant catalyst for investment, as well as for the rupee. A digital rupee would make it very easy for international investors to access Indian markets, while given how important banking channels are in the country, it would also improve access to banking for large swathes of the population.