Has Inflation Peaked Out?

May 20, 2022

'Nothing is ever as good or as bad as it seems'

Our perception of how bad things are, is typically much worse than they are in reality. Our perception during good times are also much better than they really are.

The above statements describe a strong perspective about life. Isn't this adage about life similar to stock markets?

I distinctly remember that during the last week of March 2020, when Covid struck major parts of the world and India, the fear levels were the highest.

This fear of the unknown led to the sharpest fastest fall in the Indian stock market I've ever seen in my life. A 40% crash in less than a month on the benchmark indices, the NSE Nifty and the BSE Sensex.

The markets were pricing the worst. The assumptions were covid will lead to a global financial crisis worse than the great depression. After all, more than 95% of the people living on planet earth had faced this catastrophe for the first time.

The only precedent we had of a similar scale was the Spanish flu. But medical science a century ago was primitive.

As we all know, the markets priced in the worst as it was an unknown event. In stock markets, we call it as a 'derivative of a derivative' type of an event.

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A derivative is itself is a derivation of an asset. To gauge an event which is a derivative of a derivative requires next level assumptions.

Ok, now let's, dive straight to the point I'm trying to make.

In my last editorial, I wrote to you about how hard it will be for central banks to undo their stupidity of the past two years by mindlessly printing money.

Central bankers around the world have now started to unwind the mess with tight monetary policy. Markets have already started to make an adverse move.

I believe, the only way to control inflation is to kill growth, and when you kill growth, you invite a recession.

I started this piece by talking about perspective. Let me give you a contrarian view...something to think about.

Stock markets fell as there was uncertainty around us due to covid. But the stock markets' reaction to the 2nd and 3rd waves of Covid were mild to say the least.

However, this time I ask... Where is the Uncertainty?

  • The current inflation scenario is not an unknown.
  • The US Federal Reserve's rate hike guidance is also clear.
  • The position with respect to supply chain issues is well known.

The only question to be asked is...

Will the Fed let the US economy slip into recession or change course once inflation starts improving?

In fact, over the next 6 months, there are high chances the rise in inflation will moderate.

So what could go right in the market?

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While everyone is bearish and predicting a crash even post a 15% correction, the following scenarios could lead to upside in the market.

US Fed slows the pace of rate hikes

Analysts have indicated the US Federal Reserve is likely to keep raising interest rates to 2.5-3% i.e. at least 7-8 hikes in 2022.

However, if an increase in interest rates leads to faster than anticipated reduction in demand, the Fed could stop mid-way.

Just look at the results of consumer companies like Walmart, Target, and Amazon. They have missed estimates by a mile. Demand has already started to moderate.

Commodity prices could be on a downtrend

Russia is one of the largest commodity producers in the world. China is the largest user commodities to make final products.

If both the producer and the user is out of the market, imagine the inflationary pressure it would cause.

That is exactly what is happening.

Russia, due to the sanctions and the war, has reduced exports of commodities. China because of the lockdowns in many parts, due to resurgence of covid, is unable to produce the final products for export to the world.

If the war abates sooner than later and China battles covid (which is just a matter of time), commodity prices along with freight prices would likely come down in a meaningful way.

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My personal view is that markets are headed lower as liquidity is sucked out of the system. But I believe if these scenarios play out soon, we could see the bulls coming back in action.

Let me end this article with some food for thought.

It's priority for any central bank and government to control inflation at the earliest. But there is also another perspective.

Why would any country control inflation at the cost of a recession?

Or to put it in another way, Joe Biden and Narendra Modi both have to win an elections. Therefore taming inflation will be a priority.

But which government has been voted back to power during a recession?

We live in an India where the BJP government lost an election in 2004 when the economy was doing well and 'India was shining'. Imagine what a recession would do.

Warm regards,

Aditya Vora
Research Analyst, Hidden Treasure

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