On Monday, August 5, 2024, Indian equities corrected by 3% following nearly 13% drop in the Nikkei (the Japanese benchmark index) and steep declines in the Korean and Taiwanese markets. Subsequently, US markets fell by 3%. While most markets on Tuesday were either flat or positive, global markets have been down between 3% and 10% since the beginning of last week.
The key reasons for this sharp decline are as follows:
1. The Yen
The borrowing in Japanese currency, yen, and investing in other markets has been impacted by the Bank of Japan’s (BoJ) recent interest rate hike. The yen has appreciated by 10% against the dollar in the past couple of weeks, following the BoJ’s rate hike from 0.10% to 0.25%.
With rising interest expenses and a stronger Yen, the carry trade has become costly. Investors are being forced to sell underlying securities before the trade becomes unviable. It is estimated that at least $1 trillion worth of such exposure is outstanding across all asset classes.
For context, Lehman Brothers had $600 billion in debt at its peak in 2007, largely funding mortgage assets. Defaults on these assets led to Lehman’s bankruptcy, with estimated economic losses of $10 trillion-16 times the company’s debt. Given advancements in technology and liquidity, the impact of similar issues today could be even larger.
Post-COVID, liquidity-driven rallies have propelled asset prices worldwide. Gold recently peaked at Rs 76,000 per 10 grams, an all-time high. The Sensex, before Monday’s fall, was at its highest level of 81,867, and real estate prices in many Indian cities have surged, with some premium properties in NCR selling out in days.
With easy and cheap money regime likely coming to an end, assets globally are facing selling pressure as investors seek to book profits or minimize losses due to higher borrowing costs.
2. Recessionary Fears In The US
Last week’s US jobs data for July showed a rise in unemployment rate to 4.3%, the highest in three years, following June’s 4.1%. This marks the fourth consecutive month of rising unemployment, stoking fears of a recession. Investment Banking firm Goldman Sachs now estimates a 25% chance of recession in the US, up from a previous 15% probability.
The expectation of a gradual economic recovery appears to be fading, with markets bracing for a possible hard landing. Uncertainty surrounding the upcoming US elections is also adding to the concerns.
3. Rising Geopolitical Tensions
Last week, Israel was suspected of killing senior Hamas officials in Tehran and Beirut. This escalation has prompted Hezbollah to launch drone attacks on Israeli military sites, raising the probability of a broader conflict in the region. And that is bad news for all risky assets.
4. Weak Domestic First Quarter Earnings
Indian corporate earnings have been weak, with 8% quarter-on-quarter decline (Nifty 50) and 6% year-on-year growth. The Indian market’s post-COVID rise was driven by strong earnings growth. However, earnings growth has recently been muted, with high inflation, rising crude prices, and lacklustre volume growth posing risks. Achieving a 12-14% growth in FY25 earnings seems challenging, given the low single-digit growth in Q1.
Following capital gains taxation hike announcement in the budget, the potential for positive news has diminished significantly.
5. India’s Outperformance
India has been among the top-performing markets in 2024, with a rise of over 10% (Sensex). Market experts have been warning of an impending correction and advising investors to consider balanced funds or increase exposure to debt products.
SEBI has tightened F&O norms to curb excessive speculation, and AMFI has been promoting debt funds through its ‘Mutual Fund Sahi Hai’ campaign.
Until there is more clarity on positive developments or limited negative outcomes, investors may be better off booking some profits on their equity investments. As the adage goes, “Don’t try to catch a falling knife”.
Experts recommend waiting and watching rather than buying on the dips amid global uncertainty.
(Amitabh Tiwari is a political strategist and commentator. In his earlier avatar, he was a corporate and investment banker.)
Disclaimer: These are the personal opinions of the author
