"Every catastrophe calls out loud inviting you to see the Opportunity lying
within"
By - Siddhartha Rastogi
This was true in 1997 (the Great Asian Financial Crisis), was upheld in 2008(the Great Financial Crisis), was true in 2018 (the Great Indian NBFC Crisis) and holds true now (the Great US Banking Crisis).
What's happening today - the collapse of the tech sector valuations, rising Inflation, Strong Job Market, recessionary pressures, shrinking corporate margins, the regulator suing the largest crypto exchange (in volume terms), large banks failing & falling, winter setting in for the start-up funding, serious correction in the crypto market, all is not a direct outcome of events, happenings or incidents of a week, month or a year, this is an outcome of actions taken by different leaderships of different countries of different economies at the turn of the most severe catastrophe that hit the humankind in a century - The Covid 19 Pandemic.
The cause of the Global Halt in March 2020 was the same, but the actions and the reactions undertaken by different countries were different and thus some are facing the heat so mammoth, that their survival has come into question, whilst for others the sailing is smooth.
What & Why
When covid struck, free money doles from the Western governments and substantially lower interest rates (Near Zero) fueled hyper fundraising from corporations.
Evidence - Q2, 2020 peak of Covid Chaos, Goldman Sachs leading American investment bank reported the biggest earnings outperformance in nearly a decade. So was the case of other investment banks. The decline in interest rates created a bond rally triggering a huge upside for bond traders.
During covid consumption of services slipped down, however, consumption of goods jumped as it was believed that the mental distress of covid could be set off by the materialistic world by shopping goods online.
Roughly one-third of the goods consumed in the US were and are produced directly or indirectly in China. Despite tariffs on logistics in 2020, going higher, due to covid, the average American continued on its buying spree. When covid receded, services consumption surged, fueling inflation.
The biggest challenge that the world faces today are not war, rise in wages, reduced corporate profitability or recessionary pressures but they can be summarized in two simple pointers –
1. Steep rise in Interest rates
2. Velocity of rise in Interest Rates
Actions leading to Reactions
During the period of covid, all investment asset classes flourished and so did crypto. With excess time in hand and zeal to make quick money, the world started chasing Crypto.
1. Crypto has no underlying strength and is solely dependent on demand and supply. As crypto gained momentum during 2020 and 2021, market participants started taking exposure to crypto using it as collateral for lending.
Some of the US and European banks had significant exposure to crypto and when the crypto collapsed (cheap liquidity being withdrawn due to a rise in interest rates), the banks became insolvent leading to bankruptcy.
2. Post covid there was a surge in US Gsec Yields.
This led to a huge Market to Market (MTM) loss in the Investment book of the banks and financial institutions that were invested in US Govt bonds or fixed coupon securities.
A rise in yields leads to a drop in bond values. This is true for individuals as well as institutions holding Long-dated bonds.
A further rise in yields (on account of rising interest rates) jacked up the losses and banks that were not able to raise money by selling equities (difficult in a weak equity market scenario playing out since Jan 2022), led to insolvency leading to bankruptcy.
3. Account holders in the US banks are assured of Insurance on deposits or balances of up to 250,000 USD or below.
As of Jan 2022, American banks had assets worth 24 trillion USD invested in loans, MBS (Mortgage Backed Securities), cash in hand, US treasuries & bonds.
These assets were funded by 19 trillion USD of depositors’ funds. With interest rising to 4.5% (current Fed rate 4.75% - 5%), unrealized marked to market (as mandated by the US Accounting Norms) losses bludgeoned to 620 billion USD as per some estimates. If all assets are adjusted to marked to market at the current prevailing Fed rate, the asset base of the banks will reduce by a whooping 2 trillion USD.
Only a small percentage of depositors are insured by the FDIC (Federal Deposit Insurance Company) ; the rest remains largely unsecured. The Social Science Research Network study, named “Monetary Tightening and US Bank Fragility in 2023” states that as high as 186 US banks remain at
risk of insolvency and bankruptcy.
This is the dichotomy between what people think they have and what exists.
(Perceived Safety Vs Real Safety)
Oasis in the deep dark desert
With this backdrop, First half of FY 24 will surely give Braveheart’s a lot of opportunity to participate in the upside of equity markets. India in midst of this chaos is building bit by bit its strength to remain resilient.
Non Cash dole outs with Credit guarantee to SME & MSME during covid, focus on free food, health and vaccination infrastructure, make in India, make for India, & Make for World with schemes like PLI across 14 sectors ensured India stands out like an Oasis in midst of the deep dark
desert.
Step by Step acceptability of Rupee globally (35 countries willing to initiate rupee trades) with Rupee trade settlements, UPI platform going global, arrival of digital rupee along with less dependence on energy sources settled in USD is and will continue to have far reaching positive consequences on India and Indian economy.
The Compulsion
With the US Presidential Primaries to kick start soon, Democratic leadership has to move back on the path of QE (Quantitative Easing) from QT (Quantitative Tightening).
Remember the US average home loan rate stood at 3.2% in 2019 (pre-covid) and now stands at 7.5% on average hitting and affecting the bottom of the pyramid.
But till such time, the trajectory of the US interest rates plateau or start progressing southward, the
bright sunny days of risky assets including Global Equities is far.
Hence FY 24 will witness a tale of two worlds, with first half marred with volatility, whilst second half bringing positivity. One must always remember the Seatbelt during uncertain, capricious and turbulent times is quality and consistency in earnings.
Generally Equity markets present money making opportunities every 3 -5 years, but if one ventures out today with armor of Quality & Consistency (in earnings), the outcome will be phenomenal even in the forthcoming 24 months.
Stay Safe in the first 6 months, & reap the benefits in the second 6 months.
Disclaimer: The Author is the Managing Director and COO of a leading Full Service Investment Bank. However the views presented above are strictly personal and don’t reflect the stance or official viewpoint of company or any of its affiliates, where author is presently employed. The author does not take responsibility of authenticity of any of the data mentioned above. This note is not a solicitation of Investment into any kind of Product or Services. One must not take any Investment decision basis the above commentary, things, events, happenings, may turn out to be very different as has been anticipated in the note. One must consult the Investment advisor or Investment Specialist before undertaking any investments.
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