Reflection on financial market volatility

Over the years, financial markets have become accustomed to expecting the unexpected. Almost every passage of time in the history of financial markets is filled with events that caught market participants by surprise.

However, it would be fair to say that the 2020s just took that to a whole new level. On a lighter note, one wonders how the first quarter of recent years has got into the habit of making fun of the forecasts at the start of the year. While 2020 has been a year that began under the looming threat of geopolitical tensions between the United States and Iran; at the end of the first quarter, what had turned the world upside down was, after all, a virus. Early 2022, when all eyes were on the spread of Omicron; at the end of the first quarter, the event that really shook everyone was geopolitical (Russian-Ukrainian war).

However, what is worth remembering is that if history is to be believed, the world will not only find a way to overcome this crisis, but will also come up with game-changing ideas along the way. . Looking back at Covid and its repercussions, as things stand, the next few years could actually set the course of history for an extended period of time. The early months of this ongoing conflict have already shown that in the future there may be less reliance on physical warfare and more on economic warfare.

This, in turn, could lead to the formation of new economic blocs and change the course of globalization as we know it. Supply chains disrupted by the pandemic have been further strained due to the conflict and countries around the world are increasingly opposed to the idea of ​​economic dependence on countries with divergent security interests and different ideologies. In this regard, India stands out as one of the natural alternatives to fill the void left on the food security front, by Russia and Ukraine, and in the manufacturing sector, by the post-pandemic shift. China+1.

Besides the threat to food security, another major consequence of the war has been the threat to energy security. Soaring energy prices have had a crippling effect on many economies. Therefore, it could force everyone to rethink how energy is produced and consumed; and above all, focus on reducing dependence on fossil fuels. This, in turn, could accelerate the favorable winds for renewable energy at a time when worries about climate change are already making the world sweat. It goes without saying that this change will not happen overnight, as the immediate focus will be on energy security rather than clean energy.

For example, the recent energy crisis has prompted India to turn back to coal. Notwithstanding the recent easing in commodity prices; years of underinvestment can keep prices structurally high. Rising commodity prices, energy transition, supply chain realignment, as well as the political desire to increase defense spending, by nearly every country, could trigger a major investment surge.

In a sort of side story, the fate of the US dollar has become the focus of all eyes in the financial world. The recent turn of events, coupled with the declining share of the United States in world trade and changing geopolitical equations, has raised apprehensions about the hegemony of the dollar. However, the US dollar benefited from the apparent lack of an alternative at this time. The relative preference of most countries to align themselves politically with the United States, instead of an alternative such as China, as well as the relative ease of access to American capital markets and a hawkish American Fed have helped the because of the dollar. All in all, one may have to “reserve” judgment on the global reserve currency for now.

India’s large foreign exchange reserves should help stave off a significant threat to the stability of the rupee. Although India does not remain immune to global developments, it continues to remain better positioned compared to other emerging markets at this stage. Rapid digitization, fiscal dynamism (tax revenue growth nearly double nominal GDP growth for FY22), service exports at record high (FY22), healthy corporate and banking balance sheets, policy reforms, formalization of the economy and push for privatization and capex hold India in good stead. On the other hand, the main risks to watch are the surge in commodity prices (especially oil), the impact of tighter global liquidity and the rising food and fertilizer subsidy bill.

For Indian equities, strong retailer participation (63% increase in dematerialized accounts in FY22) and strong mutual fund flows cushioned the decline in the recent wave of REIT sales. However, it should also be noted how the last two years have been a baptism of fire for investors, as the sharp fluctuations in financial markets and numerous unforeseen events have kept investors on their toes.

Given the rapidly changing geopolitical landscape, the changing course of globalization; and with central banks retreating to their role of dampening inflation expectations instead of doing “whatever it takes” to support asset markets, volatility is likely to remain elevated. The equanimity and patience of investors will continue to be tested for the foreseeable future, but don’t we know from history that the formula for building wealth equals smart investment + time + patience.

In a world where new geopolitical alliances are being formed and existing ones are being tested; a sound financial plan and prudent asset allocation are still investors’ best allies in countering the formidable enemy of financial market volatility.