Don't lose sight of the long term

There could be disruptions in the near term, but ultimately the economy will bottom out

Geopolitics moved markets last week as US-Iran tensions peaked and then dropped. For a while, it looked as though a major conflict between Iran and the US was inevitable. As of now, it seems this has been averted. Markets crashed all round the world while the crisis boiled up and then, as tensions eased, markets also recovered. The price of oil and gas first spiked up and then slid down. 

Markets always respond to uncertainties of this nature with rising volatility. The Iran-US situation is by no means permanently resolved. It could easily flare up again. Apart from the potentially catastrophic supply disruptions in energy markets, there is the threat of triggering a larger conflict. Israel may be dragged into this, or the Gulf States may be hit. 

There are other potential areas of geopolitical stress. The US-China trade War has also shown signs of easing but it is also not over. Brexit is a given but the timelines and exact details will be important. President Trump may also suffer personal embarrassment due to his ongoing impeachment proceedings. There is an admittedly low probability scenario that the Republican-dominated Senate will vote to remove Trump from office. But Trump could look to trigger distractions. 

In India itself, protests and mass rallies against the CAA-NPR-NRC have led to political instability and substantial loss of productivity. The Bharat Bandh last week also indicated that most trade unions will oppose the government’s economic agenda. 

Market swings will become more pronounced while all these scenarios are live. There are three or four negative scenarios, which could be worth watching. One is higher energy prices, which would mean more pain for the Indian economy. 

The second situation is a perception that the BJP’s control has been shaken by the protests. The Delhi elections in February could be considered a bellwether. Political vulnerability could mean that the BJP is pushed into taking populist economic measures when the economy is close to tanking.  

A third situation is abrupt currency pressure. The rupee could see a big crash if FPIs pull back on India exposures. A falling rupee would not be a bad thing in itself but a sudden crash would be destabilising. Another escalation in Iran-US hostility would mean pressure on the rupee. 

The fourth situation is mundane in comparison. A Budget that doesn’t do enough to revive consumption will lead to a sell-off. Most investors have already braced for the fact that the Fiscal Deficit will be higher than targeted.  But they are hoping that the Budget will enable growth and revive consumer confidence. If that hope is belied, the stock market could head south.

How can you hedge these situations and perhaps, make a little money if they do occur? Derivatives may help. Rising oil prices can be played in the commodity market, or by shorting businesses in the marketing and refining sectors. Rising oil prices will also mean a falling Nifty, which will also be the result if the Budget is received badly. 

The Nifty looked set to open 300 points down on Wednesday before it recovered. Anybody holding long puts could have booked big profits. If you see this sort of tense geopolitical situation recurring – and there’s ample chances of that – be prepared for similar crashes. A trader might try rolling over long puts at around 5 per cent below the money. 

Similarly, a falling rupee can be hedged in multiple ways. One, invest abroad in hard currency assets. This is a safe, low-risk strategy. Another method is to take positions in the IT sector and other export-oriented businesses. This is slightly more risky but these stocks are often safe havens when the rupee falls. A third possibility is to take long dollar-rupee positions or long euro-rupee positions. This is an aggressive strategy, which could also lose a lot of money.   

In between all the excitement, don’t lost sight of the long-term. The situations outlined above can cause disruptions and volatility, and hedges could help to protect your net worth. But in the long-term, the stock market should go up and the Indian economy should bottom out. It could take a while to recover, or bounce back quickly. Continue to invest for the long-term, whether you do it indirectly through diversified mutual funds or you do it directly with specific stocks.