Correction lurking for Wall Street-driven markets, warns Christopher Wood

Wall Street-correlated stock markets are facing the risk of correction, as Christopher Wood, the global head of equity strategy at Jefferies, conveys to investors in his latest edition of GREED & fear.

Rising crude oil prices, which are nearing $100 a barrel (Brent), pose a threat to the global central bank’s battle against inflation and have led to a re-evaluation of its exposure to Indian stocks.

“The potential for more US Federal Reserve (Fed) rate hikes, combined with the risk that monetary tightening finally bites as regards the economy, remains a risk for Wall Street-correlated world stock markets. There is also the oil factor. This is why GREED & fear continues to believe the pain trade is down. Areas in Asia, such as Indian midcaps, which have already done very well, are at obvious risk of some profit-taking,” writes Wood.

The investment in Container Corporation of India within the India long-only portfolio will be removed and replaced with an investment in JSW Energy.

“An investment in State Bank of India (SBI) will be introduced with a 4 per cent weighting. This will be paid for by shaving the investments in Oil and Natural Gas Corporation, HDFC Bank, and Bajaj Finance by 2 percentage points (pp), 1 pp, and 1 pp, respectively. The investment in Sea in the Asia-ex-Japan long-only portfolio will also be removed and replaced by an investment in SBI,” he says.

Crude reality

Another concern for both markets and central banks, according to Wood, is the escalating oil prices, which have risen nearly 14 per cent in the past month to reach $93 a barrel (Brent) after production cuts by Saudi Arabia and Russia.

They recently surpassed the $96-a-barrel mark before experiencing a slight decline.

Wood believes that this surge in oil prices has the potential to trigger a risk-off trade in global equity and bond markets.

“The practical problem for the Fed for now is that inflation remains well above its 2 per cent target on the traditionally dovish measure of core Personal Consumption Expenditures inflation. The stickiness of core inflation is why further rate hikes cannot be ruled out as long as the US employment market is deemed to be healthy. This is also why the oil price has the clear potential to trigger risk-off action in both stocks and bonds if it keeps rallying,” he observes.

Losing altitude

Meanwhile, Indian markets have been on a slippery slope for most of this month. In the past two weeks alone, the S&P BSE Sensex has shed nearly 1 per cent to reach 66,009 levels.

The fall in the mid and smallcap indices has been more pronounced, with both BSE counters slipping by 2.2 per cent and 3.1 per cent, respectively, during this period, according to ACE Equity data.

According to Chokkalingam G, founder and head of research at Equinomics Research & Advisory, global markets could witness increased volatility due to firm oil prices and rising inflation amidst slowing growth in some major economies. Another potential risk factor for the domestic markets is the upcoming state elections.

“We see significant potential for a major downturn in the small and midcap segments in the short term. However, Sensex/National Stock Exchange Nifty stocks may not experience significant declines, as they did not participate in the small and midcap rallies. Moreover, domestic institutional investors and retail investors may provide substantial support to Sensex/Nifty stocks in the event of a significant correction,” he predicts.