Are current inflation worries overstretched for the markets?

Record high inflation levels in India and overseas continue to dent investor confidence as disrupted supply chains due to the Russia-Ukraine crisis build up price pressures on the economy.

However, an analysis of historical data shows that high inflationary environments are not necessarily unfavourable for equity markets. 

For instance, between April 2013-March 2014, the markets were resilient despite inflation levels of 8 to 11%. Of these 12 months, the Sensex and Nifty delivered positive returns in eight months.
 
Similarly, between April and December 2020, the benchmark indices gave nominal negative returns in only two months despite average inflation of 6.6% during the period.
 
Overall, the retail inflation has risen 60 times on a month-on-month basis since April 2013, wherein positive monthly returns were 38 times and negative returns were 22 times.

This, analysts say, is due to an environment where high demand coupled with high prices leads to rise in corporate profitability and nominal growth. 

Naveen Kulkarni, chief investment officer at Axis Securities, believes that current inflationary pressures remain less of a worry for markets as companies are witnessing robust demand amid high prices.
 
With March CPI inflation leaping to 7%, and rising above the RBI’s upper tolerance band for the third straight month, brokerages expect inflation to remain higher ahead and see interest rate hike cycle to begin from June.

Global brokerage HSBC, for instance, says it raised inflation forecast of FY23 to 6.1% as against RBI’s 5.7%, and its FY24 inflation forecast to 5.2%. The brokerage expects repo rate hikes to begin in the June meeting with likely four repo rate hikes of 25 bps each till December 2022.

The brokerage further sees two repo rate hikes of 25 bps each in April and June meetings of 2023, which would finally take the repo rate from 4% now to 5.5% by mid-2023. 

That said, the near-term outlook for the markets remains bleak as the Russia-Ukraine conflict stands in a deadlock with no prospects of peace in sight. 

Kulkarni of Axis Securities expects the markets to remain range bound in the short term as interest rates will begin rising given the inflation situation. 

Given this, Kulkarni believes that commodity players will benefit from rising inflation.

The market action will be stock-specific today as investors will continue to track Q4 results. Tata Elxsi, Angel One, Reliance Industrial Infrastructure and ICICI Securities are among those slated to release their earnings today.