Japan Triggers the Fall for the Market- The Economic Truth of Capitalisim

 

 

The strengthening of the Japanese yen has triggered selling pressure from investors who had previously engaged in "carry trades." In such trades, investors borrow in a low-interest currency like the yen and invest in assets denominated in higher-yielding currencies, such as the U.S. dollar. Well this cannot go on for unlimited time decade after decade. When the yen appreciates, the cost of repaying these yen-denominated debts increases, prompting investors to sell off assets, including U.S. equities, to cover their positions.

The negative reaction of U.S. equities to the yen's rally is a sign of how interconnected U.S. equity valuations are with the global monetary system. As the yen strengthens, investors' need to unwind carry trades could put additional downward pressure on U.S. equities. The combination of carry trade unwinding and Japanese financial institutions repatriating capital could lead to significant selling pressure on U.S. equities, exacerbating market declines. As Japan potentially moves toward financial repression and a focus on domestic assets, this shift could lead to a prolonged period of capital repatriation.

The recent drastic shifts in the global stock markets, marked by significant declines in major indices like the Nasdaq 100 and Japan's Topix, have led to widespread panic among investors. The VIX index, Wall Street's "fear gauge," has spiked, reflecting heightened market volatility. Here's a breakdown of the factors contributing to this turmoil:

Key Factors Behind the Market Turmoil

1. Diminishing AI Euphoria:
• The rapid decline in tech stocks, particularly in the semiconductor sector, has been a significant driver of market fear. Companies like Nvidia and Intel have seen sharp fluctuations, reflecting investors' reassessment of the high expectations placed on artificial intelligence (AI) and chipmaking.
• The downturn was exacerbated by disappointing earnings from major tech firms, including Alphabet, Amazon, Apple, Meta, and Microsoft. Despite some positive revenue reports, the overall sentiment has soured, leading to a sharp sell-off in tech shares.
2. Geopolitical Concerns:
• Comments from former U.S. President Donald Trump regarding Taiwan's defense responsibilities and the Biden administration's plans for new restrictions on chipmaking equipment exports to China have added to the uncertainty. The potential geopolitical risks, particularly concerning Taiwan's strategic importance in the semiconductor supply chain, have further weighed on investor sentiment.
3. Shifting Economic Expectations:
• The recent U.S. jobs report showed a higher unemployment rate and fewer jobs added than expected, raising fears of an impending recession. This shift from the previous "bad news is good news" mentality, where weak economic data was seen as a sign for potential interest rate cuts, has now flipped to "bad news is bad news," with concerns about economic slowdown outweighing the potential benefits of lower borrowing costs.
• The Federal Reserve's potential rate cuts have not provided the expected market boost, as investors are more concerned about the implications of slowing growth on company earnings.
4. Strengthening Japanese Yen:
• The Japanese yen has strengthened significantly, partly due to the Bank of Japan's unexpected decision to raise interest rates. This appreciation has negatively impacted Japanese stocks, particularly those of companies with significant overseas earnings.
• The unwinding of yen carry trades, where investors borrowed cheaply in yen to invest in higher-yielding assets, has led to additional market instability as these positions are closed.

Market Reactions and Investor Concerns

Investors have sought traditional safe havens like gold, the Japanese yen, and U.S. Treasuries amidst the turmoil. However, even these assets have shown signs of strain, with gold prices experiencing a sharp drop, possibly due to forced selling to meet margin calls elsewhere. This suggests a risk of a broader market sell-off, further exacerbating the situation.

Looking Ahead

The immediate future of the markets remains uncertain, with two critical questions looming:

1. Asset Exposure: Whether the sharp price swings have significantly impacted heavily exposed entities, potentially leading to broader financial instability.
2. Market Sentiment: The collective investor mood will be crucial in determining whether the market will stabilize or continue its downward trajectory.

Conclusion Analysis 

Given the recent volatility and the range of contributing factors, caution is warranted. The potential for further declines and increased volatility remains high as markets adjust to changing economic, geopolitical, and financial conditions. Investors are advised to monitor these developments closely and consider the implications for their portfolios. The recent rally in the Japanese yen, appreciating by 2.7% against the U.S. dollar since the start of the week, signals a significant shift in market expectations and monetary policy dynamics. This movement has prompted money markets to anticipate that Japan's overnight call rate could reach 0.4% by the end of the year, indicating a tightening stance by the Bank of Japan (BoJ).

The diverging monetary policy trajectories between the BoJ and the Fed have several key implications:

• Currency Movements:
• The contrasting stances are likely to lead to further appreciation of the yen against the dollar. A stronger yen could have various effects, including making Japanese exports more expensive and potentially dampening economic growth in Japan.
• The yen's appreciation might also exacerbate the challenges for Japanese investors engaged in carry trades, as mentioned earlier, and could lead to more significant capital flows back to Japan.
• Global Financial Markets:
• The differing policy approaches could create volatility in global financial markets, as investors adjust their portfolios in response to the changing interest rate landscape. This volatility could affect equity markets, bond yields, and foreign exchange rates.
• Investment Strategies:
• Investors may need to reconsider their investment strategies in light of these shifts. For instance, the expected tightening by the BoJ might make Japanese assets relatively more attractive, while the Fed's easing could support U.S. equities and bonds.

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U.S layoffs Speaks Loudly 50 to 75 bps rate Cut

 

The U.S. market has been in a slowdown phase for a longer time but it was hiding. The corporate has been struggling and the same is evident from the number of layoffs in CY-2024. Numerous companies have announced layoffs in 2024, including significant cuts at firms like Tesla, Amazon, and Microsoft, among others. These layoffs span various industries and highlight broader economic challenges.

 When people stop consuming McDonald's and shift to some other foodstuff then it's well clear that the U.S inflation is choking the households, furthermore, customer traffic at US fast-food restaurants fell 2% in the first half of the year compared to the same period a year ago, according to Circana.

Looking at the number of companies cutting down jobs in 2024 its expected that in September 2024 we will witness a 0.5 to 0.75 rate cut from the U.S.

Overall, the report highlights a challenging economic environment characterized by weaker job growth, rising unemployment, persistent inflation, and significant market volatility. The anticipation of interest rate cuts and widespread layoffs further underscores the concerns about a potential economic slowdown or recession.

 The U.S. July Jobs Report presents a concerning picture of the economy. Here's a summary of the key points:

Job Growth: The economy added only 114,000 jobs in July, the lowest since January 2021, following a significant downward revision for June from 206,000 to 179,000 jobs. This marks a downward revision of 27,000 jobs.

Unemployment Rate: The U.S. unemployment rate rose from 4.1% to 4.3%, reaching the highest level since October 2021.

Inflation Concerns: The 3-month annualized core Producer Price Index (PPI) inflation rose to 5.0% in June, the highest since 2022, and more than doubled in six months. Core PPI inflation increased to 3.0% in June and has risen in four out of the last five months, signalling that inflation is still elevated.

Mortgage Rates: The average rate on a 30-year mortgage fell 22 basis points to 6.40%, the lowest since April 2023. The recent high was 7.52% in late April 2024. The average interest rate on personal loans is 12.36 per cent, as of July 24. In 2021, the average rate was just 9.38 per cent, when the fed funds rate was near zero.

Market Reaction and Rate Cut Expectations: Prediction markets are now anticipating four interest rate cuts in 2024, with a 50 basis point to 75 basis points cut expected at the September meeting. There's even a 31% chance of five or more rate cuts in 2024, suggesting growing concerns about an economic recession.

Stock Market Performance: The S&P 500 has lost $3 trillion in market capitalization since July 16th, indicating significant market turmoil. The Nasdaq 100 index has entered correction territory, down over 10% from its all-time high.

 Revisions in Job Reports: Revisions have consistently lowered job growth figures, with 5 out of the last 6 and 10 out of the last 14 jobs reports being revised downward, reflecting weaker-than-expected employment growth.

 Federal Reserve Actions: The Fed's balance sheet has decreased by $1.71 trillion since April 2022 but remains $3.1 trillion higher than pre-COVID levels. The pace of balance sheet reduction slowed from $95 billion to $60 billion per month in June. The govt is on pace for spending $1.5 trillion for interest payments on the debt during the next 12 months.

The govt collects about $5 trillion in revenue annually, so that means 30% of all revenue is going to interest payments. By late 2026 we will have $40 trillion in debt. If rates stay at 5% that will be about $2 trillion per year in interest payments. Our debt is out of control and swallowing the govt budget.

Market Dominance and Volatility: The U.S. stock market remains dominant, accounting for nearly 50% of global market capitalization. Historical data shows that the Volatility Index (VIX) typically rises during election years, leading to market corrections.

 Conclusion:

The weaker-than-expected job growth and rising unemployment rate highlight potential challenges for the U.S. economy. Inflationary pressures remain concerning despite a decline in CPI inflation, as core PPI continues to rise. The expectation of multiple rate cuts indicates market anticipation of economic slowdown or recession. The stock market's recent performance suggests investor caution and potential volatility ahead.

The rate cut is now expected to be 0.75 but there is nothing to bet now since the Fed will not take action based don one-month data. Hence more data is required to firm up the rate cut for next month. Further, if the rate cuts are being delayed further then equity markets will react negatively since the current optimism for rate cuts is so high that every bad economic news is being discounted. This discounting might take a reverse hit. The biggest advantage of the rate cut would be that funds will flow to India and emerging markets as we have seen historically.

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From Rs21 to Rs 100 NAV ( In 4 years) Journey & Celebration of Motilal Oswal Midcap Fund -

The Motilal Oswal Midcap Fund-Regular has shown strong performance across various time horizons, particularly in the medium to long term. Despite short-term volatility, the fund's substantial returns over 3 months, 6 months, 1 year, and beyond indicate effective management and favourable market conditions for mid-cap stocks. Investors seeking exposure to the mid-cap segment may find this fund to be a valuable addition to their portfolio, given its demonstrated potential for significant growth and resilience over time.

If we do the analysis of the returns, we find stellar analytics.

Medium-Term Performance

3 to 6 Months Performance: The fund has demonstrated strong medium-term performance with returns of 19.21% over 3 months and 30.45% over 6 months. This significant growth reflects the fund's ability to capitalize on market opportunities and effective stock selection within the mid-cap segment.

 

9 Months Performance: The return of 53.29% over 9 months underscores the fund's robust performance in the medium term, suggesting effective fund management and favourable market conditions for mid-cap stocks during this period.

Long-Term Performance

1 Year Performance: With an impressive return of 63.02%, the fund has significantly outperformed in the long term, indicating strong growth and resilience in its portfolio.

 

3 Years Performance: The fund's annualized return of 37.66% over 3 years showcases its consistent performance and effective strategy in managing mid-cap investments.

 

5 Years Performance: The 32.60% return over 5 years further emphasizes the fund's long-term growth potential and successful track record in the mid-cap category.

 

Since Inception: The fund has delivered a cumulative return of 24.33% since inception, highlighting its overall success and growth trajectory over time.

What we are missing is that we need to find out what made the fund to achieve a stellar return? From where did the funds returns came up? It’s the sector allocation and right allocation and exposure skill of the Fund Manager in picking up the allocation.  The identification of timing by the Fund Manager in terms of Entry and Exit of sector allocation plays a pivotal role behind the fund. Effective sector allocation significantly impacts fund returns by balancing growth potential and risk. Analysing economic cycles, market trends, policies, and consumer behaviours allows fund managers to strategically allocate investments to sectors poised for strong performance, thereby optimizing returns and managing risks.

Sector Allocation Trends from April 2023 to June 2024:

During the period from April 2023 to June 2024, various sectors experienced fluctuations in their allocation percentages within investment portfolios. Here is a detailed summary of the trends for key sectors:

Alcohol

·       Trend: Showed initial growth from April 2023 (1.10%) to June 2023 (3.18%), then fluctuated, ending at 10.65% in June 2024.

·       Peak Allocation: June 2023 with 3.18%.

 Automobile & Ancillaries

·       Trend:  Consistently high allocations with fluctuations, starting at 13.93% in April 2023 and ending at 10.65% in June 2024.

·       Peak Allocation: November 2023 with 16.65%.

Banks

·       Trend: Low and fluctuating allocations, starting to be tracked from July 2023 at 1.50%, with a decline towards early 2024 and slight recovery to 5.07% in June 2024.

·       Peak Allocation: June 2024 with 5.07%.

 Capital Goods

·       Trend: High initial allocation with fluctuations, from 8.59% in April 2023 to a low of 1.38% in May 2024, recovering to 5.07% in June 2024.

·       Peak Allocation: July 2023 with 9.24%.

Chemicals

·       Trend: Stable high allocations, starting at 10.03% in April 2023, dipping slightly and ending at 4.65% in June 2024.

·       Peak Allocation: November 2023 with 9.19%.

 Construction Materials

·       Trend: Steady but low allocations, starting at 1.11% in April 2023 and remaining below 1% from June 2023 onwards.

·       Peak Allocation: April 2023 with 1.11%.

Consumer Durables

·       Trend: Generally stable, starting at 3.39% in April 2023 and increasing towards the end, with 5.39% in June 2024.

·       Peak Allocation: December 2023 with 5.74%.

Diamond & Jewellery

·       Trend: Allocations tracked from December 2023, starting at 9.59% and decreasing to 7.64% in June 2024.

·       Peak Allocation: December 2023 with 9.59%.

Electricals

·       Trend: Initially low and erratic, from 0.33% in June 2023 to a peak of 4.80% in June 2024.

·       Peak Allocation: June 2024 with 4.80%.

Finance

·   Trend: Consistent increase from 8.28% in April 2023 to a peak of 18.46% in October 2023, then stabilizing around 10.48% in June 2024.

·       Peak Allocation: October 2023 with 18.46%.

 

FMCG

·       Trend: Steady but low allocations, starting at 3.98% in April 2023 and remaining below 4% throughout the period.

·       Peak Allocation: May 2023 with 3.28%.

 Healthcare

·       Trend: Decreasing trend from 5.20% in April 2023 to 1.28% in August 2023, then fluctuating and recovering to 5.26% in June 2024.

·       Peak Allocation: April 2023 with 5.20%.

Hospitality

·       Trend: Data for this sector is only available for April 2023 with 4.20%.

·       Peak Allocation: April 2023 with 4.20%.

 Infrastructure

·       Trend: Data for this sector starts from March 2024 with an allocation of 2.39%.

·       Peak Allocation: March 2024 with 2.39%.

Iron & Steel

·       Trend: Fluctuating allocations, starting at 1.93% in April 2023, peaking at 4.84% in August 2023, and declining to 0.91% in January 2024.

·       Peak Allocation: August 2023 with 4.84%.

 

 IT

·       Trend: High and stable allocations, starting at 16.48% in April 2023 and slightly fluctuating to end at 17.98% in June 2024.

·       Peak Allocation: October 2023 with 24.14%.

 

 Media & Entertainment

·       Trend: Data starts from November 2023 with low allocations, peaking at 1.86% in February 2024 and declining to 0.65% in May 2024.

·       Peak Allocation: February 2024 with 1.86%.

 

Plastic Products

·       Trend: Initial high allocations, starting at 1.26% in April 2023, peaking at 2.02% in May 2023, and gradually declining to 0.50% in November 2023.

·       Peak Allocation: May 2023 with 2.02%.

Power

·       Trend: Data starts from April 2024 with an allocation of 3.76%.

·       Peak Allocation: April 2024 with 3.76%.

Realty

·       Trend: Fluctuating allocations, starting at 4.30% in April 2023, peaking at 8.66% in January 2024, and decreasing to 4.79% in June 2024.

·       Peak Allocation: January 2024 with 8.66%.

 

Retailing

·       Trend: High allocations with fluctuations, starting at 4.51% in April 2023, peaking at 9.31% in July 2023, and stabilizing around 7.15% in June 2024.

·       Peak Allocation: July 2023 with 9.31%.

 

Telecom

·       Trend: Low allocations, tracked from July 2023 with 1.71%, peaking at 12.34% in April 2024 and ending at 10.98% in June 2024.

·       Peak Allocation: April 2024 with 12.34%.

 

Textile

·       Trend: Stable but low allocations, starting at 2.37% in April 2023 and gradually declining to 0.25% in January 2024.

·       Peak Allocation: May 2023 with 2.55%.

Key Ratio Analysis with Respect to the Fund

. Standard Deviation: 13.13%

Standard deviation measures the fund's volatility or risk. A higher standard deviation indicates greater variability in returns, suggesting the fund experiences larger swings in its NAV. At 13.13%, this indicates that the Motilal Oswal Midcap Fund has moderate volatility, which is expected for a mid-cap equity fund. Investors in this fund should be prepared for fluctuations in their investment value.

2. Semi-Standard Deviation: 3.79%

Semi-standard deviation measures the downside volatility, focusing only on the instances where the returns are below a certain threshold, typically the mean return. A lower semi-standard deviation compared to standard deviation indicates that the fund's downside risk is relatively contained. At 3.79%, this metric shows that the fund has managed to limit its losses, suggesting effective risk management.

3. Correlation with Benchmark: 0.82

Correlation measures the degree to which the fund's returns move in relation to the benchmark (Nifty Midcap 150 - TRI). A correlation of 0.82 indicates a strong positive relationship, meaning the fund's performance is closely aligned with the benchmark's movements. While this implies that the fund generally moves in the same direction as the benchmark, it also suggests that it offers limited diversification benefits from the broader mid-cap market.

4. Beta: 0.83

Beta measures the fund's sensitivity to market movements. A beta of 0.83 suggests that the fund is less volatile than the benchmark. Specifically, for every 1% move in the benchmark, the fund's NAV is expected to move by 0.83%. This lower beta indicates that the fund might experience smaller fluctuations compared to the benchmark, making it relatively less risky.

5. Treynor Ratio: 4.84

The Treynor ratio measures the excess return earned per unit of market risk (beta). A higher Treynor ratio indicates better risk-adjusted returns. At 4.84, this ratio suggests that the fund has delivered strong returns relative to its market risk, indicating effective management and potential for higher returns relative to its volatility.

6. Sharpe Ratio: 1.07

The Sharpe ratio measures the excess return per unit of total risk (standard deviation). A Sharpe ratio above 1 indicates good risk-adjusted returns. With a Sharpe ratio of 1.07

 

Performance Comparison: The Motilal Oswal Midcap Fund has outperformed its benchmark, Nifty Midcap 150 - TRI, across all timeframes provided. Notably, its 1-year return of 69.30% significantly surpasses the benchmark's 55.38%.

Risk and Return: The fund exhibits a strong Sharpe ratio of 1.07, indicating good risk-adjusted returns. The beta value of 0.83 suggests lower volatility compared to the benchmark, while the tracking error of 2.27% indicates moderate deviation from the benchmark.

Capture Ratios: The Up Capture Ratio of 104.48% shows that the fund has captured more gains than the benchmark during market upswings. The exceptionally low Down Capture Ratio of 11.58% demonstrates strong downside protection.

Conclusion

The Motilal Oswal Midcap Fund-Reg(G) has demonstrated impressive returns and favorable risk metrics, making it an attractive option for investors seeking exposure to mid-cap equities. However, potential investors should consider their risk tolerance and investment horizon, as mid-cap funds can be more volatile compared to large-cap funds. The fund's strong performance and risk management suggest it may be a suitable addition to a diversified portfolio, particularly for those seeking growth opportunities in India's mid-cap segment.

Overall, the sector allocations show significant variability over the months. Notably, IT, Finance, and Automobile & Ancillaries sectors maintained high allocations, indicating a strong investor preference. Meanwhile, sectors like Construction Materials and Media & Entertainment had relatively low and inconsistent allocations. The data reflects dynamic shifts in investment strategies, likely influenced by market conditions and sector-specific performance.

Well this is just an analysis of the Past allocation and hence not an investment advise. This is for information purpose. We will be coming up with such analysis of other funds too.

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