Thread by @itsTarH

Its not the weekend!
But grab a cup of chai anyway ☕ here is a ad-hoc thread on

1. Why US Fed Interest Rates matter?
2. What impact does it have on growth stocks?
3. What do rising rates in US mean for emerging markets like India?

Lets first explore what objectives US Fed has and what mechanisms does it use to achieve those objectives?

Fed is entrusted with two main objectives

1. Price Stability (Control Inflation)
2. Maximize Employment

Doing the above two ensures that US economy keeps growing, as long as prices are stable (stable inflation) and economy is running at full capacity (employment)

So how does Fed control inflation?

It has two main tools available at its disposal

1. Control interest rates on Federal Funds

2. Quantitative Easing

(fancy word for Fed purchasing US Treasury Bonds and other Corporate Securities)

By controlling interests rates US Fed can effectively control the yield on a bond

This may get a bit technical for those who aren't familiar with bond pricing mechanisms so here is my take on explaining it

Bear with me for the next part, it is a bit technical, but its important

Interest rates and prices of a bond have an inverse relationship

When interest rates rise, prices of bonds go down and when interest rates fall, prices of bonds go up

Yield on anything is simply how much return it generates vs the price you pay

So when Fed raises interests rates, prices of bonds fall and yields go up

This helps lure in investors who are looking for safe risk free investments

*US Treasury Bills and Bonds are considered at par with US Dollar and one of the safest financial instruments available in the world to invest in

US Fed's goal is to enable the yields on Treasury bonds to reach 3%

Why 3%?

Cause inflation target for Fed is 2%

As long as bonds pay more than inflation in an economy, there will be buyer of these bonds

The second tool is called Quantitative Easing

This was established right after financial crisis of 2008, where US Fed intervened, expanded its Open Market Operations and started buying US Treasury Bills and Bonds along with select corporate securities

Quantitative Easing helps control the money supply in the economy

Fed effectively spends USD 120 Billion per month in buying these bonds and other securities from the financial markets

This makes US Fed the single largest market participant in US Financial Markets

So how do US Fed rates matter for stocks?

By using the above two tools available at its disposal, US Fed indirectly influences stock markets

By doing quantitative easing, Fed is able to increase the money supply and liquidity in the economy, there by making it cheap to borrow

The second indirect influence US Fed has over stock markets is 'sentiment'

Stock markets run on sentiment in the short run

If the sentiment is cautionary and market expects liquidity and money supply to decrease, negative sentiment prevails and stocks correct

When liquidity is ample, interests rates are usually low and money is usually chasing high growth stocks

This causes valuation multiples to expand and what used to be valued at Price to Earnings, suddenly starts getting valued at Price to Sales

When bond yields climb back to near 3%, money starts leaving stocks and moving towards bonds (as they are risk free)

Money no longer needs to chase the high growth unprofitable loss making company anymore

As such when money starts leaving these stocks, they tend to correct sharply

What used to get valued at 25 times Sales now gets valued at single digit price to sales

In my view, the bottom of these stocks is not reached until US Fed commentary changes back to stable or accommodative stance

Yesterday (5th Jan 2022), Fed released minutes from the Dec FOMC meeting

In those the Fed took a hawkish tone and expects to increase rates more aggressively than previously stated

This came as a surprise to stock market as Fed has maintained until quite recently that inflation was transitory (yeah, right Mr. J Powell!)

The result most high growth names in US corrected

The higher they were valued, the sharper they corrected

SaaS Names like Monday . com (-14%)
Overvalued Automation names like UiPath (-10%)
Even Google corrected by (-4%)

I expect this trend to continue and not stop until Fed's tone changes back to accommodative, which may not happen anytime soon

US 10 Year Treasury Yields are a long way from 3% magic number

So what was up if everything was correcting?

'Value' stocks like energy company, utilities company, companies that actually generate Free Cash Flow were all up

Share of Berkshire Hathaway hit an all time high

Mr. Buffett is having the last laugh after all

What do rising interest rates mean for emerging markets like India?

Short Answer: I don't know

There are lot of variables at play and its beyond my technical prowess to decipher what can exactly happen

In my view, more FII money should enter India 🇮🇳

Why?

We are the only large economy that is growing at high digits (8 to 10%)

Our Central Bank is sitting on humongous foreign deposits for more than $600 Billion

We are politically stable democracy

Corporate Balance sheets have been stronger than ever before

In the light of no other alternative (China being in doldrums and dealing with their own self created mess) India 🇮🇳 seems like a logical choice for foreign investments

All of the above combined, serves as a potent cocktail 🍸 for one of the best bullish stock market runs for our country

Long India 🇮🇳
Bottom Fishing in US Growth 🇺🇸

That's it from me, thank you for reading!

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