Swift Rise and Swifter Fall

The Indian equity market’s smooth ride came to an abrupt halt in the first week of August. Frontline index Nifty 50 lost 1,000 points in a matter of three trading days. Following the election results, the Nifty 50 index had gained roughly 4,000 points in three months, an impressive increase of almost 17 per cent. However, as the saying goes, “The market takes the staircase up but the elevator down.” In this recent correction, the market seemed to take a freefall instead of the usual elevator. Several factors have contributed to the sharp decline in the indices.

The most apparent reason was the significant appreciation of the Japanese yen. This spurred fear of a reverse yen carry trade due to an interest rate hike in Japan. The yen carry trade is a popular strategy where investors borrow funds in yen at low-interest rates and invest in higher-yielding assets in other currencies. This strategy carries two major risks: exchange rate risk and interest rate risk, both of which are currently in play.

If the yen appreciates significantly against the currencies of the invested assets, traders may face losses when converting back to yen to repay loans. Additionally, if Japan raises interest rates or the target country lowers them, the differential may narrow or even become negative. Over the past three weeks, the yen has appreciated by almost 10 per cent against major currencies. Recently, Japan increased its interest rate to 0.25 per cent from a range of 0.0-0.1 per cent, marking the second hike since March 2024 when the central bank ended its 17-year ultra-loose monetary policy.

Additionally, fears of a recession in the USA have intensified following extremely poor job data, which has further spooked the market sentiment. The key figures included a notable drop in job creation for July and a sharp increase in the unemployment rate to 4.3 per cent, nearly a three-year high. These indicators have raised doubts about the resilience of the US economy and sparked concerns about the Federal Reserve’s ability to achieve a soft landing.

To compound these issues there are escalating geopolitical tensions. The Middle East remains a volatile region plagued by conflict. Recent strikes by Israel in Tehran and Beirut have exacerbated tensions. Israel is on high alert for a potential attack from Iran, which has vowed to retaliate for the assassinations of Hamas and Hezbollah leaders. Investors are worried about the widening of the conflict and its implications. Meanwhile, China and Europe are already grappling with economic slowdowns, and the escalating geopolitical tensions in the Middle East are adding additional pressure on the global markets.

I believe the era of easy money is behind us, at least for now. Investors who see all market dips as buying opportunities should exercise caution. A cautious, risk-off approach is warranted. We may now see a rotation towards defensive, quality and value stocks instead of momentum-driven investments. It’s crucial to understand what to avoid, such as overvalued stocks or small companies with poor fundamentals. The focus should not only be on what to buy.

The best thing an investor can do is to manage risk effectively. If risk is managed appropriately, returns will follow. Unpredictable events can impact the equity market and jeopardise investments. For instance, while everyone was euphoric about a rate cut, no one anticipated the appreciation of the yen and its impact on the yen carry trade. At DSIJ, we strive to help you stay informed and make profitable investment decisions. Stay tuned with us for a successful investment journey.

RAJESH V PADODE
Managing Director & Editor