If dollar weakness continues and it breaks the current level where it seems to have stalled its down move, we could see further upside in EMs including India.
Ajay Bodke
The clearest single indicator of global risk appetite is the US dollar index. Sharp fall from 103 levels during the peak of COVID-19 related fears in end-March 2020 to 96.5 levels now is signaling massive risk-on trade with money pouring out of safe haven US government bonds into risk assets like equities, including EM equities.
This is underpinned by trillions of dollars of liquidity support provided by global central banks and fiscal stimulus by various governments.
An index of EM currencies has strengthened from its record lows corroborating this scramble to buy EM risk assets. All this is based on expectations of a V-shaped global economic revival after reopening of economies and flattening of curve in China, Korea, Australia, Japan, Europe and now USA.
For continuation of this rally one needs to keep a hawkish eye on the US dollar index.
If dollar weakness continues and it breaks the current level where it seems to have stalled its down move, we could see further upside in EMs including India. Also, sectors which are beneficiaries of "opening up of economy" trade will outperform verses defensive. Consumer discretionary, global cyclicals, financials, entertainment, travel, hospitality will outperform verses healthcare, consumer staples, IT etc. If the US dollar weakness reverses then expect the opposite.
What could puncture the rally
1. A realization that damage to aggregate demand is so severe due to psychological impact on consumer behaviour that earnings rebound may not be as swift as the market is optimistically pricing-in,
2. The scale of unprecedented demonstrations all over the West are bound to act as "seeding events" with a lag of about a fortnight for the rapid re-emergence of a second wave of COVID-19 affliction leading to sharp spike in positive cases and narrative focusing back on the health scare and pandemic.
On the other hand any news of emergence of a preventive cure i.e. vaccine or a curative one i.e. any effective anti-viral medication to treat the disease will continue to fan the flames of risk-on behaviour.
The author is CEO & Chief Portfolio Manager (PMS) at Prabhudas Lilladher.
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