Indian markets experienced a volatile session today, primarily influenced by global cues. A sharp decline in US markets overnight due to concerns over a potential recession triggered a risk-off sentiment, and the turmoil in the Japanese market spooked investors further. Domestically, profit booking after recent gains also contributed to the downward pressure. While banking and financial stocks faced selling pressure, select IT and FMCG stocks displayed resilience. Overall, the market exhibited a cautious undertone, with investors awaiting further clarity on the global economic outlook.

Significant Market Movements

1. Japan's Historic Drop: Japan's stock market posted its biggest two-day drop in history, with Tokyo stocks sinking more than 12%. The Nikkei 225 index plunged 12.4%, while the broader Topix index lost 12.23%.

2. Tech Stock Losses: The "Magnificent 7" tech stocks erased over $1 trillion in market cap in a single day, highlighting severe volatility in the tech sector.

3. Crypto Market Collapse: Crypto markets saw a massive decline, with over $500 billion in market cap wiped out within 24 hours.

4. Emergency Fed Rate Cut: Markets are now pricing in a 60% chance of an emergency rate cut by the Federal Reserve to stave off a deeper economic crisis.

5. South Korean Halt: South Korea halted all sell orders on their stock market to prevent further panic and stabilize the situation.

6. Nasdaq Futures Drop: Nasdaq futures fell as much as 6.5% in one day, reflecting widespread fear and uncertainty.

Japan Market Crash

Japanese stocks' year-to-date performance erased, with Topix down more than 20% since last Wednesday. The Japanese market's catastrophic plunge was a stark reminder of the interconnectedness of global financial systems. Triggered by a confluence of factors, including a strengthening yen, fears of a US recession, and a potential shift in Japan's monetary policy , the crash exposed vulnerabilities in the global economy.

This event has underscored the fragility of the Japan Yen carry trade strategy , where investors borrowed cheaply in yen to invest in higher-yielding assets, and highlighted the risks associated with excessive leverage and market exuberance. The recent interest rate hike in Japan to 0.25% pushed the yen higher against USD. This has made the carry trade less attractive, leading to significant outflows and a subsequent market crisis. The aftermath of this crisis will likely reshape investor behavior and investment strategies worldwide.

US Economy Recession Fears

The specter of a US recession looms large, casting a long shadow over global economic prospects. Last week's economic data from the US cast a shadow over the Federal Reserve's ability to manage a soft landing for the world's largest economy. Key figures included a notable drop in job creation for July and a sharp increase in the unemployment rate to 4.3%, at nearly a 3 year high. These indicators raised doubts about the resilience of the US economy and sparked fears that more aggressive rate cuts might be necessary to prevent a slowdown. The VIX, known as Wall Street’s “fear gauge,” hit its highest level since early 2020.

A confluence of factors, including persistent inflation, aggressive monetary tightening, and a decelerating economy, has fueled concerns for inflation. A recession typically leads to job losses, rising unemployment rates, and a decline in consumer spending, creating a vicious cycle that amplifies economic contraction. As the world's largest economy, a US recession could have a domino effect, impacting global trade, investment flows, and financial markets. Many expect the rate cuts to come in the US at an accelerated rate due to these concerns.

US Unemployment Rate

Middle East Escalation

The Middle East remains a volatile region plagued by conflict. The recent twin strikes in Tehran and Beirut have exacerbated tensions in the Middle East. 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 currently weighing 2 potential scenarios:

1. Continued Escalation: Ongoing conflicts could damage local economic activity and have broader implications for international markets.

2. Cease-Fire: Pressure from Israel's allies could lead to a cease-fire in Gaza, potentially stabilizing the situation and allowing Israeli shares to rebound.

The US has sent reinforcements to Israel and expects an attack on Israel in the next 24 to 48 hours. US is also pushing for a Gaza cease-fire deal to cool down geopolitical tensions in the region. Brent and WTI oil prices reached their lowest levels since January, with WTI down by 2.38% and Brent down by 2.08%. Demand concerns from China and the U.S. recession fears are driving oil prices lower, while geopolitical risks in the Middle East continue to pose a threat.

Military Intervention in Bangladesh

Closer to home, Sheikh Hasina has resigned as Prime Minister of Bangladesh amid violent protests and the Bangladesh Army's intervention. Army Chief General Waker-Uz-Zaman announced the formation of an interim government, appealing for peace and promising to protect citizens' lives and property. The resignation follows intense demonstrations against a controversial quota system favoring descendants of freedom fighters for government jobs. Over 300 people were killed in clashes, further inflaming public anger.

The turmoil in Bangladesh threatens the stability of Sheikh Hasina's government, posing a potential policy challenge for India. While regime change in Bangladesh is unlikely, India should prepare for such a possibility and empathize with the Bangladeshi people to prevent an anti-India sentiment. With the Army now in control, Bangladesh faces a crucial period of transition, as the interim government seeks to address the protesters' demands and restore stability. India needs to support peace rather than maintaining a hands-off approach.

Time to Buy or Time to Hedge?

India's burgeoning bull market has created a climate of optimism, with investors viewing recent dips as buying opportunities. In the current market environment, characterized by heightened volatility and global uncertainty, a cautious approach is warranted. While India's bull market has seen optimism, recent global events suggest that it may be prudent to adopt a risk-off strategy. Investors should consider:

1. Hedging Strategies: Given the potential for further market declines, hedging against downside risks is advisable. This could involve increasing cash positions or deploying hedges in portfolios to protect against sudden drops in asset prices.

2. Selective Buying: While the markets may offer buying opportunities, it is essential to be selective and focus on high-quality assets that can withstand economic downturns. Waiting for clear market signals, such as a breakout from recent lows, could help mitigate the risk of further declines.

3. Defensive Positioning: Shifting towards defensive sectors, such as utilities or consumer staples, which tend to perform better during periods of economic uncertainty, could provide more stability in portfolios.

The markets have turned oversold in a day, but given global economic uncertainties and supply chain disruptions, a cautious risk-off approach is warranted. Our models will watch for this transition and shift allocations accordingly. We have added some cash positions and deployed hedges in most of our PMS portfolios. We would also be on the lookout to add more—but only once the markets give a clear breakout from the lows, which, given the heightened volatility, could, in fact, be a few days off.