There has been a massive upsurge in crude, natural gas, metals, and agro commodities after the beginning of Ukraine's invasion by Russia. This surge is because the most significant impact of war is felt by commodities first and then everything else.
The up move in commodity prices would impact the input costs for India's wide range of sectors. As a result, margins will face tight pressure in such an environment, seeing earnings decline.
Let’s Talk Business, Let’s Talk Impact
The run-up in commodity prices would impact the input costs for India's wide range of sectors. While crude oil will affect downstream oil firms, paints, chemicals, aviation, and auto sectors, the rising metal prices will hit manufacturing, auto builders, and other metal consumers. Margins will face tight pressure in such an environment, seeing earnings decline.
Only the larger players with pricing power will pass on the price rise to consumers, and smaller companies might struggle to maintain profitability. The demand will also slow down due to rising prices and bad sentiment.
Where can money be made? The Sectors to bet on
In the recent turmoil, easy picking would have been metal and oil and gas manufacturing companies which are commodity sellers and stand to gain from the commodity price rise. But as the commodity prices might have peaked to a certain extent, the future outlook on these sectors is cautious.
If the war does not escalate further, the next stressor would be the rate hikes by the US Fed, and in light of that, Banking & Financials would be the sector to bet on as it flourishes at a high rate environment. On the other hand, the IT and Pharmaceuticals sectors have shown momentum as they have no commodity exposure and gain from currency depreciation.
Why is the price of Crude Oil rising?
It’s not like crude oil prices were at an all-time low, and they started rising. It is important to note that the cost of crude oil was already on a gradual rise. As the situation on the Russia-Ukraine border became intense and the perception of war became evident, the price of Crude Oil, Metals & Other Commodities shot up. At its peak, the cost of a barrel touched $130.
Simply put, when geopolitical tension rises, the demand for commodities such as crude oil increases, and the supply seems to get affected as the country would focus its resources on addressing the war.
From the perspective of the Indian economy, a rise in crude oil prices would weaken the rupee. As a result, the trade gap would grow, putting India's current account balance under strain. Higher oil prices wreak havoc on the current account, exacerbate inflationary pressures, and make the economy more vulnerable to Fed rate hikes.
In essence, if the price of crude oil remains above $100 per barrel in 2022-23, it will significantly impact India's budget calculations. Experts believe every $10 per barrel increase in Brent prices will impact India’s GDP by 16-20 basis points.
History of rising Crude Oil prices
There have been numerous instances of substantial changes in oil prices. In actual terms, oil prices in the twentieth century remained constant until the 1970s. The coronavirus epidemic in 2020 caused prices to drop. The recent & ongoing confrontation between Russia and Ukraine in 2022 has prompted prices to rise.
What lies ahead?
There are better days ahead for the market. We are at historically low valuations, and the geopolitical situation is likely transitory. However, the Indian economy is strong, and earnings are expected to keep doing well in the coming quarters despite a blip caused by the current situation. The tricky question is, when does the consolidation end?
The index has been on a path of recovery for the last week, but it is tough to call the crisis over with geopolitical uncertainty.
Robustness during the crisis?
Wright ⚡Momentum has given a significant outperformance in the bull market and outperformed quite smoothly in the last six months, which were full of volatility.
The current allocation is dominated by Metals, Banking & Financials, and Technology. The tilt has been made towards large caps, and we expect the performance to keep going strong.
Check out the Momentum portfolio on smallcase
Also, find a link to our comments on sector allocation on Moneycontrol