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Equity Market Insights:
A few themes are dominating the equity markets worldwide and in India. Many investors decide their investments based on themes which have already gained a lot of popularity. Here are some of the popular themes and the risks associated with them:
Falling Interest Rates: There has been earnest demand by market participants to cut interest rates in the US and other developed economies on the back of falling inflation rates. Central Governments have given hope of meaningful rate cuts within this year. Falling interest rates make money cheaper and thus fuel equity market returns. However, unsatisfactory progress to the falling inflation trajectory in the latest numbers has dampened the hope of cutting the rates anytime soon. If the inflation doesn’t fall as per the expectations, we would see the impact on equity prices which are discounting lower interest rates sooner. RBI also goes in tandem with the other central banks regarding rate cuts to maintain stability in the exchange rate and avoid the risk of loosening too early.
Elections: Globally, more voters than ever in history will head to the polls. At least 64 countries represent a combined population of ~49% of the people in the world. Equity markets are riding on the expectations of the strong comeback of the NDA-led Government resulting in policy continuity. Polls are predicting a big sweep for the NDA, especially after recent wins in the state elections. In case, the results in June 2024 come contrary to the expectations of the thumping majority, we are at a risk of markets correcting by at least 5%. There are still mixed views on US elections but Global markets will start reacting to it in the runup to the main election result date.
Wars:The ongoing wars between Ukraine & Russia and of late between Israel & Iran seem to have been contained and no major blow-out is expected. Any wrong decision however has the potential to cause a full-blown war which could sink the equity markets badly. These are some of the known risks associated with the dominant themes for this year. There are some unknown risks (like COVID-19) which we are not even aware of and could come in different forms. These unknown risks have the potential to cause major damage since we are not prepared for the same.
The optimism based on these themes resulted in a good quarter for equity markets worldwide. S&P 500 (US Benchmark Index) saw gains of 11% over the last quarter. European indices also saw decent returns. Indian equity benchmark BSE Sensex went up by only 2% due to already stretched equity valuations. Mid & small cap indices witnessed some correction after the SEBI expressed concerns regarding frothy valuations and nudged mutual funds to restrict inflows. BSE Mid Cap was up by 6% and BSE Small Cap was almost flattish.
It was a mixed bag for different sectors with major sectoral growth seen in energy (up 19%), Auto (up 17%) and realty (up 14%). The major laggards were FMCG (down 6%), IT (down 2%) and financial services (down 2%).
At present, the Sensex PE ratio of 25x is higher compared to long-term averages of 20-21x. At these levels, the probability of higher upside potential is lower and downside risk is higher. Consequently, the portfolio allocation should reflect these probabilities depending on the risk profiles. Therefore, we maintain our underweight position to equity (check the Model Portfolio Current asset allocation below). For our equity allocations, we are maintaining positions in large-cap value funds while completely exiting mid & small-cap funds. We continue to recommend the allocation of 5-7% of portfolios to the funds investing in Chinese & other Southeast Asian economies due to multi-decades low valuation on the back of excessive negative coverage, which we believe has been discounted in the prices.
Debt Market Insights:
Someone rightly said that the Fed has the most difficult job in the world. They have to balance innumerable aspects while making any decision. They have to manage pressure from the politicians, and key stakeholders in the markets, understand the impact of their decision on the global economy and the consequent impact on the US economy and always stay at the risk of too much loosening (causing inflation) or too much tightening (causing recession). I have my sympathies with Jerome Powell.
After a downward trend in inflation in Q3FY24, inflation started coming higher than expectations, significantly worrying the FED which was patting itself for bringing down inflation. Falling inflation could help them lower interest rates and stave off some pressure from market stakeholders. The inflation numbers released in April 2024 for March 2024 in the US & India are 3.5% (more than expected) and 4.85% (in line with the expectations) respectively. The core inflation has remained sticky in the US and has moderated in India.
After falling less than 4% mark, the US 10-year yields have climbed above 4.50% in a matter of a few weeks. The debt yields have inched up across the yield curve maturities in the developed with the realization that the rate cuts are still far away. In India, the 10-year Govt. Bond yields went up from the lows of 7.01% to 7.18% in line with the direction of yield curves globally. The short-term yields have come down on the back of comfortable liquidity conditions after the end of FY.
The yields on top-rated commercial papers (CPs) with 6-month and 1-year maturity are 7.84% and 7.95% respectively, still above the bank FD rates.
We continue to avoid betting on a falling inflation rate sooner. We believe that we can’t be certain of falling inflation and significant cuts in the interest rates in this calendar year. In our view, sturdy economic growth in the US and volatility in commodity prices on the back of war tensions would continue to put upward pressures on inflation. This could disturb the assessment of the US FED and impact their estimation of interest rate trajectory. Further, any major upheaval in terms of war will upend the entire calculations causing significant mark-to-market losses to those holding long-maturity debt papers. We prefer investing the debt portion of our asset allocation in short-term papers which offer decent yields compared to long-term debt securities along with low interest rate risk. One can consider debt portfolios with floating rate instruments for long-term allocation. Arbitrage funds could be considered for short-term surplus funds (holding period of up to 1 year) due to better tax-adjusted returns.
Other Asset Classes:
Gold sparkled in the last quarter, going up by 9%. The underlying factors supporting the Gold rally are expected fall in interest rates, war tensions and strong buying by the central banks to build up their forex reserves in order to reduce dependency on the dollar. The gains in the Q4FY24 were after the 10% gain in the Q3FY24. Another interesting aspect is that Gold has gone up even when equity markets have been doing well, which is unusual. We believe there are strong macro factors driving gold prices which will sustain for the medium term at least. Any correction in equity prices will further give a boost to Gold prices, thus hedging the portfolio from any major losses from equity. We continue to maintain a 10-15% allocation to Gold, to hedge against falling equity prices, currency depreciation and gain from macro-tailwinds supporting gold’s up move. Interestingly, Gold prices (per 10 grams in INR terms) and Sensex levels were similar in 2015 (around 26,000) and are in close range even today.
Real estate sector is seeing a strong demand resulting in price appreciation and increasing rentals in absolute terms in major metro cities. The upward cycle that started three years ago is in full swing. However, we believe the real estate cycle will approach its peak in the next 1-2 years and there is not very significant upside from the current levels. We expect real estate prices to grow in line with inflation over the next 5 years period from the current levels.
Uncertainties or not, one should always follow this – Asset Allocation, Asset Allocation & Asset Allocation. Not getting too greedy or too fearful while sticking to a carefully designed asset allocation plan will help you stay in the game for the long term resulting in wealth from compounding. Moving away from asset allocation puts you at a risk of losing money and forcing you to quit consequently impacting potential wealth creation. Discipline, temperament and risk management win over speculations in the long term.
TRUEMIND’S MODEL PORTFOLIO – CURRENT ASSET ALLOCATION
Truemind Capital is a SEBI Registered Investment Management & Personal Finance Advisory platform. You can write to us at connect@truemindcapital.com or call us at 9999505324.
