Equity Market Insights:

The news of Higher interest rates for longer sent the stock Market down, but then the expectation that the interest rates have peaked and would be cut sooner sent the markets up, until the realization that the higher rates might result in hard landing pushed the markets down, before it ultimately went up on the expectations that the slowdown in the economy would lead to a re-imposition of lower interest rates scenario.

This is a modified version of a joke published in 1981 on the see-saw in the equity markets with high volatility in perceptions. This holds true even today considering the scenario over the last few months.

Equity markets are at a very interesting juncture where the market participants have not been able to ascertain the future outlook of the US and world economy (with a bias for positive outcomes).

Despite the hawkish tone of the Fed Chairman, markets are expecting a cut in interest rates sooner than projected by the central bank. Even after reducing the balance sheet size from $8 trillion to $7 trillion, the impact on liquidity has not been much due to excessive spending by the US Government. The current fiscal deficit of the US Government is expected to be 7% in the current financial year, which is multi-decade high. Fitch Ratings downgraded U.S. debt from AAA to AA+ on August 1, citing rising deficits, a broken budgeting process, and political brinksmanship—echoing S&P’s downgrade after the 2011 debt limit episode. However, the downgrade was brushed aside by the markets.

India being a bright spot in terms of higher sustainable growth amid the expected global slowdown continued to demonstrate resilience in the stock market. The positive global perception and growing domestic inflows ensure that the premium valuations of the Indian market are maintained. Sensex values remain unchanged over the July-Sept quarter whereas the BSE Mid and Small Cap index rose by 11% and 14% respectively. Some of the institutions dropped coverage or discouraged investing in Mid & Small Cap stocks owing to very expensive valuations boosted primarily by retail participation lured by past returns. Most of the sectors went up with major sectoral growth seen in metal (up 12%), realty (up 10%), and IT (up 8%).

Indian market valuations remained stretched compared to historical averages. Despite the rosy outlook, the valuations do not provide comfort for the short to medium term given our strong linkages with the Global economies. The current Sensex PE ratio of 24x is much higher compared to long-term average of 20x amid high Global uncertainties. The ongoing conflict between Russia-Ukraine and Israel-Palestine poses a risk of greater escalation of war impacting global trade and supply chains. We expect higher volatility over the next 6 months which could offer better opportunities for higher returns over the long term.

We maintain our underweight position to equity (check the 4th page for asset allocation) on the back of pricey markets. A few sectors like energy and banking have relatively better valuations compared to other sectors. Value stocks in large-cap space should be preferred over mid & small-cap stocks. We strongly reiterate our recommendation to minimize exposure to small & mid cap portfolios which have seen a sharp rally and therefore created very unfavourable risk-reward ratio.

Debt Market Insights

The debt yields have gone up across the yield curve maturities in the domestic markets due to constraining liquidity and higher global interest rates. The rising cost of crude oil also contributed to the upswing in market interest rates due to the fear of an inflationary outlook. The yields on the highest-rated commercial papers with 6-month and 1-year maturity are 7.75% and 7.95% respectively, much more attractive compared to FD rates offered by the biggest banks.

Long-duration yields remained elevated on the back of higher interest rates in developed economies. Long-term yields declined briefly on the news of the inclusion of India to the JPMorgan Government Bond Index-Emerging Markets starting June 28, 2024. We maintain caution with respect to the interest rate outlook due to the strong factors (including friction from realignment of global equations) indicating that the next few years could see higher inflation compared to what the world experienced during 2014-2021.

The reversal in interest rates may take more time than the market anticipates owing to changes in geopolitical alignment and structural supply-side constraints on the back of low capex towards traditional energy sources. The inflation numbers released on 12th October for September 2023 in the US & India are 3.7% (more than consensus estimate) and 5% (less than consensus estimate) respectively.

Allocation to long-duration securities should be avoided unless there is some semblance of stability in the Global energy outlook. We continue to prefer a portfolio duration of around 1-1.5 years with preferably floating rate instruments. For short-term requirements, one should consider arbitrage funds over debt MFs, for the favorable tax treatment of the former, if you are in the highest tax slab.

Other Asset Classes

Gold cooled off further in Q2FY24 due to higher interest rates offered by US treasuries along with the expectation of falling interest rates. Continued global uncertainties, however, offered some support to the gold prices. Gold continues to act as a portfolio insurance against any global shock or depreciation of domestic currency. Needless to say, the chances of global shock are higher this decade than last decade. We continue to recommend gold allocation of 10-20% depending upon risk profile and equity exposure.

Real estate prices see an upward trend owing to higher interest towards owning and investing in physical assets. The prices are expected to not grow more than inflation over the next few years due to higher interest rate and sharp rallies over the last two years which has reduced affordability.

The key to managing an uncertain investment outlook is to stick to time-tested asset allocation models without any emotional decision making. This is the only way to ensure higher risk-adjusted returns over the long term along with peace of mind.

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 [email protected] or call us at 9999505324.

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