FDs might be attractive for common man but equity gives 12-14% over a 10-yr period

“FDs will suddenly become more attractive for the common investors as interest rates continue to rise, especially socially for those who do not like to take any kind of market risk.,” says Dr Joseph Thomas, Head of Research, Emkay Wealth Management.

In an interview with ETMarkets, Thomas said: “But the opportunity cost is a return of 12 % to 14 % which equities can give over a ten-year period, and that too in a fairly diversified portfolio.,” Edited excerpts:

With central banks looking at tightening the money supply – what is your view on markets in the medium to long term?
As central banks tighten the monetary policy and normalize liquidity, the markets will trade lower because the liquidity glut had a certain role to play in the high valuations.

As the US inflation is staying largely above 8%, the US Fed is likely to tighten more aggressively. In addition to that, the Fed has a plan to downsizing the balance sheet which will lead to a flow of liquidity from the markets to the central bank coffers. This will scaffold the efforts to tighten to attain price stability. The ECB too may start tightening in a short while, while the Bank of England like a few other central banks are already halfway through their inflation-combatting measures.

High inflation, higher interest rates, and lower liquidity are the principal foes of equity markets. What needs to be seen is that to what extent this is going to pull down growth.

Despite negative developments, a fiercely growing economy could offset the impact of many a dampener and help speedy turnaround in the markets. The markets have already traded lower and the room for the decline may be quite limited from hereon compared to the movements witnessed so far. Inflation may peak only over the next two quarters, and as such, the central bank policy stance may also evolve in line with that. A large number of stocks have seen a 30 % or 40 % fall compared to their 52-week highs. It may be time to start investing in a phased manner to take advantage of the relatively fair valuations, or else the levels may just go away.

Encouraging data from MF in May and SIP flows are increased marginally which is a positive sign, but at the same time redemptions are also happening. But do you foresee more funds getting allocated towards fixed income vs equities?
The historical trends indicate that protracted fall in the markets could disincentivise people from continuing the SIPs. This may happen as we have seen quite a bit of correction, now spread over several months. But there is no way the average SIP figure of Rs.10,000 cr. completely disappearing. At worst it may dwindle by half.

But, the fact is that for the retail investors’ SIP is perceived as a safe mode to invest in equities. This fundamental thesis still stands. That equities are correcting does not by itself lead investors into fixed income. Fixed income also does not offer many opportunities in the immediate term due to the expectations of rising rates, especially at the long end of the curve.

The fall in interbank liquidity, the heavy government borrowing program, high oil prices and a weak Rupee re all factors that have a bearing on the trajectory of market yields.
The next target for the GOI 10-year benchmark is around 7.90%. Therefore, in fixed income, if one needs to stay out of the risk of depreciation is to stay at the very short end of the curve like overnight funds or liquid funds, and short-term bonds. The demand for long bonds will come up only after the market yields saturate and there is a general feeling that rates might have relatively cheaper and that it may plateau out or saturate.

If someone plan to put Rs 10 lakh now – which is the ideal medium. What is the ideal asset allocation strategy?
The asset allocation strategy is to be linked to the risk profile of the individual. However, in the case of a moderately aggressive risk profile or investor, at the current market levels, equities may be around 60 % and the rest in very short-term debt with an option to re-deploy another 20 % of very short debt into equity over the next two to three months.

Do you think FDs will now become more popular at least for the risk-averse investor in light of rising interest rate scenario?
FDs will suddenly become more attractive for the common investors as interest rates continue to rise, especially socially for those who do not like to take any kind of market risk.
But the opportunity coat is a return of 12 % to 14 % which equities can give over a ten -year period, and that too in a fairly diversified portfolio.
FDs, if they give 5 % or 7 %, it is barely sufficient to hedge against high inflation.

We saw rupee hitting record low in June – which stocks or sectors are likely to benefit the most from the surge?
The depreciation of the Indian Rupee benefits export-oriented firms, but the benefit would also depend on the quantum of unhedged positions of receivables and payables. One of the major sectoral beneficiaries is Technology and IT Services.

This is because these companies have a majority of their business from foreign countries especially the US and Europe, and it is invoiced in US Dollars. Even the Nifty50 companies have significant business revenues earned from abroad.

Crude oil is also hovering around $120/bbl – which might not put India in a comfortable scenario if it holds around this level. How will it impact the economy, as well as valuations?
India spends almost US$ 120 to US$ 130 billion to import oil every year. This is a large enough bill. A rise in oil prices upsets this calculation. We end up spending more to buy oil. This is rendered more painful for the economy with a weaker Rupee which again leads to higher import costs. These import costs translate into a higher price levels for the whole economy. Higher prices adversely affect aggregate demand and also reduces profit margins for companies except where they are able to pass on some of these costs to the consumer. Labor costs also rise in a high-cost and inflationary economy. Due to these factors, the valuations are also affected.

With rise in interest rates do you think it would dent valuations?
Cheap liquidity and lower interest rates help P/E expansion, and in case of dwindling liquidity and rising rates, the reverse will happen.
The only preventive factors are a very high rate of GDP growth and robust aggregate demand. Therefore, almost always, rise in interest rates will dent valuation.

 

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