Are the US equity markets headed for a crash?

The chatter around a possible market correction in the US grows

If one were to glance through some of the recent commentary across most economists, investors and market commentators the growing discomfort around market valuations especially in the Mag 7 is very noticeable. Nvidia just crossed USD$5 trillion in market capitalization. The company had reached a historic market capitalization of USD 1 trillion just a couple of years back, November 2023 to be precise. At that time many observers would be forgiven for thinking that there may be pause in its meteoric rise thus far. I am not sure if even a single person could have imagined that the stock will rise 5 times from there! If one puts this in perspective, it is logical for most observers now to sound the alert on valuations alone.

To keep most investors on a safe footing, it is comforting to note that major market corrections or crashes are never predicted. They always are surprises far beyond everyone’s expectations. Given the general feeling of unease one can conclude from a contrarian point of view that a crash appears unlikely as of now, as a result! Now let’s look at the reasons for the nervousness among observers and investors:

The US equity markets are skewed in favor of a few companies, i.e. most of the incremental market capitalization in the US is coming from only a handful of technology led companies while the broader markets remain pedestrian. A classic K pattern. In fact, most stocks have underperformed the index due to such a tilt. This statistic is a little more skewed than in most other periods or the average. On an average 60% of the companies in the S&P 500 underperform, while in the recent 2–3-year period only 25% of the companies have outperformed. That means nearly 75% of the companies in the index have underperformed. This indicates a higher amount of concentration compared to the average.

Closer home, Indian equity markets have remained lackluster for over a year. While there are a few companies that have outperformed the index, tepid earnings growth so far in the year and pricey valuations at the start of the year ensured no significant gains. FPI activity was hugely negative throughout the year not giving any support to markets from a momentum perspective. While domestic investors continued to place their faith in the markets if MF inflows were any indication, the rate of NFO’s declined from the same period last year indicating slowing overall inflows into the market. Precious metals stole the show and appeared to take the limelight away from equity markets this year.

So, what should we look at?

Well, the jury is still out on what is likely to happen in the US since there are far too many moving parts currently to paint a coherent picture. US unemployment figures continue to remain under control, inflation is seen inching up but the full force of tariffs on the same will be visible only in the next year and it is the same reason that the US Federal Reserve chairman sounded the alarm on interest rate cuts not to be taken as a given in the future post the most recent cut in the monetary policy.

How do we navigate the next few quarters?

There is no safe haven

• The returning strength to the US dollar post the recent announcements of the Fed indicate that the move away from non-dollar assets may be reversing, indicating weak potential returns for precious metals and Cryptos

• Emerging markets that also rode non-US dollar asset popularity may also move sideways, as the recent uptick in the same will be now looked upon with more circumspection and global flows may yet reallocate to US Dollar assets

• India continues to look attractive from an earnings perspective for the next few quarters as the impact of the GST reform and substantial banking reforms take root and start showing up in the numbers. The current earnings season still is not indicative of the full increase in earnings momentum and investors may have to wait for a full quarter more before they see the evidence in numbers though we suspect that the markets may respond by scaling new highs in December itself.

Asset allocation and diversification will be the key change that investors may need to make in their portfolios. While returns expectations should also be tempered an increase in equity allocation to longer term averages is called for at this time. The flat return on the equity market for the year is bringing 3-year historical returns in the “average” range. This allows for expectation to build for the next 3-5 year to be attractive from here on. If investors had reduced equity exposure at the start of the year due to stretched valuations, they may be induced to increase them back up a bit.

Time to take a serious look at increasing exposure?

Given the above scenario, it looks a strong case for increasing India equity exposure. While it is never easy to predict the general trend of the market for any period in the future, the overall picture emerging from a robust expectation of GDP growth, lower interest rates, and a significant boost from a reform perspective signal for better times ahead.

However, a portfolio consisting of a judicious mix of various asset classes led by an increase in the India equity allocation appears the most reasonable bet by far. Risk perceptions and appetites for individual investors notwithstanding. Investors are encouraged to take a professional view of their portfolios before making any significant changes and all caveats as mentioned in the disclaimers apply!

Happy investing!