Challenging times for investors!

Challenging times for investors!

There is a lot of discussion on the current state of equity markets, not only in India but also in the US. The sharply higher US equity markets are especially worrying given the backdrop of the continuing situation surrounding tariffs and the resultant impact it is likely to have on the US economy, inflation and interest rates. Globally there is a lot of chatter around “geopolitical reset” and the emerging uncertainty that would provide for commodity markets and trade, in general. This indeed makes for challenging times for investors.

Let’s take the US equity markets for starters. They matter because they do set the tone for investor sentiment in general and set the tenor for investor expectation across the world. They also influence capital flows in and out of the US that have an indication on how other asset classes are likely to react. Bond markets too are showing contrary signs indicating difficult times ahead.

The elephant in the room: Concentration of market cap in the select few that has created most of the upside in US equities now for over a decade. The so-called Mag7 has led to bubble like valuations not only in the 7 companies themselves but also in a range of related entities that take an ancillary view on their growth, whether in AI infrastructure, LLMs, or the supply chain for the Mag7 in years to come. In comparison small and mid-cap indexes in the US are trading much cheaper and so can be said for a large mass of US listed entities.

Indian equities though shy of their all-time highs, are continuing to trade at above average multiples, especially in the mid and small cap area. Earnings this year so far have not justified the multiples these companies on average are trading at, which could lead to a sharp correction to longer term averages or a general de-rating across companies. The emerging situation vis-à-vis trade relations with the US could lead to significant reform initiatives, which may be positive from a longer-term perspective, but could cost the government in near term revenues leading to higher interest rates and inflation concerns.

Alternative asset classes are also flashing warning signs. Gold and Silver, a relatively uncorrelated asset class and a safe haven for anticipated volatility in capital markets, are themselves at life highs. So, if investors wish to reduce risk in their portfolios at this time by cutting financial market exposure may be in turn entering at historically high prices of these commodities. Not a good sign for reduction of anxiety. Real estate and other commodities also do not provide for satisfactory answers given where the industrial demand situation is likely to be. The impact of the possible reduction in hostilities between Russia and Ukraine is also unlikely to be discounted in the current crude oil prices. A supply glut could head oil prices downward.

All in all, quite a challenging time for investors at this point of time

What can investors do to protect themselves?

Revisit the investment horizon

• Longer term equity investors should ignore the noise if they are in broad index fund ETFs or in diversified equity funds or hold a market neutral portfolio. Hard to do in practice given the behavioural impulse to bolt at the first sign of a drawdown. This includes systematic long term periodic investments, read SIPs.

• Shorter term investors should diversify across asset classes and increase non-equity exposure at this time. This will help protect the downside without necessarily exiting the position, in case events are likely to surprise on the upside. Shorter term high quality fixed income funds appear the best choice at this time given lower volatility and certainty of intervening cash flows without undertaking significant duration risk.

• Investors who are unaware of the dangers of the equity markets should plainly heed to caution and invest in shorter term debt funds to ride out this period of uncertainty without significant cost to their capital before signals emerge to the contrary. In any case the asset allocation should drive their decisions. The help of proper financial advisor will be invaluable at this time

It is of course not only the time period that investors should focus on to make decisions at this time or any other time, but also necessary to focus on a goal. Many times, great performance in chosen assets if under allocated hardly take us closer to our financial goal. Conversely, “over allocation” to risk assets can contribute to a goal not being met due to the time taken for certain asset classes to deliver. Remember compounded growth rates are exactly what they are, they cannot be substituted for “per year rates of return”

How long can this volatility continue?

The way the trade issue has taken center stage in the US, it appears unlikely that the storm will pass anytime soon. The markets can remain volatile for a considerable amount of time. Expect strong earnings growth and fundamental strength to eventually overshadow current volatility in the next two quarters. This could be an attractive opportunity for tactical allocations for institutional investors.

Happy investing!