Even after the recent 6 percent correction from its peak, India trades at a significant premium to its emerging markets (EM) peers, says Shantanu Bhargava, managing director and head of discretionary investment services at Waterfield Advisors.
"When we compare the current valuations with its own historic averages, broader market valuations are at acceptable levels," he says in an interview to Moneycontrol, adding that the MSCI EM Index is trading at a discount to its long-term averages.
Bhargava anticipates a surge in market volatility in the coming months because of a combination of factors such as global macroeconomic and geopolitical developments, surge in crude prices, recovery or lack thereof in the overall consumer sentiment during the holiday and wedding season, FII flows, the RBI policy stance, strength in corporate earnings, and the results of state and general elections. Bhargava is also the managing director of listed investments at Waterfield.
Excerpts from the interactions:
Do global equities look expensive now, especially given the US 10-year treasury yields at multi-year highs?
US stocks (that form the bulk of global market capitalisation) continue to appear expensive and offer relatively low-potential returns in relation to the associated risk. The PE ratio of S&P 500 index is above the long-term average on both trailing and one-year forward basis. Crucially, the equity risk premium, or the additional return an investor can expect from investments in US equity markets as opposed to risk-free 10-year Treasuries, is at its lowest point in nearly two decades.
In the UK and Europe, growth is expected to decelerate and equity markets are already discounting the same – MSCI Europe’s PE is slightly below long-term averages. Though lesser than earlier in the year, equity valuations in Japan are still attractive. In China, the increased risks and likelihood of slower growth are already factored into equity valuations, which trade at a discount to long-term averages.
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Overall, the MSCI EM index is trading at a discount to long-term averages. India still trades at a significant premium to its EM peers but when we compare the current valuations with its own historic averages, broader market valuations are at acceptable levels.
Do you expect the foreign outflow to continue from the emerging markets (EMs), including India, given the macro headwinds, high US bond yields and strong dollar?
Further FII withdrawal from EMs will be influenced by how US long-term yields evolve and how the geopolitical environment shifts, creating a risk-on or risk-off scenario.
Trajectory of the long bond yields during the initial stages of the tightening cycle in the US, there was a positive association between short-term and long-term interest rates. A reprieve followed in the past one year with long bond yields remaining largely unchanged, despite the persistence of short-term rate increases, as the market anticipated easing and the Federal Reserve employed a strategy of issuing T-bills to raise funds instead of issuing duration in order to prevent pressure on long-term rates.
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These factors changed post third quarter this calendar year, in which rates on long term bonds have risen and which was felt recently with the US 10 Year hitting a 16-year high of 5.02 percent last week. Higher rates for a longer period of time are anticipated to raise bond yields in US markets. If the T-bill rate remains at 5 percent, and with further supply of long-dated bonds in the US on the anvil, private investors (who are expected to absorb the supply) would want a risk premium over T-bill rates, therefore bonds must yield more than 5 percent, maybe touching 5.25 percent or higher. US 10 Year above 5 percent will be attractive for investors.
Investors in the stock market globally have been selling off stocks in the recent past due to apprehensions regarding the escalation of the war to additional nations in the Middle East. If the battle intensifies and spreads to other countries in the Middle East, the risk-off mode will be triggered.
A combination of elevated US treasury yields (considered a safe haven asset) and accentuation of risk-off mode could lead to greater outflows from emerging markets and even some developed markets ex-US.
Do you see more redemption pressure in midcaps and smallcaps in the near term?
The midcap and smallcap indices have shown superior performance compared to the Nifty50 index in recent months. Retail investors have been investing a significant amount of money in mid- and small-cap funds. This is evident not only from the increased proportion of monthly mutual fund inflows, but also from the substantial rise in the number of folios of mid-cap and small-cap funds in recent months.
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Despite the fact that immediate past performance is the single worst approach to select funds, most investors continue to make investment selections based on an asset's or product's recent performance. As a result, while new inflows and folio creation may slowdown, significant redemption pressure may occur with a lag when trailing returns of mid and small cap funds appear relatively dismal in comparison to large caps or other equity MF categories if there is a significant divergence in performance of small/mid versus largecaps prospectively.
Further, do you see the flow shifting from midcap-smallcaps to largecaps now?
Continuing with the same premise, if largecap funds outperform mid and small cap funds over the course of next few months or next 1 year, retail fund flow may shift to large cap funds after that.
This transition (from mid/small to large caps) appears to be already taking place in HNI and family office portfolios, which benefit from the availability of competent counter-intuitive advice that allows them to make proactive changes.
Are the investors/clients focussing more on the upcoming state elections, especially ahead of general elections next year? Also do you expect lot of volatility in the markets closer to elections?
We deal with ultra-wealthy clients. Based on the recent reduction in Indian stock market valuations, particularly in the largecap sector, we have been advising our investors to use some of the dry powder to increase the equity weight in their portfolios by 2-3 percent. In almost all cases, we have not encountered opposition to increasing equity allocation due to concerns about approaching state and general elections.
Interestingly, JP Morgan has upgraded India to ‘overweight’ from ‘neutral’ ahead of the elections. According to a JP Morgan research, Indian markets have produced positive returns ahead of the general elections, since 1991.
We anticipate increased market volatility in the coming months, but this will be due to a combination of factors such as global macroeconomic and geopolitical developments, commodity prices - particularly Brent Crude, recovery or lack thereof in overall consumer sentiment during the holiday & wedding season, FII flows, the RBI's monetary policy stance, strength in corporate earnings, and the results of state and general elections.
Do you think the focus will remain on the central banks' action than geopolitical tensions, though Middle East conflict remains a source of uncertainty for the equity markets?
Global economies are in an unbalanced position (desired inflation, growth, market prices). When the economies are out of balance, the road back to equilibrium is iterative, taking months or years to resolve depending on the size of the disequilibrium and will be specific to different countries.
Therefore, across the world different central banks will continue to iterate with their policy tools till such time desired conditions are met (for a transitory period). Geopolitical conflicts have the potential to postpone or delay this phase of normalisation of conditions.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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