Equity Market Insights:
“Investing is 5% intellect and 95% temperament. It means finding the strategy that will allow you to sit quietly when your emotions are screaming at you to do the wrong thing.” – Ian Cassel
Unfortunately, having the right temperament for investment is not common. Stories of someone in your circle making a lot more money than you have a great potential to disturb the peace of mind and create an urge to go against the carefully laid out strategies & plans. Such stories most of the time don’t give a complete picture. People like to talk about their winners and not losers. They like to talk about Bajaj Finance and not Yes Bank in their portfolio.
Most of the time, even the winners account for very low weight in the overall assets, resulting in miniscule contribution to the portfolio returns. For example, a stock rising by 100% in a year, if had a weightage of 1% in the overall assets, adds only 1% more return to the portfolio. But people will gloat about buying that particular stock.
With the equity market seeing a rapid rise over the last quarter, a few investors start getting the feeling of missing out after hearing the stories in their social circle, thus wanting to get more aggressive towards equity at the wrong time. The stories have the potential to draw many investors into the overvalued market, leaving them distraught after the correction.
Contrary to the expectation of an economic slowdown in 2023, the year turned out to be full of surprises, mostly positive ones. Global growth exceeded projections, primarily propelled by the resilient performance of the US economy. Despite reducing overall liquidity and increasing interest rates by the FED, the widening of the government fiscal deficit, a tight labor market, rising wages, receding inflation, and positive wealth effects helped maintain abundant liquidity and boosted sentiments.
S&P 500 (US Benchmark Index) saw gains of 11.32% over the last quarter and in turn released a flood of foreign money in emerging markets, barring China.
Indian stock markets continued to enjoy its bright spot perception globally, drawing more funds that catapulted the Sensex levels by 10% over the Oct-Dec quarter. Euphoric retail investor sentiments boosted the BSE Mid and Small Cap index by 14% and 13% respectively. Some of the fund managers continued discouraging flows in Mid & Small Cap stocks by either sounding cautious, dropping coverage, or stopping the inflows owing to frothy valuations in the space. All the sectors went up with major sectoral growth seen in realty (up 34%), energy (up 19%), and metal (up 16%).
The current Sensex PE ratio of 26x is stretched compared to long-term averages of 20-21x which increases the downside risk potential while reducing the upside returns probabilities. Any disturbance in the narrative of falling interest rates or escalation of regional conflicts could result in PE multiples mean-reverting.
We maintain our underweight position to equity (check the 3rd page for asset allocation) due to an unfavorable risk-reward ratio. We continue to hold positions in large-cap value stocks and maintain no allocation to mid & small-cap funds. Some allocation of 5-7% in portfolios focused on the Chinese economy can be taken given multi-decades low valuation, which may not sustain in a large economy expected to grow at 3-4% annually over the long term.
Debt Market Insights:
Fed’s dovish stance in the December policy meeting resulted in a surge in bond prices and consequently fall in yields. Bond prices and yields have an inverse relationship. Fed Chairman Jerome Powell took a victory lap on the back of a substantial decline in inflation without any slowdown. A notable change in Fed views has predictably fueled market conviction that the happy days of extremely low-interest rates and abundant liquidity are going to be back soon.
Inflation significantly receded from its peak across most developed nations, driven by corrections in food, energy, and commodity prices and the smoothening of supply chains. With back-to-back zero change in policy rates, it appeared that most central banks have largely reached the end of the rate hike cycle.
The US 10-year yields have fallen below the 4% mark after almost touching 5% a few months ago. The debt yields have declined across the yield curve maturities in the developed economies. In India, the yields at the longer duration have also come down following global trends and inclusion in global indices. However, the short-term yields continue to remain elevated due to tighter liquidity conditions. The yields on the highest-rated commercial papers with 6-month and 1-year maturity are 8.15% and 8.20% respectively, much above the bank FD rates.
The inflation numbers released in January 2024 for December 2023 in the US & India are 3.4% (more than expected) and 5.69% (more than expected) respectively. The core inflation has remained sticky which reduces the chances of rate cuts this quarter.
In our view, the interest rate outlook still looks quite uncertain owing to prevailing Global disturbances. Allocation to long-duration securities should be avoided at the current juncture. Short-term papers still offer lucrative yields compared to long-term debt securities. One can consider debt portfolios with floating rate instruments for long-term allocation. For short-term cash management, arbitrage funds offer better tax-adjusted returns. However, owing to volatility in arbitrage funds in a sharp market correction, the portfolio should be balanced with ultra-short term debt funds.
Other Asset Classes:
Expectations of easy monetary policy and ongoing conflicts provided tailwinds to gold prices which rose by 10% over the Q3FY24. Notably, gold defied the broader commodity downturn, deviating from its customary inverse correlation with the USD and equities. Gold returns were similar to Sensex’s returns in the last quarter.
In a landmark decision, the US Securities and Exchange Commission (SEC) recently approved applications for exchange-traded funds (ETFs) that are primarily based on bitcoin. This move, following applications from several US-based fund management firms, marks a significant shift in the financial landscape. Additionally expected loosening of monetary policies led to soaring prices of cryptos which many perceive as an alternative to centralized fiat currency which is losing its value due to unrestricted printing of money. We have no view on cryptos due to the absence of any basis or framework to evaluate its real value.
We continue to recommend a 10-15% allocation to Gold, which is widely seen as a tangible alternative to fiat currency. The Gold status of safe haven gets more credibility in an uncertain global environment which has the potential to flare up localized conflicts to a global level.
Real estate prices continue on their upward trend, especially higher end, owing to rising income levels and continued momentum over a sharp rise in real estate prices over the last 2 years after a long period of dull returns. As per the report by Jefferies, the average residential property price across the top 7 cities saw a CAGR of meagre 2% from 2013 to 2021. We do not expect real estate prices to grow more than inflation over the next 5 years period from the current levels.
In the current uncertain global economic environment with excessive valuations of fundamentally strong assets, we recommend diversifying portfolios across asset classes and geographies to avoid concentration risk and contain any sharp decline in the portfolio values.
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 connect@truemindcapital.com or call us at 9999505324.
