We are coming out of a decade when the US Equity market did exceptionally well. The average return of the S&P 500 over the last decade was ~10% against the 10-year breakeven inflation rate of 2.29%.
The near-zero interest rate through the decade made sure that the bond stayed an unattractive investment option. There was no alternative (TINA) to the Equity investment. Even the conservative Pension Funds in the US increased their asset allocation to Equity in the search of higher returns.
Passive investing (e.g. Index Funds and ETF) picked up steam as the majority of the investors believed that it will be difficult for them to beat the market return. The design of these investment vehicles made sure that the fund continued to flow in the index companies.
Globalization flourished. The technology companies found significant growth opportunities across geographies. They lived up to the hype by generating market-beating performances year after year. The trillion-dollar market cap became achievable for the first time.
Growth investing trounced value investing by a huge margin.
The retail investor found it easy to invest in the Equity market. You did not have to be an intelligent investor to make money. You could simply invest in ETF or Index Fund and stay the course to earn an inflation-beating return. When the market struggled, the US Fed came to the rescue (The Fed Put) and did not let it fall. Investors developed a cult following for the large technologies companies by coining acronyms such as FANG and FAAMG.
The environment encouraged Risk taking and winning became a habit.
COVID struck in the year 2020. A worried government and the Reserve Banks all over the world pumped trillions of dollars through Fiscal Stimulus and Quantitative Easing (QE) programs. They printed too much money for far too long.
The pandemic forced people and businesses to work remotely. That gave a final big push to digital growth which resulted in superior performances of the large-cap tech companies one final time while other companies struggled. The Market cap weighted index started losing its significance as a few big tech companies represented a large part of the index.
Situation Today
Come 2022, COVID has slowed down but not before jamming the supply chain. The manufacturing and supply of goods across the countries have suffered. Countries have started prioritizing their needs over global needs. The production of critical items in-house has become important. The world is taking two steps back when it comes to globalization.
The Russia-Ukraine war has adversely impacted the global economy, particularly the economy of low-income countries. Ukraine (the “food basket of the world”) has struggled to supply food items to other countries. Russia, the biggest provider of oil and gas to Europe is non-committal on future supply. OPEC has cut oil production and that will keep oil prices at an elevated level aiding increase in inflation.
Reserve banks all over the world are in the process of increasing the interest rate at a brisk pace to tame inflation. It remains to be seen how effective those measures would be and how long it will take to control inflation.
What should be our Investment Strategy?
The goldilocks economy of the last decade has given way to an inflationary economy headed for recession. The increase in interest rate may not necessarily bring down inflation quickly and the Equity market will continue to stay under pressure in the near future. The Reserve Banks will stay the course till the time they see a reduction in inflation and that wait may be long this time. In that scenario, what should be our investment strategy?
Investing in the US
It will not be a surprise if inflation stays persistent for a relatively long period. That means buying on a dip may not hold good as the dip could go worse and the recovery could be longer. It might be wise to wait for a convincing reversal of the economy with a note of caution that it is very difficult to time the market.
Value investing will get its place in the sun.
It would not be surprising if bond returns beat Equity returns in the next 3-5 years, hence right asset allocation will be important.
Investing in India
India is in a relatively better position. The Russia-Ukraine war had less impact on it so far. The Reserve Bank of India (RBI) has been able to keep the Indian currency relatively stable in the wake of a swift rise in the dollar with the strong dollar war chest it has built over the years. The aftereffects of Covid have forced countries and companies to diversify the supply chain to which India is a beneficiary. Inflation in India is not in a comfortable zone but RBI is on top of it. While growth is slowing down all over the world, India is one of the exceptions with reasonable projected growth.
The Indian Equity market is trading today at a premium to other equity markets, but the high valuation is based on the premise that the Indian economy will do well in the coming decade. Do not expect the Indian market to go up in a hurry as the world economy is sluggish and it may take time for that to come back again.
Align your investment to your financial goals as per your risk profile and asset allocation.
A democratic India with a large skilled young population, strong economy and decisive leadership with belief in “Vasudhaiva Kutumbakam” (The World is One Family) may be the beacon that the world is pinning its hope on.
Wish you and your family a very Happy Diwali. Stay safe and take good care.
The writer is a SEBI Registered Adviser and Founder of FinMyn (https://finmyn.com). He provides Fee-Only Financial Planning and Investment Advisory services.
He has advised many clients in India, the US, Europe, the Middle East, South East Asia and Australia.
To know more about him, click on https://finmyn.com/about/.