Quantitative Easing

Difficult times for those who invest in the stock market

There are now clear indications that given stubbornly high inflation, the US Fed will be more aggressive in the intensity of its rate hikes. Inflation is on the rise, partly due to external factors such as the war in Ukraine and the continued covid shutdowns in China’s major manufacturing hubs. The US Fed influences employment and inflation levels primarily by using monetary policy tools to control the availability and cost of credit. Here, the Fed’s main tool is the federal funds rate, changes in which influence other interest rates – which, in turn, influence borrowing costs for households and businesses as well as broader financial conditions. wide. When interest rates rise, borrowing becomes more expensive; consumption demand is impacted and investments are postponed. All of this eventually drives down wages and other costs, which in turn keeps runaway inflation in check. Foreign Portfolio Investors (REITs) tend to borrow from the US at lower interest rates in dollars and invest that money in bonds/stocks from countries like India in rupees to earn a rate of return. higher interest.

A rate hike in the United States could have a triple impact: making emerging countries like India less attractive for currency carry, slowing growth in the United States (which could be more bad news for global growth ) and trigger a rotation in emerging market equities (thereby dampening the enthusiasm of foreign investors). There is also a potential impact on currency markets, resulting from outflows from countries like India. Indian markets had reduced their dependence on REIT flows in recent quarters, but now the specter of continued unloading from them has impacted valuations and affected retail investors’ risk appetite. If this downtrend continues, even retail investors might consider taking money out of the markets wherever they are in profit or small losses. Although the Nifty P/E has come down to 20x, one should be aware of the possibility of earnings downgrades that could push the P/E back up. While the REIT sold since October 2021 looks large at $32.3 billion, it represents only 4.8% of their stake as of that date (out of their 20.5% stake in the market value of NSE companies 500 of 3249 billion dollars) and 15% of their cumulative inflows up to that date. While this denotes downside risk, care should be taken in stocks where REITs have a large stake even after 8-9 months of selling.

For investors who are not fully invested or who have raised cash in the recent past by making profits, these periods provide an opportunity to gradually increase the equity portion of their portfolio. When screening stocks, care should be taken not to have limited exposure to sectors or stocks that have been downgraded due to very high valuations (including some consumer staples/discretionary companies, new internet stocks era, mid-cap niche IT companies, retail, multiplexes, specialty chemicals) or very high financial forecasts that seem difficult to achieve.

Additionally, stocks that have performed well due to a surge in commodities over the past year should be closely scrutinized for earnings sustainability. Quantitative easing and restrictions in China have led to a very strong rise in commodity and equity prices in recent quarters. Now, with quantitative tightening in effect, those tailwinds will no longer be available, especially when economists expect recessionary conditions to set in across most parts of the globe. Investors should focus on structural stories where leverage on the books is limited, sales are growing at a CAGR of over 15% over the past three years, and yield ratios are high and steadily rising. They could have a mix of large caps (high proportion) and mid/small caps (balance) depending on their risk appetite.

Although equity markets may be slow to find a sustainable bottom, investors could consider debt options (including listed NCDs, RBI bonds, etc.). They may also consider placing funds in fixed bank deposits (FDs) once interest rates have risen enough and locking in high rates for a long time. They should be careful when investing in corporate FDs and weigh the rates offered against the risk assumed and compare them with the alternatives discussed above.

High inflation can cause property prices to rise slightly, and investors looking to buy property on their own can speed up their decision-making process. REITs and InvITs also provide a window to secure high returns at a time when interest rates are rising and their prices may have been depressed. Equities have not gone out of style but could experience a period of mild consolidation/correction. A prudent allocation of funds will now make it possible to take advantage of the next rally which could be in a few months.

Dhiraj Relli is Managing Director and CEO of HDFC Securities.

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