scorecardresearchRate hike concerns weigh heavily on equity investors, says Vetri Subramaniam

Rate hike concerns weigh heavily on equity investors, says Vetri Subramaniam

Updated: 02 May 2022, 09:50 AM IST

With the global markets heading towards slowdown, equity markets are in a tizzy with mounting losses for equity investors. Global growth estimates, too, continue to be slashed across the board. How should investors tread and what kind of lessons and investments strategies to employ in these times? 

A file phot of National Stock Exchange building in Mumbai. pti

A file phot of National Stock Exchange building in Mumbai. pti

NSE's Nifty50 dropped over three percent in April 2022 and the market participants are expecting further losses given growing global inflation concerns, Russia-Ukraine War and interest rate reversals.

The talks of global recession are gaining momentum as well given the US Federal Reserve's resolve to tackle inflation which is clearly not ‘transitional’. It has kicked off raising interest rates with a 25 basis points hike and is expected to raise rates by similar amounts for seven times this year – a 175 basis points interest rate rise in 2022.

This is on the back of 7.9% inflation in the US in February 2022 – a new high – and 6.1% in India. Inflation in India is expected to continue to inch up as the fuel price hike has only started to trickle down. Fuel prices in India were halted for nearly four months on the back of state elections in major states like Uttar Pradesh and Punjab. Fuel prices in India started to rise again in April.

Clearly, India's Reserve Bank of India (RBI), too, will look to raise rates to tame high inflation. The RBI Act clearly defines its duty to maintain the country's inflation between two to six percent. Failing which, the central bank is answerable to a parliamentary committee.

Although the RBI did not raise rates in its April Monetary Policy Committee meeting, it used other levers at its disposal to get the job done. Following this, banks have started to raise interest rates on loans and fixed deposits.

What does this mean?

Banks hiking loan and fixed deposit interest rates mean your equated monthly instalments (EMIs) will get dearer. This will put people off from taking fresh loans. Clearly, this will impact the country's growth as well.

Global agencies, including the RBI, have been revising India's GDP growth and have cut growth estimates.

Ratings agency ICRA, India Ratings, World Bank, International Monetary Fund (IMF) and Asian Development Bank (ADB) have all lowered India's GDP forecasts for the current year. To be fair, global growth estimates, too, have been lowered and India isn't immune to macro developments.

Why are bonds failing?

The concern about likely rate hikes weighs heavily on the minds of equity investors, said Vetri Subramaniam, Chief Investment Officer, UTI Asset Management Company, in Aditya Birla Capital's May edition of Investime.

Bonds (with a fixed coupon), have no flexibility. An increase in rates means the value of the bond falls. This is why long-term bonds are an extremely unattractive investment when faced with the likelihood of a sharp increase in interest rates, Subramaniam wrote, adding, bond yield curve has flattened. The 10-year bond's yield is less than the 2-year bond. A full inversion of the curve has normally been an effective harbinger of an economic downturn.

“Policy makers are operating with constraints in a difficult situation and the probability of a policy error is high,” he wrote.

The past efforts by the US Federal Reserve in tackling inflation weighs heavy on the minds of investors as well and doesn't inspire confidence.

Off the 10 times in the past 60 years the US Fed tried to tame high inflation, seven instances led to a recession.


What is recession?

A recession is when economy of a country contracts for two consecutive quarters. A financial year is divided into four quarters of three months each.


Subramaniam said, “Orchestrating a recession is the high probability, albeit unhappy outcome based on the Fed's track record.”

In the three instances when the Fed managed to avert recession, it backtracked mid-way, as things went awry on the macro front.

The lesson in diversification

The lesson for investors is clear – diversify.

“Diversification across asset classes such as Equity, Debt, Gold, Real assets is based on the premise that the assets behave differently and reduce the overall portfolio volatility. But choosing to emphasize an asset class solely because it has lower volatility (debt) or for that matter superior returns (equity) is not a sound strategy. The differences in risk and return are to be embraced, not avoided, to improve the risk-return outcomes in the aggregate portfolio. And it is always to be aligned with one's financial goals,” Subramaniam said.

He further said, “We are dealing with probabilities, not certainties."

How to invest now?

A staggered investment approach appears to be the most appropriate, he said.

"We take comfort in India's relatively healthy macroeconomic indicators in dealing with headwinds. The persistence of the headwinds of higher commodity prices and supply chain disruptions pose a risk to earnings estimates for FY23. The Reserve Bank of India (RBI) and Monetary Policy Committee (MPC) are likely to remain supportive of growth but may choose to narrow the policy corridor in their bi-monthly meeting. We expect bond markets to respond more to supply demand dynamics in the near-term, with investors preferring to remain at the short-end of the curve,” Subramaniam concluded.

First Published: 02 May 2022, 09:49 AM IST