stock markets: How to invest in a high inflation and low interest rate environment

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The last decade (2011-20) was marked by a moderate growth low inflation environment while in the earlier decade, particularly the 2002-2007 period, we saw higher growth with increasing inflation. We are currently seeing high inflation and low growth, something the world has experienced in the 70s. The rising geopolitical tensions add to the uncertainties. The starting valuations of the market remain high, despite the recent correction.

Such a macro situation is more damaging to emerging markets in general. We have seen many EM countries (including some of our neighbors) getting into economic difficulties. This is leading to redemption by FIIs from emerging markets, which we have also seen in India since last October. However, India is much better placed to face the current situation as:

  • Economic activities, post the short lived Omicron scare, have resumed strongly. Services sector, which was a laggard in growth for last two years is also showing strong improvement.
  • With crude oil at around USD 100/bbl, current account deficit for FY23 is likely to be around 3% of GDP, much lower than the 4.5% levels seen in FY12-13.
  • External debt levels remain low. Forex reserves are strong and adequate to meet the projected CAD and external debt payments.
  • Inflation differentials between India and developed world are much lower than the levels seen in FY12/13.

While India is much better placed economically to face the current situation, starting valuations of the market are high, despite the recent correction. Such a scenario warrants caution and circumspection. Investors should brace for increased volatility over the next 6-9 months. They should keep the return expectations low and not expect to make a repeat of last two years returns. Investors investing lumpsum amounts can opt for balanced advantage funds, which toggle allocations between equity and debt. More conservative investors should opt for conservative hybrid funds. Investments in mid and small cap categories can be staggered over the next 6-9 months using SIP/ STP route.

Mid and small cap stocks have strongly outperformed large caps in last two years. Mid and small cap companies are more susceptible when liquidity is tightening and interest rates are rising. Among debt funds, short term debt funds and dynamic debt funds can be the preferred categories.

We also feel such a macro environment is conducive to value stocks as compared to growth stocks. In the last decade, we saw growth style strongly outperforming value style as inflation was low and liquidity abundant. Growth stocks are like long duration bonds as cash flows for many years are discounted in the price resulting in high multiples. The period of extremely low interest rates was very good for growth stocks ― and very challenging for value investors. The road ahead is likely to be different, restoring some of the appeal of a value strategy.

(The author, George Heber Joseph, is CEO & CIO, ITI Mutual Fund. Views are his own)

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