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Where should you invest now?
November 04, 2004 14:18 IST
Now where do you invest in current times? Debt? Equity? Or do you hold cash or near cash assets (including liquid funds and short-term deposits) until a clear opportunity presents itself?
The answer to these questions depends on your time horizon of investing and your ability to absorb near term volatility.
Let's take the debt market first. In recent months, two factors had a significant impact on the debt markets. One, rising oil prices, which started showing up in higher inflation numbers. Two, a rise in demand for credit on the back of what possibly could be a turnaround in the domestic investment cycle.
Both these factors, were 'negatives' as far as the debt markets are concerned. Why?
It was widely expected that the Reserve Bank of India will attempt to slow down domestic demand by increasing interest rates in its attempt to bring the inflation rate under control.
This view was vindicated when the RBI announced a 0.25 per cent hike in the Repo Rate (simply, the rate at which RBI borrows from the market) in the monetary policy announcement for the busy season.
As regards bank credit, the demand has been higher than anticipated, resulting in a 'reduction' in liquidity in the market. Although there is no current shortage of credit, it nevertheless impacts the market from a 'sentiment' perspective.
And the result of these developments? The yields on benchmark government debt with a maturity of 10 years has risen from about 4.9% earlier this year to nearly 7.0% now.
If you were invested in debt/funds during this period, you probably lost a packet. If you locked yourself into long term fixed deposits earlier this year, again you lost out on an opportunity to benefit from higher interest rates.
But this was in the past. From here onwards, things may just be starting to look better for the debt markets.
Why do we say this? For one, the RBI has marked down its expectation of domestic economic growth by 0.5 per cent for the year.
Two, globally the concern is increasing that the US economy may grow much slower than anticipated (this view has been vindicated by the 3rd quarter numbers) and that China may be headed for a slowdown (sharp or otherwise). Both these factors support a case for lower, rather than higher, interest rates.
Third, the increase in investment activity that we are witnessing domestically is something that has come about after a gap of about 7 years and therefore the RBI may not be keen to stifle this nascent recovery too soon.
Finally, due to a technical factor of a higher base last year, there is likely to be a downward pressure on the inflation 'number' in the future.
We are not saying that yields will not go any higher (and therefore hurt investors in debt funds and long-term fixed deposits). They may, and possibly will as market always tend to over and under shoot.
And for this same reason, investors with low risk appetites should probably continue to favour short-term fixed deposits over long term funds or other forms of debt. But for an investor with an appetite for 'some risk', from a 1-2 year perspective, the long term debt funds may be starting to look attractive.
Interview with Nilesh Shah, CIO, Pru ICICI AMC -- Time to invest in debt funds?
Now coming to the stock markets. As can be expected, things start to get trickier here! The price of crude oil has risen rapidly in recent months. But, then, so has the BSE Sensex.
Some would call this rather unexpected as a rise in oil prices, historically, has had a negative impact on sentiment. Higher crude prices, whether or not they are passed onto the consumer, impact the health of the government, the corporate sector and the investor.
So, to take an example, the petroleum minister may defer a price hike at the retail level, but then this does not mean crude costs any less. The government (higher fiscal deficit) and the oil refining company (lower profits) have to bear the brunt.
The situation has become even more 'trickier' as the stock markets responded to declining oil prices with another run up. So when oil prices go up, it is 'we are no longer impacted as much as we used to', and therefore the rally continues.
And when oil prices go down, it is 'better for the economy, and the rally still continues!!
But this is just one of the many factors that impact the stock markets. Another concern for the market is how the economies of the United States and China behave going forward.
A sharp slowdown in either will have significant ramifications for the Indian corporate sector (most Indian IT exports are to the US, while a lot of the run up in prices of commodities like steel is due to the surge in demand in China).
Finally, interest rates in India have risen sharply in recent months and seem to be stabilising at existing levels. The higher returns offered by the debt markets could pull back some money which moved on in search for higher returns.
While it is difficult to estimate the kind of pullback there will be and consequently its significance, it will nevertheless be one factor that will play on the minds of the investor who is underweight in debt.
Indeed, corporate results have been good and it is anticipated that the trend will be maintained in the future. Another major positive is with long term capital gains tax is now zero.
It is anticipated that monies from large global players (including pension funds) who were skeptical of investing in India via Mauritius (to get a tax benefit) would now look at India much more favourably. This should bring in much needed long-term monies into the markets.
Long term, the Indian markets are widely expected to do well. We support this view. It is the near term that we are concerned about. And therefore we recommend, and have been advising our customers, to avoid making large one-time investments in the equity markets.
Go in for systematic investment plans, which will protect you in case there were to be a sell off in the near term. In either case, ensure you have at least a three-year investment horizon and are prepared for some serious volatility in the near term!
Our detailed view on "Why invest in India?" is part of the September issue of Money Simplified, a free to download publication.Click here to get your copy!