Validus Wealth

Rising interest rates is a global phenomenon and it will cause volatility in equity markets across the globe, not just in the US

As interest rates harden, should you continue investing in US-focused mutual funds?

Moneycontrol, 24th  January 2021, Rajesh Cheruvu

Rising interest rates is a global phenomenon and it will cause volatility in equity markets across the globe, not just in the US.

Investing in US-focused funds and ETFs has been rewarding. For example, the Motilal Oswal Nasdaq 100 ETF has given 25 percent returns over the last decade. However, as we face the possibility of an interest rate hike cycle, is it prudent to check if investments in the US still make sense?

Rates on the rise

The consumer price index – a measure of inflation in the US climbed to 7percent for December 2021. The US Federal Reserve FOMC meet is scheduled on January 25 and January 26, 2022 to review monetary policy. Given the sticky inflation there is an expectation that the monetary policy may take a ‘U’ turn sooner than expected. The Fed may hike interest rates soon. Traders of interest rate futures in the US expected 86 percent chance of a rate hike in March. The liquidity injected by central bankers have caused rallies in stocks worldwide in last one and half years. “When the central banks withdraw liquidity and hike interest rates, the volatility will come back,” says Rajesh Cheruvu, Chief Investment Officer, Validus Wealth.

The market participants have taken cue from the US Fed commentary earlier in 2021. Nasdaq 100 index has shown weakness and lost 9.26 percent after hitting a high of 16764 on November 22, 2021. S&P500 index quoted at 4577, down 5 percent from its high of 4818. In last one year ended January 18, 2022, Motilal Oswal Nasdaq 100 ETF has given 23.93 percent compared to 28.84 percent given by Nippon India Nifty BeES, as per Value Research.

Economic slowdown caused by Covid-19 pandemic has made central bankers across the globe to infuse liquidity. However, the situation is changing. Sujan Hajra, Chief Economist, Anand Rathi Shares and Stock Brokers in his note released on January 12, 2022 has pointed out that nearly 40 percent of the 100 countries to watch, have already raised policy rates by an average (median) of 150 basis points. India though have not raised rates so far, cannot stay out of this rising interest rate cycle. Hajra expects Reserve Bank of India to raise rates by 100 basis points in CY2022.

Are equities costly?

“Rising interest rates is a global phenomenon and it will cause volatility in equity markets across the globe, not just in the US,” says Vikas Gupta, Founder and Chief Strategist, Omniscience Capital. Do not sell out of US stocks completely. US stock indices have low correlation with Indian stock indices. By allocating some capital to a diversified US stock index such as S&P 500 Index, Indian investors can bring down the volatility in their equity portfolio, adds Gupta.

The valuations in some pockets of the US and Indian equities are rich. But a look at the broader markets show a different picture. S&P 500 Index quotes at 26.1 PE compared to five year average PE of 25.36. Nifty 50 Index quotes at 25 PE compared to five year average PE of 27.6.

“Some stocks in US are enjoying high valuations. But expectations of high growth in future supports the high valuation multiples,” says Cheruvu. He expects more of time correction than price correction in US markets. Put simply, the price may not fall much, but may move sideways for some time.

The earnings growth bounced back due to cheap monetary policy. If the inflation does not come down and the interest rates need to be hiked, then it will have a negative effect on consumer demand, the key driver of corporate earnings. Capital expenditure too may take a backseat if the interest rates continue to climb. The quantum of impact may be known only over a period of time.

What should you do?

This is not the best time to invest all your money in one go. Vishal Dhawan, Founder and Chief Financial Planner, Plan Ahead Wealth Advisors says, “Invest in diversified index funds tracking the S&P 500 in a staggered manner with a seven to ten years timeframe. Avoid thematic funds.”

If your asset allocation to equities has risen too much, consider booking some profits in stocks, including in your overseas mutual fund holdings. Do not dump all investments in US-centric funds fearing possible volatility. Investing in US-focused equity mutual funds offers you diversification benefit. It not only helps investors to participate in global growth but also offers better governance standards, transparency and less volatility. Gupta recommends investing in schemes that track Nasdaq 100 and S&P 500. Diversification helps when a particular economy does not do well.

“If you are keen to diversify overseas beyond the US, you can consider investing in global equity schemes such as HDFC Developed World Indexes FOF and Motilal Oswal MSCI EAFE Top 100 Select Index Fund, ideally in a staggered manner,” says Dhawan. Index funds work better as most active fund managers tend to underperform the benchmark indices in developed world, he adds.

Not all developed markets such as Europe and Japan may be investment worthy. “The valuations are cheap for a reason. There is no earnings growth in many of these developed markets,” points out Cheruvu.

Though most experts advise investing in the US to benefit from global growth, there are voices that believe in the iron rule of financial markets – mean reversion. “Returns delivered by Nasdaq 100 over the past decade are behind us. Emerging markets have not rewarded investors since the global financial crisis,” says Gajendra Kothari, Managing Director and CEO, Etica Wealth Management. He expects emerging markets to do well over a five-year period. He recommends investing in actively managed emerging markets funds and Hang Seng Tech Index.

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