The world has a problem of growth and lack of inflation and global central banks are striving hard to fix these problems by keeping interest rates at record lows and pumping in liquidity into the system. The end result that central banks hope for is growth and inflation picking up to sustainable levels to enable them to withdraw stimulus. However the end result usually differs vastly from the desired result and your portfolios have to be prepared for a not so desirable result.
The end result of central bank stimulus could range from currency debasement to spiking inflation to a liquidity trap that makes monetary stimulus ineffective.
Table 1. gives you IMF latest growth and inflation projections for major economies in the world.
The above table shows that apart from India and Brazil where inflation is running higher than central bank target, all other economies have inflation running lower than central bank target. Growth is an issue for most countries except the US that is seeing the positive effects of Fed maintaining record low interest rates over the last few years and increasing the size of its balance sheet by 4X. China and India are growing at well below trend levels of over 10% and 8% respectively. Brazil growth is anaemic on weak commodity prices. Eurozone is showing very weak growth with lack of inflation and ECB is keeping rates at record lows and is pumping in liquidity through asset purchases and LTRO (Long Term Refinance Operations).
Indian Bonds offer good returns going forward
India is expected to grow by 6.4% in 2015 from levels of 5.6% this year while inflation is expected to come off from 7.8% to 7.5% as per IMF forecast. CPI inflation is at levels of 6.46% as of September 2014. RBI inflation target is 6% and the central bank is maintaining an anti inflationary stance as against the pro inflation stance maintained by most of the major central banks.
Given that global central bank liquidity has brought down yields on government bonds to junk bonds to record lows in the US and Eurozone, the high liquidity pumped in by central banks will flow to higher yields offered by INR bonds. The fact that RBI and Government are working in tandem to lower inflation expectations (Government is forecasting a fiscal deficit of 3% of GDP in fiscal 2016-17 from this year levels of 4.1% of GDP) is highly positive for global liquidity to chase domestic yields.
Table 2 gives the central bank policy rates and ten year bond yields of major countries
Leaving out Brazil, INR ten year bond yield offers a strong pick up over yields available in bonds of other countries and with expectations of inflation coming off in India, the scope for yields to fall is high.
Your portfolio should have good exposure to INR bonds either directly or through bond funds.
Indian Equities will benefit from global liquidity but company and sector specific challenges will remain
Indian equities have benefitted from global liquidity that has found its way to a politically stable India post the 2014 general elections. The benchmark indices, the Sensex and Nifty are trading at record highs and have gained 30% over the last one year and 66% over a five year period. India is the best performing equity market over a one year period and is a top performing market over a five year period.
Table 3 gives the performance of equity indices over a one year and five year period
The worst performing indices over a five year period are the Chinese and Brazilian indices reflecting the inherent issues facing each of the economies. China is grappling with over investments, property price bubbles and bad loans while Brazil is facing the effect of weak commodity prices with commodity indices down 50% from peaks seen in 2007.
India is seen as coming out of problems of high inflation, high fiscal and current account deficits and slowing growth that took down the INR by over 50% against the USD over the last few years. Economic and corporate prospects look brighter given a stable government and improving macros. However given weak global growth prospects, India could continue to see growth weakness.
In this scenario, Indian equities look attractive in relative terms and that could drive in portfolio flows. The market will not see broad based rallies but specific stocks and sectors will pull the markets higher.
Your equity portfolio should be invested in the right stocks and sectors. Refer our presentation on 2018 for the right sectors for your equity portfolio.
The world is becoming riskier with central banks trying to prop up economies. The liquidity pumped in by central banks would be positive for asset prices for a while but when it comes to withdrawal of liquidity, there could be large scale volatility in markets. Your portfolio should be able to withstand the volatility and be liquid enough to sell if the volatility looks to be on the horizon.
Timing the market for the onset of volatility will be tricky and the best way to lower risk will to maintain strong, liquid portfolios.
Your portfolios should be invested in fundamentally strong stocks and bonds that offer liquidity as well as protection against volatility.