Stocks have already reacted but high rates make debt attractive.
At last, the two big events that had markets in a tizzy over the last four months are over and done with: Ben Bernanke’s decision on tapering Fed’s stimulus and RBI governor Raghuram Rajan’s call on interest rates. Both gentlemen have managed to surprise the usually clairvoyant market.
Bernanke by deciding not to taper after making ominous noises about it since May and Rajan by hiking interest rates, when many expected him to cut. If you are an investor who has spent the last four months chewing your nails and waiting on the sidelines, these events are a cue to act. Here’s how you can overhaul your portfolio now.
RESPONSE TO ‘TAPER LATER’
Bernanke’s decision to ‘taper later’ does away with one immediate uncertainty for domestic stock markets. Foreign institutional investors (FIIs) may no longer have reason to beat a hasty retreat.
Had they stampeded out, it would have shaken up markets quite a bit. FIIs have withdrawn about $1.6 billion from Indian equities since May, on hints about tapering. But this is a minuscule portion of their cumulative investments of $175 billion till date in Indian equities.
But while FIIs have no reason to rush out, they have no reason to stroll in either. With economic growth at a decade-low and profit growth at India Inc on a downswing, the Indian market simply doesn’t look like a compelling buy today.
Domestic market valuations at about 17 times trailing earnings aren’t particularly cheap. And the 2000-point rally in the Sensex since the beginning of the month has made index stocks over-heated. But with a number of stocks still languishing at their 2008 levels, there are pockets of value that can be explored. For investors, this suggests a few things. If you’ve been parking all your savings in cash, deposits or gold, there is no longer any reason to keep avoiding stocks, fearing apocalypse. While lumpsum investments should be avoided, now is a good time to start systematic investments.
Yet, it is best not to join the bandwagon by investing in defensives. Let value, in the form of a low price-earnings multiple, be your guidepost to selecting stocks. Finally, while buying stocks, it is best to focus on quality. With rate cuts not likely anytime soon and Fed’s tapering still likely to come through, this is not the time to bet on companies which are in forex or debt distress, hoping for miracles.
BACK TO BONDS
Rajan’s decision to hike repo rates is certainly not good news for stock market investors. But it does benefit those who want to play it safe by investing in bonds. With RBI keeping up the pressure on rates, interest rates on bonds and fixed deposits are unlikely to decline anytime soon.
Yields on the 10-year government bond, which had plummeted to 8.2 per cent last week, have since shot up to 8.6 per cent. This strengthening of yields augurs well for two debt instruments that are pegged to gilt yields — tax-free bonds from companies and small savings schemes.
Recent tax-free bond issues from quasi-government entities such as HUDCO offered attractive interest rates of 8.3 per cent or more. Investors must make full use of similar bond offers to lock into these high tax-free returns, as yields will surely soften over the next two or three years.
Strengthening gilt yields are also a positive for investors relying on small savings schemes. Interest rates on these schemes are benchmarked to the gilt yield for the previous year. That suggests attractive returns from options such as National Savings Certificates and Public Provident Fund for a year longer.
High interest rates can also prop up returns from debt mutual funds, particularly those with shorter maturities. With Rajan not ruling out a further rate hike and Bernanke still toying with tapering, bond prices could remain quite volatile in the next three months. Buying gilt funds or long-term income funds in the hope of price gains will remain a risky option for retail investors, but fixed maturity plans or short trem bond funds may yield good returns.
Gold, after notching up a 30 per cent gain since April, is likely to take a bit of a breather. With the rupee showing stability, currency depreciation may no longer aid domestic gold prices. Global gold prices may head higher with taper fears out of the way. But these gains may not be sharp enough to deliver double-digit returns on the yellow metal. In balance, bonds seem to be your best bet until Bernanke and Rajan decide to address us once again.
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