Stock Markets: How to Invest in a High Inflation and Low Interest Rate Environment

The last decade (2011-20) was characterized by moderate growth and a low inflation environment while in the previous decade, particularly 2002-2007, we witnessed higher growth with increasing inflation. We are currently experiencing high inflation and low growth, something the world saw in the 1970s. Rising geopolitical tensions are adding to the uncertainty. Initial market valuations remain high, despite the recent correction.

Such a macro situation is more detrimental to emerging markets in general. We have seen many emerging countries (including some of our neighbors) facing economic difficulties. This is causing FIIs to pull back from emerging markets, which we have also seen in India since last October. However, India is in a much better position to face the present situation as follows:

  • Economic activities resumed strongly after a short-lived Omicron panic. The services sector, which has been slow in growth for the past two years, is also showing strong improvement.
  • With the price of crude oil at around $100/barrel, the current account deficit for fiscal year 23 is likely to be around 3% of GDP, well below the levels of 4.5% seen in fiscal year 2012-13.
  • External debt levels remain low. Foreign exchange reserves are strong and sufficient to meet the expected foreign debt and Canadian dollar payments.
  • Inflation differentials between India and the developed world are well below the levels seen in the 2012/13 fiscal year.

While India is in a much better economic position to face the current situation, the initial market valuations are high, despite the recent correction. Such a scenario requires caution and caution. Investors should prepare for increased volatility over the next six to nine months. They should keep return expectations low and not expect a repeat of the returns of the past two years. Investors who invest pooled amounts can opt for balanced-advantage funds, which alternate allocations between equity and debt. More conservative investors should choose conservative hybrid funds. Investments in the medium and small business categories can be arranged over the next 6-9 months using the SIP / STP path.

Mid- and small-cap stocks have outperformed large companies in the past two years. Medium and small-cap companies are more vulnerable when liquidity is reduced and interest rates are higher. Among debt funds, short-term debt funds and dynamic debt funds can be the preferred categories.

We also feel that such a macro environment is conducive to increasing the value of stocks compared to growth stocks. In the past decade, we’ve seen the growth approach strongly outperform the value approach as inflation has been low and liquidity is abundant. Growth stocks are similar to long-term bonds in that the cash flows of many years are discounted in price resulting in high multiples. A period of ultra-low interest rates has been very good for developing stocks – and has been a huge challenge for value investors. The path forward will likely be different, which brings back some of the appeal of the value strategy.

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

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