For Indian investors who have been exploring foreign markets over the years, the US has been the most popular choice by a long shot. However, US indices are trading at dizzying valuations by virtue of unprecedented stimulus during 2020. The S&P 500 index is currently trading at a forward price-to-earnings ratio of 20.7 times (considering consensus estimates of FY21 EPS), which is markedly above the 10-year average level of 13.9 times.
Given the frothy valuations amid economic uncertainty, the most obvious question that investors have is - Will this momentum continue? From a fundamental standpoint, we believe the answer is 'yes', notwithstanding some weakness expected in the near future.
What works in favour of the US?
- Going forward, technology is likely to be one of the biggest themes across the world. Being a tech bastion, the US is strongly positioned to capitalise on this advantage
- Healthcare, telecom (transition towards 5G), e-commerce and online media are becoming promising secular growth sectors
- Owing to US' trade partnerships with several countries across the world, recovery in global growth augurs well for the world's largest economy
- The US Fed continues to maintain a supportive stance, implying that interest rates will remain low for the foreseeable future. This will encourage borrowing, investment and spending
- A stimulus package amounting to nearly USD 1 trillion is likely to trickle into the economy starting January 2021
- Lagged effects of fiscal and monetary measures taken in 2020 will be visible this year
- Positive sentiments around the finalisation and mass distribution of a vaccine will, in turn, cause cyclical and economy-linked sectors such as financials, industrials, utilities and transport
- Specifically, for Indian investors, currency movements can help deliver incremental returns. Since India is among the largest importers of oil in the world, it has been a current account deficit nation. Consequently, the Rupee tends to weaken against the US Dollar over long periods.
And what are the risks to look out for?
- Geopolitical tensions in the Middle East, particularly with Iran
- Escalations of trade war with China
- Inability to flatten the Covid-19 curve
- Periodic partial lockdowns
- Unsupportive employment data in recent months. This may be an early sign of temporary layoffs transitioning into permanent job losses
- Restricted retail consumption, especially on discretionary fronts, in light of the uncertainties ahead. Since 70 percent of US GDP is linked to consumption alone, the negative impact could be significant
- Profit booking in tech stocks, which comprise 27.7 and 56.6 percent of the S&P 500 and Nasdaq 100 indices, respectively
Mutual funds the best bet for Indian investors
Indians are permitted to invest in international stocks up to USD 250,000 per financial year without seeking approval from the RBI. However, if they choose to invest through international mutual funds offered in India, there is no limit on such investments.
After a stellar bounce back from the March 2020 lows, stock picking has caught the fancy of many investors worldwide. This is especially true of new investors who have been swept into the market on the back of the liquidity surge and are looking to make quick money.
Benefitting from both - passive and active strategies
Passive investing options like index funds and ETFs provide the benefit of low-cost investing without any bias associated with a fund manager’s stock selection. Returns are close to the respective benchmark as well.
In India, US-based passive mutual funds track two indices - Nasdaq 100, S&P500. We prefer the latter given its diversified sector exposure vis-a-vis the former.
On the other hand, fund managers have the flexibility to alter stocks and sectoral weights within the portfolio of actively managed funds. This enables them to capture potential upside opportunities at reasonable valuations.
In a market largely influenced and driven by liquidity, stocks across the market capitalization band witness a re-rating. In such a situation, small and mid-cap names tend to outperform the comparatively well-discovered and richly valued large and mega cap stocks.
The road ahead
Heading into 2021, the levers to support the rally in equities are strong. Global central banks will continue to print money, equities will remain attractive due to low-yielding fixed income instruments, earnings growth is expected to bounce back markedly and vaccine roll outs seem just around the corner.
While concerns about a frail economic scenario and rising covid-19 cases will continue to linger on for a while, we opine that the positives may outweigh the negatives in 2021 - on similar lines as what we've seen in 2020. Investors should brace themselves for intermittent volatility at regular intervals.
Krishna Karwa is a Senior Research Analyst at iFAST Financial India. The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.