There is a crisis brewing in America’s banking system once again. Raghuram Rajan, former RBI governor and a close observer of the US economy, warned of long-term systemic consequences of short-term bailouts of banks that choose to take risks. He said that the story was not over yet. That is no good news for America and the world economy. Financial markets worldwide were spooked by the turmoil in two small US banks and Credit Suisse, a Swiss banking group.
It is a world that is far more integrated than it was in 2008. There are fears of a contagion hurting markets from Europe to Asia due to problems in America. That should worry you too. A paper by the Bank of International Settlements published in March 2023 observes that a 1% increase in the US bond yields leads to a 1.15% increase in local currency yields in emerging markets. It leads to a 6% depreciation in currencies and a fall of 5% in domestic equity markets.
The paper also measures the money pulled out during every such spike. About 8% value of bond and equity funds is pulled out from the emerging market assets. India is a significant part of global emerging market funds. Money passively invested in India and other markets could continue to move out. The paper adds that a 10% appreciation in the US broad dollar index, a measure of the strength of the US dollar against major currencies, leads to a currency depreciation of about 8% and a similar size fall in equity prices.
Foreign portfolio investors have pulled out $2.7bn from equity markets in 2023. That is on the back of $16bn pulled out in 2022. While domestic mutual funds continue to put close to $2bn monthly in equity markets, the overall negative sentiment in the world markets is unlikely to push up share prices in India. That is primarily because Indian shares trade at a higher valuation than the average multiple in other emerging markets.
The consumer price Inflation will remain elevated as the latest data for February 2023 showed no respite. It was higher than the 6% upper limit target of the Reserve Bank of India. That means interest rates are likely to stay elevated too. If stock markets are not going anywhere and interest rates are likely to stay high, you must protect your money from losses. You will see equity assets lose some sheen and money lose value to inflation. Diversification is the best weapon you could use to protect your investments.
Portfolio diversification is a strategy to spread money across different asset classes, industries and geographical regions. That will ensure that a drop in one asset class does not hurt your overall portfolio. The asset classes could include equity, debt, gold, commodities and real estate. The downside of such a strategy is that you will not get the highest return as you prioritise safety.
However, your return potential is much higher in the long term than in a concentrated portfolio. We must assume that you invest the money you do not need to spend now. If you have short-term expenditures to incur, you don’t need to worry. To protect your capital, you must park your funds in instruments like fixed deposits or liquid funds. Even holding on to your capital is an achievement during a global financial market meltdown. Avoiding significant losses by cutting down on risky investments will allow you to use your cash when the opportunity arises.
When market volatility is high, portfolio diversification will allow you to buy peace of mind. You can reduce stress and anxiety in the short term and focus on your long-term financial goals. Regularly investing through systematic investment plans will help you with the advantage of rupee-cost averaging. That means you will buy fewer units or shares when prices are high and more of them when prices are low. A disciplined approach towards investing will help you ride through any potential market turmoil.
Higher valuation
Indian shares trade at a higher valuation than the average multiple in other emerging markets. When market volatility is high, portfolio diversification will allow you to buy peace of mind.
Rajas Kelkar
(The author is editor-in-chief at www.moneyminute.in)