The Russia-Ukraine conflict and the West’s reaction to it have thrown the global economy and financial markets into unchartered territory. The post-1991 consensus in the world economy that depended on the free flow of major reserve currencies such as the US dollar and Euro has come to an abrupt halt. The conflict and the Western sanctions on Russia have also ruptured the global trade in industrial and agricultural commodities that is the basis of the global industrial supply chain.
This has sent the financial markets into a tailspin. Risk assets such as equity have seen a sharp decline while there has been a rally in safe-haven assets like precious metals and US dollar and treasury bonds. The rally in commodities has been even bigger which is not surprising given that Russia and Ukraine combined are one of the world’s top exporters of industrial and agricultural commodities.
In India, we have seen a sharp decline in stock prices on Dalal Street driven by a sell-off by foreign portfolio investors (FPI). The Indian rupee has depreciated against major currencies and interest rates are once again on the rise.
Many analysts expect a big alignment in the global economy after the dust has settled on the conflict between Russia and Ukraine. Many see it as a regime change in the global economy or the rise of new world order.
This has major long term implications for various asset classes and our investment portfolio. But it can also throw up new opportunities and investors should realign their finances to make the most of it.
Here are five things you can do to minimize the risks from the ongoing turmoil in financial markets and gain from it.
1. Go light on long-term debt such as home loans. The last twenty years or so were a golden period for home buyers. A secular decline in interest rates and tax breaks on home loans made it affordable to buy a house either for self-occupation or for investment. The sentiment was boosted by low and stable inflation and a steady appreciation in home prices in most major markets. This era is now coming to an end. The interest rates have bottomed out and lending rates have begun to inch up. The process will gather more steam as the US Federal Reserve starts raising interest rates from next month followed by a contraction in its balance sheet.
Secondly, the cost of living has gone up due to a rise in inflation. A sharp spike in the price of energy, industrial metals and agricultural commodities due to the Russia-Ukraine conflict will translate into even higher inflation in the coming months. A combination of a rise in interest rates and higher inflation could stress the finances of many families and households.
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2. Reduce exposure to risk assets such as equities. The post-1991 era was a great time for equities. The period saw a sharp rise in stock prices in all major markets including India fueled by a boom in global trade, cross-border capital inflows and a steady decline in interest rates and inflation. These factors also enabled a boom in corporate profitability, especially for the big corporations that further supported the rise in share price.
These tailwinds are however coming to end with inflation at a decade-high in major economies, a steady rise in higher interest rates and a re-emergence of geo-political tensions that threaten global trade. This will keep stock prices under check given that valuation in the broader market is still quite high on a historical basis and doesn’t fully account for the downward risk to corporate earnings that lie ahead.
3. The biggest risk is for growth stocks. An environment of record-low interest rates and low inflation created an unprecedented boom in the stock price of companies that promised faster growth in revenue and profits. In India, these growth stocks were largely in emerging sectors such as consumer goods, retail, retail lending and technology stocks. In contrast, there were few takers for slow-growing but cash-rich companies in sectors such as oil & gas, utilities, commodities and institutional financing.
So investors are advised to go underweight on growth stocks and raise exposure to value stocks that offer higher dividend yields.
4. Raise exposure to commodities and physical assets in your portfolio. Higher energy and commodity prices will translate into higher prices for all kinds of physical or hard assets such as industrial metals, agricultural products and even land, buildings and industrial machinery. Most commodities are already trading at a record high and analysts expect them to rise further in the coming months in line with the inflation forecast. Given this, investors should use market correction to either accumulate commodities directly or buy the stocks of companies that produce these commodities.
5. Add more gold and silver to your portfolio. Precious metals such as gold and silver have been a store of value and universal currencies since ancient times. Their prices are also uncorrelated to other changes in the price of risk assets such as equity or bonds. This makes them a safe haven in times of economic or political uncertainty such as we are witnessing right now.
The prices have since cooled down but analysts expect these two precious metals to rise further as big investors accumulate them to hedge their portfolio from inflation and geopolitical risks. The rally in the yellow metal is also likely to be supported by incremental buying by central banks in emerging markets as they replace a part of their dollar and Euro assets with gold.
(Advice: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).