Should you buy bonds, or equity or gold or something else in the coming months and years? The answer may be to bet a bit on all of them.
Depending on your view of the future, you would normally do the following: if you expect inflation to run rampant, you would go for a mix of gold and commodities. If you expect higher growth and lower inflation, you would go for a mix of equity and debt; if you expect stagnation, you will go for bonds and fixed-income instruments.
Unfortunately, there are not normal times. It is tough to formulate any view of the future since governments everywhere are trying to boost growth with endless infusions of cash, while also simultaneously toying with some degree of fiscal austerity, among other things.
Satyajit Das, a derivatives expert and author of Extreme Money, brings out this confusion by pointing out that despite the flood of money and lack of growth last year, equities did very well. And perversely, even bonds did fairly well despite offering very low interest rates – or even zero interest – with high risk.
Smart money has got away with doing dumb things in 2012.
Writing in Business Standard, Das says in the current investment climate, returns will depend on reading government and central bank policies right, and not necessarily on fundamentals. He writes: “Investment outcomes are now influenced more by government and central bank policy decisions than fundamental factors. The rally in the euro and European bonds and stocks following the European Central Bank’s announcement that it would purchase unlimited quantities of peripheral country debt demonstrated the risk of misreading policy.”
The problem for investors, though, lies in the fact that policy is often not effective. One cannot assume that if the US Fed keeps pumping in easy money, we will get higher growth but not inflation. We can’t assume that public sector austerity in the UK or Greece or Spain will give space for private sector-led growth.
In India, for example, the finance minister is hoping that a combination of buoyant stock markets and lower interest rates will revive business confidence and growth. But as this analysis by BusinessLine points out, the reality is that corporate profits have a greater linkage with the value of the rupee than just market buoyancy or rates. The article shows that whenever the rupee has fallen, corporate profits have fallen – because India is more import-dependent than many other economies.
Put another way, the stronger the rupee, the more positive India Inc becomes. This may lead us to a counter-intuitive understanding of what may lead to higher business confidence: policies for stabilising the rupee by following fiscal rectitude and lowering inflation may be more important than just lowering interest rates. As HDFC CEO Keki Mistry told Firstpost in a recent video interview: “My hope and expectation from the Budget is that the fiscal deficit will be kept under some check. It will be extremely positive then.”
But the rupee’s value depends on what happens to risk-appetite abroad, and which assets global investors prefer.
Says Satyajit Das: “If policymakers succeed in restoring growth with modest inflation, then equities may prove the best investment. If the policies result in high or hyperinflation (such as that experienced in Weimar Germany or Zimbabwe), then real commodities and precious metals such as gold may be the best investment to protect against the erosion of the value of paper money. If the policies prove ineffective, then a period of Japan-like stagnation may result. In such an environment, bonds or other fixed income instruments will be the favoured investment.”
But nobody is reading policy right, for, as Das points out, “there have been times when equities, bonds, commodities and gold have all risen together.
The dismal conclusion is this: 2013 will stay unpredictable as ever for investors. It might thus be best to not bet too heavily on equity or bonds or even commodities like gold. Best to diversify till the signals from policymakers get clearer.
It is the year in which smart money may not outsmart dumb money by much.