There was a time when, if the US economy sneezed, the rest of the world caught a cold. Right now, the US economy is facing a situation far more serious than a sneeze. The 10-year US bond yield has fallen below the 3-month bond yield. In simple terms, this means that long-term bonds are offering lower returns than short-term bonds and is seen as an indication of economic uncertainty. The yield inversion has raised fears that the US economy may be headed for a recession.Till a few months back, the big concern was a rate hike by the US Federal Reserve and its negative impact on emerging markets. However, concerns about the US economy diminished chances of a rate hike. As investors started buying US bonds betting on lower rate hikes, the US 10-year yield started coming down. The situation took a sudden turn last week when the US Fed signalled that there won’t be any more rate hikes in 2019. The initial euphoria about the US Fed action, however, was soon replaced with fears of an impending US recession as the 10-year yield fell below the 3-month yield. The last time the bond yields witnessed an inversion was in 2007. It was followed by the recession in 2008. But this time, the world economy, especially India, may not be very badly affected by the slowdown in the US.When long-term yield is lower than short-term yieldThe gap between the US 10-year bond yield and 3-month yield is negative after 12 years. This raises fears of a US economic recession.

68641974

The big question is, how will this impact Indian investors? Experts say that the impact will depend on the severity of the recession. “The long-term impact of a US recession will depend on its intensity. Emerging markets like India will benefit if it is a mild one due to easy money policy by US Fed (which could lead to more money flows to India). If it becomes steep, the impact will be negative due to economic repercussions like fall in exports,” says Ratnesh Kumar, Managing Director & CEO at BOB Capital Markets.Positive for India in short termKeep in mind that the US recession will not happen immediately but is expected only after 12-18 months. The US Fed will take several steps to prevent a recession, which could mean more money flowing to emerging markets like India. So, the situation is positive for Indian markets in the short-term. Since a slowdown is visible among other major economies, other central bankers may also cut rates or use quantitative easing. For instance, the European Central Bank (ECB) has declared a long pause in its rate hike plans and announced a new quantitative easing measure to stimulate the economy.The US recession, and the measures taken to prevent it, will have a big impact on the rupee and other markets, including equity, debt and gold. As of now, sentiment is turning in favour of the rupee. Historically, the rupee has done well when the US Fed starts cutting rates. In addition to the improvement in sentiments, continued FII inflow (in both equity and debt) has bolstered this. “Due to the fall in forward dollar premium, it makes sense for FIIs to hold India bonds,” says Lakshmi Iyer, Head of Fixed Income and Product, Kotak MF. FIIs have already pumped in Rs 18,150 crore in March into Indian debt. If you add Rs 27,335 crore of equity inflow during same period, the total net inflow in March is more than Rs 45,000 crore.FII inflow is picking up againStrong FII infl ows will keep the Indian equity markets strong.

68641984

Debt market has also seen big FII inflowStrong rupee and fall in forward premium has made Indian debt attractive for FIIs.

68641989

FII inflow has pushed up the rupeeStrong rupee is creating a ‘virtuous cycle’ and attracting more FII inflows.

68641999

Time to book profits in global fundsGlobal funds have done well in the past but it makes sense to book profits now. Fund 1-Year Return (%) AUM (Cr) * Motilal Oswal NASDAQ 100 Exchange Traded Fund 18.34 133.94 ICICI Prudential US Bluechip Equity Fund 16.61 267.62 Franklin India Feeder Franklin US Opportunities Fund 15.96 789.02 DSP US Flexible Equity Fund 9.26 216.32 DSP World Gold Fund – Regular Plan 5.26 226.69 *Only schemes with at least Rs 100 cr AUM considered | Data as on 26 March; Source: Value ResearchWill the rupee continue to rise? Maybe not, because a strong rupee will hamper exports and encourage imports. “It is not in our interest to have huge rally in the rupee, so the RBI may step in once it reaches around Rs 68 per dollar mark. Rupee may not weaken also because of the higher forex reserves now,” says Iyer.Equity depends on FIIsThough domestic inflows are strong now, the Indian equity market sentiment is still dependent on FII inflows. Experts feel that a mild slowdown in the US is good for these inflows. “FII inflows into India have slowed down during the past four years, mostly because of the strong US economy. A weaker global growth is not bad for India because Indian growth will look better,” says Sonam Udasi, Fund Manager, Tata Mutual Fund.Due to lower corporate earnings in recent years, the PE of Indian markets is higher compared to other markets. But experts feel this will not impact FII inflows. “PE is not a right measure now because we are going through a phase of very low corporate profits compared to GDP. Index level PE will come down when the corporate profits normalises,” says Anand Shah, Deputy CEO & Head of Investments, BNP Paribas Mutual Fund.Though FIIs are more concerned about global factors, they will still be concerned about the upcoming general elections.“While global factors are important, investors should not ignore domestic factors. The market will react positively if the new government is stable. Stable governments usually do fiscally prudent things in the first three years and therefore, can be good for the markets,” says Udasi. Suraj Saraogi of New Berry Group believes equities will rally once this uncertainty is over. “A lot of systemic clean up happened during the last 3-5 years, so there will be a clear runway for equities once the political uncertainty is over,” he says.The equity markets have witnessed a big rally in large-caps in the last one year while mid- and small-caps did poorly. Experts feel that this will not get repeated this time. “Due to the deep correction in mid- and small-cap valuations, there is no need to have any segmental preferences now and the upcoming rally is going to be more balanced,” says Kumar of BOB Capital Markets. Shah of BNP Paribas MF concurs with this view. “Mid- and smallcaps will start looking up now because the panic situation is already behind us. We are planning to increase our exposure to mid- and small-caps selectively,” he says.Sectors to bet onFears of a global recession have pulled down the prices of several global commodities. While the fall in crude oil prices is restricted due to OPEC actions, most metal prices reacted negatively. “We are negative on global commodities because they will continue to be impacted by the slowdown in China and the US,” says Kumar.Among global oriented sectors, everyone continues to love IT services because it is in a steady growth phase. Since most Indian IT services are into off-shoring, the US recession may even benefit them.Private sector banks continue to be the favourite of experts, mostly because of domestic factors. Though valued a bit higher, private sector banks focused on retail continue to report good growth rates. “Profitability of corporate facing banks was compressed during the past four years. Their profits may get normalised now,” says Shah. The improvement in the environment is helping them. “Due to the expected rate cuts by the RBI, interest rates will remain benign. The asset quality concerns are already recognised and addressed,” says Udasi.Domestic consumption is another theme that was driving the economy for some time. However, the sudden slowdown in auto numbers has raised question marks about it. Also Read: Should investors dump consumer stocks?At the same time, there is no pick up yet in capital expenditure by private sector companies. Experts says that a full recovery is still a few years away. First, companies catering to foreign markets will wait for further clarity now. High leverage is another problem. “Since several corporate balance sheets are still over leveraged, private capex recovery will happen only gradually. The capacity utilisation levels are also not very high, so it will take 1-2 years more before full capex cycle comes back,” says Kumar. Political uncertainty triggered by upcoming elections is also delaying the capex cycle. “Several companies that have strong balance sheet and want to invest now, are also on waiting mode now. Since capacity expansion takes a few years, they want clarity before starting,” says Saraogi. That means investors should avoid capital goods stocks for the time being.DebtJust like equity investors, debt investors will also be impacted by the structural changes happening across the globe. Due to the fall in US interest rates, FII inflows to Indian debt have picked up once again. Continued inflows will pull down bond yields. Since the debt market sentiments have turned positive now, most domestic investors will use small corrections to buy. Given the fears of a US recession, the RBI will also step in. “RBI is expected to do two more 25 bps rate cuts in the coming meetings. The yield of actively traded 2028 papers is expected to fall to 7.2-7.3% levels from around 7.5% now,” says Iyer. Experts believe short-term funds will do well in the coming months. “Short duration funds have lower volatility and generate decent returns,” says Amit Kachroo, Managing Partner, Aaneev Wealth.Debt market in India is on a rollDue to strong rupee and FII inflows, bond yields are expected to fall further.

68642035

Go for short-term debt fundsThe fall in yield may be maximum for short-term bonds. Fund 1-Year Return (%) 6-Month Return (%) Franklin India Short Term Income Plan 8.70 6.01 IDFC Bond Fund Short Term Plan 7.50 5.66 HDFC Short Term Debt Fund 7.49 4.99 Kotak Bond Short Term Plan 7.26 5.24 L&T Short Term Bond Fund 7.26 5.18 *Only schemes with at least Rs 1,000 cr AUM considered | Data as on March 27; Source: Accord FintechGoldA weak US dollar also impacts gold, which is why international gold prices are up. However, domestic gold prices have been impacted by the rise in the rupee and have retreated. Experts say investors should have only a small allocation to gold now. “Don’t expect serious returns from gold now. The exposure to gold should be minimal (around 5% of the portfolio),” says Saraogi. Since the foreign money is now flowing mostly into domestic equities and debt, there is no point in taking an aggressive bet on gold. “Due to global inflows, Indian equities and domestic gold usually move in opposite directions. Since equity is expected to do well now, exposure to gold should be restricted to around 5%, that too only for diversification,” says Kachroo.When investing in gold, sovereign gold bonds offer several advantages. They have delivered much higher returns than physical gold and gold ETFs (see table). There is no expense ratio, an additional interest payment and tax-free capital gains if held till maturity. Just make sure you get in only in counters with decent liquidity now.Gold strong in $, but weak in Rs Due to strong rupee, domestic gold will yield mediocre returns for investors

68642137

Physical gold vs ETF vs bondGo with gold bonds that have no costs, and offer interest

68642244

* Lower price appreciation in gold ETF is because of their expense ratio** Higher price appreciation in gold bond is because of the fall in their discounts** Once you add the 2.5% interest; annual return increases to 10.15%Data as on 26 March; Compiled by ETIG.Gold bonds are lucrativeSome gold bond series have given over 9% returns NSE Symbol Price (Rs) Volume 1 yr return (%) SGBNOV24 2,978.00 504 7.98 SGBAUG24 2,987.75 478 8.15 SGBSEP24 2,995.00 249 7.68 SGBMAY25 2,995.00 65 9.58 SGBMAR25 2,969.00 56 9.64 Sorted on the basis of volume on March 26Data as on 26 March; Source: NSEGlobal equitiesInternational equity funds are among the best performers in the past one year due to the rally in US equity markets and a strong dollar. Global money flows in recent years were also based on these factors. But this is changing now. “Due to strong US economy, money was flowing from emerging markets to US in recent years. With the weakening US economy, this money will start flowing out,” says Kumar.Experts say this is a good time to reduce exposure to US focused funds and increase exposure to domestic equity funds. “Since the US economic growth has peaked, global investors will start searching for an economy that is growing fast and India’s attraction will increase once again. While it still makes sense to hold on to a few individual stocks that have cutting edge technologies, there is no purpose of being invested in a global diversified fund now,” says Udasi. Just like gold, diversification is the only reason why one should have some exposure to global equities now. “Since FII inflows to India are picking up, there is no need for Indians to invest outside now. Return expectation from domestic equity is also good, so international equities should only be held for diversification and should be restricted to 5-7% of the portfolio,” says Kachroo.