Globally, a double-digit correction long overdue, says Rupal Bhansali

'One should always think of multi-year investment horizons when investing in equity markets', Rupali Bhansali

Easy money has been reflating risk assets and the situation is likely to reverse, posing a risk to equity markets, says Rupal Bhansali, chief investment officer-global equities, Ariel Investments. Speaking during the CFA Society India’s 8th India Investment Conference, she cautioned investors to protect their portfolios by defensive positioning. Edited excerpts: 

Global and emerging market (EM) equities are having a dream run since the start of last year. Do you believe there is more steam left in the ongoing rally? 

We think value spreads are not compelling globally and feel a double-digit correction is long overdue. 
 

The US Federal Reserve has embarked on a path to shrink its balance sheet. Other central banks could follow suit in the second half of the year. Is this a major risk for the market? What’s the liquidity outlook in general?

This is a major risk because the market is underestimating how instrumental easy money has been in reflating risk assets. Corporates and governments have gone on a debt binge, as credit was easily available and at low cost. Both factors are likely to reverse. This reduction of liquidity will hurt EMs more than developed markets, as they have indirectly been among the biggest beneficiaries of easy money. It will also hurt below-investment grade companies and countries. 
 

What are the other key risks?

Bond market vigilantes might be able to assert themselves as central bank influence in the fixed income market abates. This implies higher rates across the capital structure, in particular junk bonds. The equity markets have not priced in this risk correctly. I would stay away from highly indebted companies, especially those with below-investment-grade ratings and foreseeable debt refinancing needs. 

Liquidity risk is very high in the market. The markets have very thin trading volumes and given the disappearance of prop trading desks at investment banks, are likely to experience a material widening of the bid-ask spread when one tries to sell. Risk assets are likely to gap down when investors wake up to this challenge. Investors should protect their portfolios against this by positioning defensively, by owning companies with strong balance sheets and which don’t need to access the capital markets to fund their business needs. 

Low volatility in credit and stock markets has created a sense of complacency of late that is troubling. I would be on the lookout for any stress signals that emerge in the junk bond market in the US and Europe.
 

What’s your view on India, where both economic and earnings growth has lagged. Do you think, the Indian markets here have run ahead of fundamentals?

On the surface, the valuations might appear stretched in India but if the long overdue earnings growth materialises, the market will work its way into this high multiple. Cost-push inflation is a potential headwind for India; crude oil prices have pushed past $60.  
 

Which sectors or themes are you most bullish on? Is there value available?

As contrarians, we are finding compelling value in out-of-favour sectors such as telecom and health care. We also like oil and related companies as the sector recovers from a multi-year downturn. 
 

In India, we would avoid sectors such as consumer staples because their valuation multiples are very rich.  On the other hand, financials still look attractive. While the clean-up of legacy non-performing loans will hurt near-term earnings, 

it will make these organisations and the economy stronger in the long run. A healthy, well-capitalised financial sector acts as a good lubricant for the rest of the economy. So, this recapitalisation of the banking sector will have broader salutary 

ramifications.   
 

What returns should one expect this year? How does one play the market? 

One should always think of multi-year investment horizons when investing in equity markets. Viewed over that horizon, equities are likely to offer the highest returns in the long run compared to other asset classes and should remain a core portion of one’s investment strategy. That said, given the run-up in markets, one should position the portfolio more defensively in high dividend-yielding and net cash companies versus indebted, cyclical businesses. 

I also believe it will become a stock-picker’s market where one carefully curates a collection of businesses at attractive risk reward as opposed to gaining broad market exposure through an index.