There appear to be no US excesses for severe contraction: Bruce Phelps

In the US market, one major challenge is high rates on short-term deposits, standing at 5 per cent, a vast improvement from 0 per cent returns that investors endured for many, many years, Phelps said

Despite stellar returns over the past year, the US and Indian equity markets are on solid ground, buoyed by steady economic growth, according to BRUCE PHELPS, managing director and head of institutional advisory & solutions at PGIM. In an interview with Samie Modak in Mumbai, Phelps notes that while there could be more volatility ahead, the overall backdrop for equity investors remains favourable. Edited excerpts:

What factors do you believe have supported the surge in global, US, and Indian equities over the past year?
 

As we entered 2023, there was widespread certainty that a recession was imminent. Some even placed the probability as high as 95 per cent, with concerns that a soft landing would be unattainable. Therefore, it comes as both a surprise and a relief that much of the world has managed to sidestep a recession.

This newfound optimism has prompted a rally in stocks, as investors have become less apprehensive about the prospect of a downturn.

What are the primary headwinds and tailwinds currently facing the equity markets?
 

In the US market, one major challenge is the high rates on short-term deposits, standing at 5 per cent, a vast improvement from 0 per cent returns that investors endured for many, many years. Consequently, there’s a substantial amount of capital sidelined, with investors showing reluctance to dive into the market hastily.

Geopolitical uncertainty presents another obstacle. With this year being a global election year, uncertainty looms over the political landscape, prompting some investors to remain on the sidelines, content with earning a 5 per cent return on cash investments.

While optimism for the future persists, there’s a prevailing notion that the latter half of the year could be marked by increased volatility. Thus, it might be prudent to capitalise on future volatility by waiting for valuations to soften before deploying capital later in the year.

In the event of downside volatility, investors can take solace in the US Federal Reserve’s increased capacity to cut rates, thereby stabilising the economy. Overall, this creates a favourable backdrop for equity investors.

Do you believe the golden period for US equities has come to an end? Are you anticipating a levelling off or a correction in returns?
 

No, I do not believe so. I envision the US economy entering a prolonged phase of stable and robust growth, ranging between 1.5 and 2 per cent, accompanied by mild inflation in the range of 2-3 per cent. This outlook resembles the economic landscape of the 1990s. Notably, inflation expectations are well-contained.

Moreover, there is a pressing need for fresh investments, particularly in areas such as energy transition and supply chain restructuring. These investments are poised to stimulate further growth. There remains a demand for new equity capital, and returns are expected to stay elevated to attract this capital.

While equity valuations in the US are currently high and credit spreads are tight, there are no apparent excesses that could trigger a severe correction.

Issues in the real estate sector are being addressed gradually. Therefore, the overall outlook points towards sustained growth, decent equity market returns, and a gradual tightening of credit spreads.

Are there any other asset classes that you favour, and if so, why?
 

As mentioned earlier, the real estate market has weathered the worst of its correction, presenting appealing opportunities in listed real estate investment trusts and private real estate funds, particularly in the US and Europe.

Additionally, other private assets show promise. Private equity (PE) stands to benefit from the gradual resurgence of the initial public offering market, while private credit offers higher expected returns coupled with robust credit oversight. Institutional investors are heavily allocating resources to these areas.

Moreover, public bonds are poised for a favourable trajectory. Real yields are high, transitioning from a negative 1 per cent to a positive 2 per cent. This shift is substantial and has narrowed the gap between bond and stock yields considerably.

Using history as a guide, future bond returns may prove to be quite competitive with stock returns, particularly on a risk-adjusted basis. Therefore, strategically incorporating bonds into one’s portfolio presents a compelling opportunity.

What is your assessment of the Indian markets from the standpoint of global investors?
 

India is poised to emerge as one of the most robust growth markets on a global scale, garnering significant attention from international investors.

The country has showcased commendable macroeconomic stability, instilling confidence among many that monetary and fiscal authorities are committed to maintaining this favourable environment.

As a result, India presents an enticing prospect for global investors seeking opportunities.

I would expect to see further expansion in PE and private credit activities within India. Additionally, there is growing interest among global investors to allocate more capital to infrastructure as an asset class, and India stands out as a promising destination in this regard.

Given the recent rally in equity markets, what would you consider to be the optimal asset allocation strategy at this juncture?

An investor’s ideal asset allocation will hinge on their risk appetite, allowing for variability in allocation strategies. However, drawing from my earlier remarks, an optimal asset allocation would involve incorporating a fresh allocation to fixed income compared to previous allocations.

Allocations to alternative investments such as real estate and PE could prove beneficial, provided that investors carefully navigate the liquidity constraints inherent in these assets. This needs careful thought and planning. You don’t want to find yourself desperate to raise cash if the markets or your circumstances move against you.

What are your perspectives on corporate governance standards in India, and how have they evolved? Are there specific areas that require improvement, and what actions should regulators take?
 

Corporate governance standards in India have made significant strides over the years. Companies have recognised the crucial role of enhanced governance in attracting investments, leading to improvements such as increased transparency, better management communication, greater respect for minority shareholders, and enhanced disclosure standards.

Regulators have been ahead of the curve in tightening regulations, enhancing the quality and frequency of disclosures, and implementing robust surveillance mechanisms to foster an investor-friendly governance framework in Indian companies.

In discussions with global investors, there is confidence in the Indian regulatory system. The Reserve Bank of India has effectively addressed non-performing loans in the banking sector.

Today, the Indian banking system is in good shape with a strong, independent central bank.

Similarly, the Securities and Exchange Board of India has established a reputation as an independent regulator, safeguarding investor interests and ensuring the smooth functioning of markets.

Global investors are closely monitoring Gujarat International Finance Tec-City and its unified regulatory structure. This innovative regulatory approach has the potential to stimulate greater foreign capital inflows into India.