Amidst the increasing Fed rate and tension of a global war, should Indian investors consider US equity investment?

It is a challenging time for the global equity market. The patience of Indian investors, especially those with high stakes in the overseas or US equity markets, is being tested. There are two critical factors behind this:

i) rising inflation and the possibility of further rate hikes and

ii) the spectre of a global war in the face of the Russia-Ukraine conflict. 

The complex geopolitical situation is likely to persist until a resolution to the crisis is reached. This adds to the already jittery investor sentiment, resulting in a more volatile equity market. 

While investors cannot control market moves, they can understand the forces driving the market direction. Therefore, it can certainly help them make their investment decisions more prudently. 

The state of the current global market 

In March this year, the US Federal Reserve increased the Fed rate by 50 basis points. It is the first hike undertaken by the Fed since 2018. So why did the rate-setting committee choose to hike the rate at this time?

The Federal Open Market Committee (FOMC) under the Federal Reserve is responsible for setting and controlling the inflation target and interest rates in the US. Typically, the institution targets an inflation rate of 2%. However, this year, to everyone’s astonishment, the inflation rate in March on a Y-O-Y hit 8.5%–the highest in forty years! 

Since the 2008 financial crisis, the US Fed has been accommodating with funnelling more money into the system. With the pandemic and global lockdown, the Fed extended favourable policy terms and injected more money into the system. 

This indeed supported individuals in combating the pandemic-induced financial stress. However, the rising food and energy prices due to supply chain disruptions exacerbated the tense economic environment. 

At present, a majority of nations are battling inflation. Russia’s invasion of Ukraine has made matters worse. There is pressure on global commodity supply chains, which has led to an increase in energy prices & those of crucial commodities.

This situation, coupled with surplus money in the system, has contributed to higher inflationary pressure. As a result, the FOMC had to take a crucial decision regarding hiking rates. The Fed aims to drain $9 trillion gradually from the balance sheet. Thus more rate hikes will be likely in the coming months.

Significant market fluctuations are becoming the new normal with these hikes and the ongoing conflict. The question then is–should Indian investors consider investing in the US equity market? If yes, then why?

Why invest in the US equity market? 

To bring stability to the portfolio

One of the shortfalls of relying solely on the Indian market is the higher volatility level of the domestic market. India is an emerging market, which reflects in the portfolio returns range. An analysis makes the fluctuations in returns quite evident. 

After the 2008 financial crisis, S&P 500 returns were down by 20%, while Nifty 50 returns were almost 60% low. Now, look at the table to understand what an investor would have experienced in either the Nifty 50 or the S&P 500 in 2010 if he would have invested a year back from the dates mentioned. The volatility is evident when we compare Nifty 50 to the S&P 500.

The US equity market is more mature than emerging markets like India. So investing steadily in an established market can help investors bring much-needed stability to their equity portfolios.

Helps in beating inflation

One of the significant considerations while investing is to ensure that the rate of return is higher than the inflation rate. Introducing US equity to your portfolio can add an extra layer for better growth.

Undoubtedly, investors are likely to face turbulence, given the current market condition. Yet it is essential to remember that market noises never outperform long-term investments.

In Carlos Slim Helu’s words, “Courage taught me no matter how bad a crisis gets … any sound investment will eventually pay off.” The key is to be an investor rather than a speculator.

The annualised 10-year return of the S&P 500 is 15.54% after adjusting for currency conversion. Returns on the Indian equity market typically range between 12-14 per cent. However, given its volatility, US equity investments can prove to be stable additions. Therefore, it makes sense for investors to be present in both markets.

Good for diversification

While the Indian market gets impacted by any changes in the US policy or market conditions, the correlation between the two is very low. Correlation refers to the relationship between two variables and in which direction one will move given a change in another.

The correlation between Nifty 50 and the S&P 500 for a 10 to 20-year period is between 0.13 and 0.16. A correlation near 1 suggests that given a change in the first variable, the second variable has a higher chance of moving in the same direction.

The correlation between the Indian and US market is very low (adjusting for exchange rates). This reflects that the Indian market gets impacted by any change in the US market, but that change is quite limited. A low correlation makes it a perfect opportunity for investors to diversify their portfolios.

Diversification helps investors survive market fluctuations. Therefore, investors should consider a reasonable exposure to US equity, just like gold. After all, as John Maynard Keynes says, “It is better to be roughly right than precisely wrong.”

The bottom line

Investors might have to go through some paperwork under the Liberalised Remittance Scheme (LRS) guidelines for pursuing direct investment options for US equity. As per the RBI guidelines for LRS, Indian investors can remit up to USD 2,50,000 in a Financial Year for overseas investments.