Indian rupee is currently under pressure. The answer to this will have a bearing on the core question of investing in the international market.
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Why is the rupee getting hit so much?
Relentless US Fed interest rate hikes to counter the rise in local US Inflation have led to dollar outflows from Emerging markets. Previously, the dollar had entered emerging markets when the US rates were close to 0 percent.
Due to supply-side issues and geo-political uncertainty, factors like high commodity prices, especially fuel and edible oil prices, are rising. These, in turn, have resulted in higher US dollar demand by Indian companies.
India, an import-dependent country, gets hit on both the trade and investment flow sides.
When could the INR start to recover from the lows?
As and when the US Inflation rate gets tamed, and geo-political worries subside, we should see the INR recover as the dollar starts to chase the Emerging Markets again.
The normalisation of Interest rates by US Fed authorities and an overall lesser uncertainty would lead to FII’s turning net Investors in India. This, in turn, would give a maximum buck for every dollar invested in India.
India’s export pick-up has been quite encouraging, and the high INR depreciation will help get higher realisations. This, in turn, is likely to result in better corporate profits.
Now let’s understand investing in international markets
Inside International Markets, there are the Emerging Markets. India is, by consensus, the best choice here.
Apart from India within the Emerging Markets, the question is, “should you invest in the US markets?”
Again, the US market is unanimously considered the best-developed market.
An allocation to the US markets is ideal from the Asset Allocation point of view of an Indian Investor. This is because of two interesting reasons.
Reason #1. The US markets have a low correlation with the Indian markets (0.6 monthly returns correlation). Basically, they don’t generally move in lockstep with each other and portfolio sees diversification benefit, e.g., lower volatility with when it has the two asset classes
Of course, this isn’t always the case, as we see multiple conversations around the coupling and decoupling of Indian markets with global markets.
Reason #2. The US economy represents the largest corporations across the globe.
You should note that the allocation to US markets is relatively small compared to the recommended asset allocation to Indian Equities.
Let’s now look at some historical returns
The 10-year CAGR of the S&P 500 in USD terms is 9.7 percent, while in INR terms, it is 14.49 percent. The number in the case of Nifty 50 is 11.71 percent. The 15-year CAGR of the S&P 500 in USD terms is 6 percent, while in INR terms, it is 11.28 percent. Compare this to the 15-year Nifty 50 CAGR of 8.14 percent.
Looking at past returns, investing in the US Markets has given higher returns purely on the back of a near 5 percent return on the Dollar appreciation.
The future outlook on US Dollar is uncertain and could lead to lower overall S&P 500 returns in INR terms.
Historical INR-USD data suggests that immediate S&P 500 1-year returns in INR terms are not great due to a depreciating dollar post the peak.
The average 1-year return in India, post a Dollar peak, in terms of INR, has been the highest for Sensex at nearly 24 percent. Look at the data below to see it for yourself.
6 Months Prior | Peak Dollar Dates | Peak Dollar Value in INR | 6 months Post | 1 Year Post |
01-08-1992 | 01-02-1993 | ₹ 32.87 | 01-08-1993 | 01-02-1994 |
01-07-1995 | 01-01-1996 | ₹ 36.45 | 01-07-1996 | 01-01-1997 |
01-11-2001 | 01-05-2002 | ₹ 49.01 | 01-11-2002 | 01-05-2003 |
01-02-2013 | 01-08-2013 | ₹ 65.70 | 01-02-2014 | 01-08-2014 |
01-11-2019 | 01-05-2020 | ₹ 75.59 | 01-11-2020 | 01-05-2021 |
What does a correlation analysis tell us?
A correlation study suggests that the US Dollar has a negative correlation with both US Equities and Indian Equities.
This negative correlation means that the US Dollar rises when global investors don’t really like risk assets. This also implies the reverse, where greater risk-taking behaviour means rising equity markets. This is especially true in the case of Indian Equity which has a higher negative correlation to the USD/INR.
So what’s the verdict?
For the most part, investors should consider investing in the US within a certain limit. The main focus should, however, be the Indian Markets.
In both markets, it is better to take a staggered approach with the implementation of asset allocation where only a certain minimum percentage is allocated to US markets.
The author, Anup Bansal, is Chief Business Officer at Scripbox
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