Globally, equity across the world has seen a sharp fall. As per data from Jan 2022 till date, the steepest fall is seen was in Russia MSCI which has seen a 40% fall, along with we have seen the NASDAQ 100, comprising majorly of big tech companies, as well as S&P 500 growth index seen sharper falls when compared to other markets in the world. In India, we have seen mid & small-cap fall more than large caps if you see the Nifty 500 index has fallen by 5% at the start of this year, whereas small & mid-caps have been down by 9-10%.

However, the Chinese equities market has not seen many falls, especially when compared to 2021 when there was a steep fall. The year-to-date data for the equity global market year has made a differentiation between value and growth stocks, and we saw that value stocks have outperformed growth stocks or that growth stocks have fallen more than value stocks. Value stocks include industrial and cyclical kind of sectors and growth stocks comprise the IT, and Defense sectors, among others.

As far as the currency market is concerned, the Russian currency has seen a steep fall of about 29% compared to the US dollar. Russia's share in global commodity markets is significant. Russia meets about 16% of the world's production (oil and refined products) needs and this basis is the world’s second-largest producer behind the United States. Russia produces 22% of the world’s natural gas and in this also is the world’s second-largest producer behind the US. Russia is a major producer of most commodities, and due to the Russia-Ukraine crisis, we have witnessed more volatility in the global equity market, particularly in commodity prices.

However, RBI has surprisingly forecasted that inflation may come down during the next financial year 2022-23. India imports more than 80% of its crude oil requirements from the Middle East and the US. Russia is not a major supplier of crude oil to India. 13% of edible oil requirements comes from Russia and Ukraine. The area of concern now remains that the prices of edible oil have risen sharply, however, the higher edible oil prices have not been transferred to end consumers or have been impacted. Nevertheless, petrol and diesel price increase have been transferred to end consumers.

It is not only edible oil or crude oil prices that have risen but is also the prices of other commodities that have risen and we need to understand how this would impact the margins of corporates. Also if the prices of diesel and petrol rise, so would the price of transport rise which in turn will increase the price of those goods that are majorly transported. All these forms of price rises put pressure on inflation, and hence RBI’s estimate of a decrease in inflation for the year 2022-23 (4.5%) might need to be re-looked at. In addition, RBI may also look at measures to curb inflation such as hiking interest rates or reducing liquidity from the market. We have also seen that geopolitical events over the last 15-20 years that had taken place and have impacted the market. The market, in turn, has recovered over a year including generating positive returns. According to Mr. Dhaval Kapadia, Director - Portfolio Specialist, Morningstar Investment Advisers India, “The impact of the present Russia-Ukraine crisis might be probably more a short term and in the longer term the impact might be reduced. So the most important thing is to keep calm and carry on”.

Morningstar’s asset allocation is based on four pillars of valuation-driven asset allocation – absolute allocation, relative valuation, contrarian indicators, and fundamental risk. Absolute valuation of an asset class relative to its history means how Indian equities relative to its history are looking now – that is are they cheap or expensive. What is the price an investor pays for the underlying growth or value of the security? Is it expensive or cheap?

Relative value is a method of determining an asset's worth that takes into account the value of similar assets. That is, compared to European markets or the US market how cheap is the Indian market. This is in contrast with absolute value, which looks only at an asset's intrinsic value and does not compare it to other assets.

Contrarian indicators are where there is evidence of extreme investor pessimism. A contrarian investor enters the market when others are feeling negative about it. According to Mr. Dhaval, “The contrarian believes the value of the market or stock is below its intrinsic value and thus represents an opportunity. In essence, an abundance of pessimism among other investors has pushed the price of the stock below what it should be, and the contrarian investor will buy that before the broader sentiment returns and the share prices rebound”. The contrarian sees buying opportunities in stocks that are currently selling below their intrinsic value.

Fundamental risk takes into consideration what could be the possible permanent loss of capital that an investor could incur if he/she invests in the market at this particular point in time. An example of it is the Russian market where there is a possibility for a permanent loss of capital for investors considering the ongoing war and various sanctions imposed on Russia. In terms of valuation. Prices have come down and the fundamental risk is pretty high.

Taking the example of absolute and relative valuation, we view markets based on absolute and relative valuation. So we list out various markets and the return expectation over the next five to ten years. The returns considered here are real returns to make the comparison better. The real return is simply the return an investor receives after the rate of inflation is taken into account. We have taken all events as of January end of 2022 versus one year ago, how these expected returns have changed over a period of time. As stands today the expected return on the Chinese market is higher. This is because of the regulatory changes that were introduced and which had impacted a number of companies. Hence, Chinese equities are amongst the more attractive classes at this point. UK equities also look attractive but not compared to China; this is because of the UK equity market’s performance in 2021. Indian equities, however, are not that attractive; they are somewhere in the middle. We have seen a sharp run-up, as well as valuations, have moved up. The returns are on the lower side. The US market has been unattractive although there have been some corrections recently. Yet on a relative basis, they are largely unattractive.

So what drives these returns? What are the parameters? These parameters include cash growth and earnings growth and how are corporates expected to increase their earnings. In the next five to ten years. What is the dividend yield payout that can be expected in the next five to ten years finally we consider the valuations aspect. Whether the corporates are overvalued or undervalued based on the returns in the next five to ten years. 

We consider two or three parameters to understand the contrarian indicators. The first is the performance of the market. Contrarian indicators are negative if the markets have done very well over the last 6-12 months. Similarly, if the flows have been very strong the contrarian indicators are negative. Next, we take the earnings growth expectations. For example, for India, the earnings growth expectations are pretty strong and are expected to be anywhere between 5 and 9 percent. However, we must also keep in mind the increasing prices of the commodity and inflation. Hence, while the contrarian indicators at the moment show some optimism, at large there is a lot of negativity and pessimism.

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