US Credit Rating Downgrade – Impact on your Investments

The Standard and Poor’s recently downgraded the US sovereign rating from ‘AAA’ to AA+, which has sent shivers across global markets including India. For years, the dollar has acted as the world’s reserve currency, an international store of value for central banks.

However, the fact the other safe-haven currencies are gaining at the expense of the dollar suggests investors’ views are changing. Over the last month, the dollar plummeted 6 per cent against the Swiss franc and about 4 per cent against the yen.

Impact on Indian Markets

Lowering of sovereign rating of the US will impact investments or foreign fund flows to India in the short term. Market experts are of the view that in the medium to long term the growth in India will not be hurt although the pace of growth can slow down.

As regards the growth prospects, Ernst and Young’s India partner and national leader Ashwin Parekh said, “the US downgrade will not impact our economy badly, as our economy runs on its own cycle.

Because of the large domestic market, if at all there is another recession or slowdown in the global economy, our economy will continue to grow” (Courtesy: Economic Times). Analysts who predicted Sensex levels above 22,000 or higher now have to scale down their expectations. After the current trends which have caused lot of volatility and fear, most analysts are not even talking of index levels.

Sometimes even a 20K sensex level appears too far off. Experts are now talking about the lower level ranges such as 4700 to 4500 on the nifty and 16,000-14,000 on the sensex. However, most of them feel that the current bearish phase will not be as worse as late 2008 or early 2009.

Impact on your Investments & what you should do?

The downgrade of US credit rating is a global development, which can have an impact on your all your investments or asset classes. Investors should also consider looking at various investment classes to diversify their risks.

Equity

There is a high level of volatility and the Nifty index is below 5,000 level presenting a good opportunity to invest. However, the million dollar question is “Is this the low level or will there be further downside in the market?”

Its difficult to predict, because the US downgrade and its impact across the world can create more volatility for a longer period. However, Indian economy and performance of companies focusing on the domestic market still have a good growth potential. Sectors that will get affected include those that are dependent on exports to US and rely on huge fund flows from abroad – example information technology, information technology enabled services, textiles, auto (exports), etc.

However, a surprise turn could happen in information technology sector if more corporations in developed nations outsource their IT and ITES requirements to not only save costs but also to transform their processes and improve the quality and efficiency of services.

Equity Strategy

For new investors who have not had any exposure to equity this is a good time to enter and pick reputed stocks at low levels. However, a systematic or gradual investing is more safer than investing in lump sum.

Existing investors who already have a portfolio with stocks, mutual funds, etc should try to be patient provided they have stock picks which are fundamentally strong and a solid reputation

But those with small names and stocks with poor results and speculative picks can better sell and encash at this time before things get worse. Focus should be more on the large cap stocks and preferably index stocks so that you can avoid distress sale and huge transaction costs.

Debt

For people who have surplus funds or lump sum savings the current interest rates on fixed deposits seem attractive. Although the interest on 1 year deposits is around 9-10% depending on the bank/financial institution, the post tax return on fixed deposits can be much lower depending on the tax bracket of the individual.

The main motive here is to get moderate returns with more safety or capital protection in mind. Debt instruments such as fixed deposits, non-convertible debentures, etc would be a good choice.

Debt Strategy

Most investors are not sure whether interest rates are at their peak or if there are a few more rate hikes left. Given this uncertainty investors who require liquidity could consider a laddering strategy  by investing your savings gradually part by part after every 2/3 months at the prevailing rates.

If interest rate goes up the portion invested at higher rates will earn more interest, but if rates are constant you will get a rate equivalent to current interest rates

If you really don’t require surplus funds, you can simply invest the entire sum at higher rates but if rates go up you may miss that upside potential. A pure debt strategy with guaranteed returns does not work anymore because the post tax returns are less attractive compared to equity, gold and real estate.

Gold

When I was monitoring the price of gold a few days ago (mid August) I found that Gold prices are above Rs.2,500 per gram or Rs.25,000 per 10 gms.

Recently there were flashing quotes on TV showing Gold surpassing Rs.26,000 levels, and in the morning newspaper there was a headline about Gold touching Rs.28,000 levels. This is an impact of US downgrade encouraging investors to rush to a safe heaven like Gold.

Gold Strategy

For investors (including me) who already have exposure to gold should take a pause and avoid fresh buying unless they have surplus funds which can be used for speculation.

Generally speaking Gold gradually moves up over a longer period time. Recently in the international markets Gold reached a record by reaching $1,800 per ounce so a correction in prices is more likely.

For investors who don’t have exposure to gold I would frankly tell them to wait till there is some price correction.

In case there is no sign of correction or downside they can take a fresh entry post diwali season when there is not much news or talk about gold.

The best route to gold investment is via Gold ETF (read the article – Choosing the best Gold ETF for more about various Gold ETF and how to choose the right one). Whether you are a conservative investor or an aggressive one, I would still recommend that you invest some portion in Gold regularly by buying a few units of Gold ETF and accumulating overtime.

The value of this gold investment will appreciate overtime and grow your wealth slowly but steadily.

You can think of selling only in case of emergency or in case you need funds for some important investment or life goals.

Real Estate

Real estate is meant for long term investing and can consume your lifetime savings, so tread with caution here. Due to high interest rates we are already seeing lot of banks raising rates on loans, which has impacted demand.

This has lead to slowdown in sales and affected a few builders/developers. There will be some price correction due to impact from global markets. but experts say that this may not be as sharp as seen in late 2008 season.

Real Estate Strategy

The current market could be a good opportunity to visit many properties and hunt for good deals. If the global market scenario is bad and interest rates are higher, the possibility of correction remains.

However, its difficult to predict if prices have bottomed out. For long term investors who want to hold for atleast 5 years the current market is still good enough.

For those looking for a home for personal residential use the current market can present opportunities at various price points – choose something that fits your budget. Although you can reduce your budget given current market scenario try not to overshoot because this can also impact your EMIs and monthly cash flows.

Key Points to Consider

The current turbulence across global markets has lead to uncertainty but it also presents a good opportunity for investment. We have seen the impact on investments but it can have an impact of a person’s career/occupation, personal finances (other than investments), life goals, etc. We are not sure if this is a recession or just a slow growth phase, or if some more negative surprises are to come.

I’m neither a market guru nor an soothsayer to predict the future, but I can give few tips below which will help you in case the situation worsens further.

1. Emergency Funds

This should normally be equivalent to 3-6 months expenses depending on the individual requirements. However you may want to increase it further to provide for contingencies such as loss of job or personal emergencies such as illness, accident, etc.

2. Emergency Funds for Professionals/Business People

People who fall under this category should have atleast 6 months expenses in cash or bank to tackle immediate personal needs. This is for your personal requirement, however, for your business or professional needs you have to keep another emergency fund with a similar or higher savings as per your requirement.

3. Strict No-No for High ticket expenses

Whether you want to go on a holiday abroad or buy a brand new car or sign up for a new club membership, buy stylish furniture, you have to think twice. This has to be curtailed or rather postponed because the current priorities may be different. Some savings here can meet emergency fund needs discussed above.

4. Credit Cards

Minimize on this. If you are using this for monthly expenses and paying off the bill fully, then you are still on the right track. But avoid rolling over your balance, because this can put you in trouble if you have a loss of income or other negative surprises.

5. High ticket investments

These are not as bad as high ticket expenses, but have to be minimized so that you don’t get in to a cash crunch. For instance purchase of home, land (plot), jewelry, etc have to be postponed until the future outlook is more stable.

6. Avoid Major Changes unless it is important

At this point avoid major shifts and changes such as change of residence, moving to new city, foreign trips, long holiday, taking a long sabbatical, starting a business, etc.

Some exceptions could be considered provided you know the risks and can manage the same – such as change of job, overseas job opportunity, new business plan which does not affect your current occupation, etc.

7. Secondary Income Sources

Many people have not even thought about this, but this should be considered as a secondary add on to your primary income. Although the income or earning may not be as good as your earning from your primary occupation, this can supplement your main source of income, and help you in case of emergencies.

If you are unable to do this you can encourage your folks at home to get in to a productive occupation.

Secondary income can also include doing some part-time consulting, writing, giving lectures or utilizing your hobbies commercially such as photography, event management, musical or theatre performance, etc.

Conclusion

The key points above are just indicative, however, you may want to consider other areas which are important for you or your family. If you are well prepared with things like emergency funds, avoid major expenses or decisions, you will be far better off rather than being suddenly forced to cut down on your basic necessities.

Further, you will not be forced to liquidate all your investments at a significant loss. Instead you can use emergency funds and selectively sell investments which you think can be divested. The message is simple: Try to save for a rainy day and invest for the future systematically to achieve your financial and life goals.