US Equity Investing: Is It The Right Time To Catch The Falling Knives?

By: Tavaga Research

The US stock market indices, namely the S&P 500 and Nasdaq 100 are the top destinations to invest in for achieving geographical diversification. The Nasdaq 100 index in particular is home to top technology businesses and start-ups that have allowed investors to access trillion-dollar giants. 

There is a common perception that a fastest growing economy like India will always tend to perform better than the developed economies that grow in the lower single digits. However, that is not the reality. There have been periods where the S&P 500 index has generated more returns than the Nifty 50 index. While it is also true that in the last 3-4 months, the Nifty 50 index and the Nifty Smallcap Index have performed better than their counterparts – S&P 500 and Russell 2000.

Compared to the Nasdaq 100 index, even the Nifty IT index has generated more returns for investors in the last 5 years. To summarize, there will be periods of underperformance and outperformance in every market. The investor is well-placed as long as he/she is diversified. Decoupling isn’t permanent and sometimes it can be detrimental.  

A typical home country bias is often observed where the investor preferences are generally limited to companies listed in his/her own country and not the ones that are listed abroad. In reality, the wider scope for benefitting from quality assets abroad and a consistent rupee depreciation can be achieved with the help of dollar hedge investing, with the Indian rupee depreciating for more than 2-3% per annum for many years now.

Should you invest in US stocks now?

There are mixed opinions of experts on whether it is the best practice to ‘time the markets’, especially among retail investors, those whose main profession isn’t investing or trading. While it is sometimes advisable to catch the falling knives and invest in a staggered manner, consistently timing it is beyond one’s acumen. 

The S&P 500 has cracked 20% YTD due to multiple factors, mainly:

1. The Russia-Ukraine War
2. High inflation and rising commodity prices
3. Indications of a squeeze by the Fed
4. Expensive valuations
5. Supply-chain issues due to global uncertainties, increasing Covid-19 cases in China, etc.

The Nasdaq 100 Index has fallen by more than 25% YTD in 2022 mainly due to its constituents showing signs of mean-reversion. The tech-heavy index had extended gains amidst Covid-19 due to the increasing focus on digital capabilities by many index companies. Failing to exhibit consistent growth, sequentially, in the first 2 quarters of the calendar year 2022, the companies that managed to raise money at unseen valuations have now fallen.

Considering the steep fall as a result of unfavorable macroeconomic indicators, it makes sense for long-term value investors to start accumulating high-quality, beaten-down scrips showing healthy signs of growth over 5-7 years. But which is the best way to invest in these beaten-down U.S. Equities? 

Following are some of the well-known methods to take exposure to U.S. stock markets:

1. Exchange-Traded Funds: ETFs are passive funds that are similar in many ways to an index fund except for the fact that they can be purchased and sold on a stock exchange. AMCs have launched many ETFs to address the increasing demand for low-cost international diversification.
2. Other Mutual Fund Schemes: Many asset management companies operating out of India are currently offering active as well as passive investments in U.S. equities via various mutual fund schemes.
3. NSE IFSC: The National Stock Exchange, or NSE, has now come up with a more sophisticated concept to trade/invest in U.S. equities by allowing users to purchase and sell directly through the NSE IFSC Exchange.
4. Open a Trading Account with an Indian Broker: Some brokers from India have tie-ups with foreign brokers who act as an intermediary allowing domestic investors access to the primary and secondary markets of the U.S.
5. Open a Trading Account with a foreign broker: The process of investing directly with a foreign broker is quite similar to the domestic investment process but with differences in the commission.

Team Tavaga recommends its readers and investors use the mutual fund route to gain exposure to U.S. equity markets. Further, in the mutual fund space, passive investing is perhaps the best way to buy U.S. indices. There are many index funds and ETFs that can help an investor achieve geographical diversification.

ETF	Benchmark Index	Expense Ratio
Mirae Asset S&P 500 Top 50 ETF	S&P 500 Top 50 TRI	0.60%
Motilal Oswal Nasdaq 100 ETF	Nasdaq 100 TRI	0.58%
Nippon India ETF Hang Seng Bees	Hang Seng Index	0.86%

US equity stocks can be purchased through an intermediary like an Indian broker having a tie-up with a foreign broker or via a foreign broker directly. Recently, BSE and NSE have facilitated the purchase and sale of US equity stocks through the depository receipts as discussed above. 

India’s retail investor is now accustomed to dealing in international equities, thanks to the growing network of digital interfaces and platforms that provide a seamless mode to invest. However, one needs to understand the fact that there is a considerable overnight risk involved. Tracking them becomes difficult due to different time zones.

Moreover, there are minuscule chances of outperforming the index as seen in the Indian context. Sometimes, the expense attached to buying direct U.S. equity stocks is higher than buying an index. Apart from the NSE IFSC mode of transaction, none of the means to buy U.S. equities are regulated, which happens to be the most important risk for a retail investor. Lastly, if the allocation and position size of international equities to the overall portfolio isn’t going to be significant as compared to domestic equities, simply buying an index works best.

Diversification benefits

How can an investor achieve portfolio diversification? The idea behind portfolio diversification is that there should be very little or no correlation between asset classes or financial instruments and thus reduce portfolio risk. A correlation of 1 implies a perfect positive correlation wherein the assets move in tandem (in the same direction). Anything below 1.00 is said to be diversifying in nature.

It is a well-known fact that the correlation between the Indian and US stock market is increasing at a faster pace in a short term as well as on the long-term horizon (especially post-Covid). However, this is true in local currency terms. The INR depreciation has caused the Indian benchmark indices to lag on many occasions.

In the last 10 years, the Sensex and DJIA have exhibited a correlation of 0.36. Although positive, it is still way below the perfect positive correlation of 1.00 and this allows an investor to generate significant returns by optimally diversifying. On an even longer time horizon of 20 years, the correlation (adjusted for exchange rate) is a figure between 0.1 and 0.2. 

To Conclude...

Follow the basic principles of investing whether it’s domestic or international equity investing. 

1. Keep a goal-oriented approach
2. Evaluate the risk appetite
3. Focus on Asset Allocation
4. Prefer SIP over a lumpsum mode
5. Hire a SEBI Registered Investment Advisor
6. Finally, keep things simple!

Tavaga is everything you need to start saving for your goals, stay on track, and achieve them in time. 

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