How To Break Analysis Paralysis While Investing In Higher Rate Regime—Quantamentals

Different approaches with common objective of trying to predict future market course and odds of making investment/trading returns always get overwhelming. The analysis paralysis grips our thought process on how markets will behave under different interest rate cycles, and the winner-loser association with the changing market routine fogs our decision-making ability. 

The underlying analysis can be done from various vantage points ranging from discretionary fundamentals, quant-based data-driven approach, historical analysis using past data, investor sentiments tracker, money flow analysis, etc.

In the series, we will attempt to provide a comprehensive view on markets (both micro and macro), delve deeper into various approaches, using our core expertise of ‘Quantamentals’ (quantitative and fundamental) and how it helps in generating better “risk adjusted returns”. 

As an investment manager, our core belief is to be flexible in our approach and absorb the changing dynamics of the markets. Our endeavour is to adjust and adapt to incorporate different methodologies and continue to deliver consistent performance. Perhaps, this mindset has helped us so far to be one of the largest hedge funds in India.

With this backdrop, let’s dwell upon one of the widely debated topics of discussion this year—the impact of higher interest rates on the markets, macro as well as micro. Herein through various illustrations, we have tried to examine the current market regime from a data-driven quantitative approach, a pure fundamental approach and a combination of both to offer a "Quantamental" view.

Quantitative analysis is essentially a data-driven approach of understanding various trends and correlations based on historical data. The underlying assumption to the thesis is that history may not repeat but may probably rhyme. Therefore, a quant-based model tries to predict what may be in the same tune in the future.

It’s a fascinating topic of discussion, but for the time being, I will leave it here and discuss it in detail in future articles.

For now, let’s go with quantitative view as a data-driven approach and see what’s the outcome. 

We analysed data for the last 15-20 years and observed that when interest rates are high, for example, when U.S. 10-year interest rate was higher than 3%, the S&P 500 delivered approximately -0.2% during that period, along with sectors such as inflation-positive natural resources, commodities, staples and value doing well.

We ran a similar analysis for the Indian market and whenever India's 10-year interest rates have been higher than 7.5%, we have seen that Nifty has delivered 0.5%, with sectors like financials, healthcare, consumers and low volatility doing better during the same period.

A more rigorous and detailed analysis can be done, however, from a broader perspective as quant suggests, we do get a trend which to some extent can be seen in the current period as well.

As quant data suggests, we may continue to see the above mentioned sectors performing better than others. 

From a fundamental perspective, which involves research through extensive data analysis, and also factors in the discretionary view of the portfolio manager on forecasts using past experience and judgement along with sound understanding of global macros, sector implications and company-specific business drivers and valuations associated with that.

Rising interest rates have always been challenging wherein, in the shorter term, the earnings tend to be buoyant, but in the medium term, they get impacted as the higher rates precipitates into economy, which leads to slower business growth.

Despite the anticipated slowing economic growth, there are many companies with strong pricing power, which benefit given the inelastic demand.

In the current context, when the U.S. 10-year interest rate is around 4%, and India 10-year is around 7.5%, the beneficiaries are likely to be banking and financial services, consumers, resources and industrials.

On a separate theme, renewables in our view is a multi-decade opportunity. The interest rate-sensitive sectors such as real estate, higher debt companies, and commodity consumers would suffer in terms of pressure on their earnings.

Digging a bit further, even if one considers a slightly longer-term market view as markets are forward-looking discounting machine, and take into account potential terminal rate and associated future interest rates glide path, growth starts getting more attention.

In my view, markets will always stay dynamic and agile, and a blended approach of combining both quantitative and qualitative inputs, which marries the diligence of data analysis from quants with discretionary analysis using sound human judgment and intuitiveness to create a more robust and time-tested method is a better approach for predication of markets.

In the current global scenario, where we do think that the level of hawkishness on interest rates from various central bankers is likely to come off, the established sectoral preference based on past data may undergo a change, by factoring in only the element of markets being forward looking.

As rates plateau and data on slowing economy is evident, sectoral preference towards commodity consumers, financials and industrials driven by their larger order books, and growth as a factor are likely to be in focus. 

Vaibhav Sanghavi is Co-Chief Executive Officer at Avendus Capital Public Markets Alternate Strategies LLP.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.