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SPI Management Newsletter 07.04.2023

Stock Attractiveness Hits Lowest Level Since 2007

The equity risk premium, which represents the gap between the S&P 500's earnings yield and 10-year Treasury yields, has dropped to approximately 1.59 percentage points, its lowest level since October 2007. This is significantly below the average gap of around 3.5 points since 2008, making stocks less appealing to investors. To justify the risks associated with equities, stocks must offer higher long-term rewards than bonds.

The attractiveness of stocks has diminished recently as bond yields surged and corporate earnings outlooks worsened. The S&P 500 has managed to rise 6.9% in 2023, recovering some ground after last year's 19% decline. In contrast, the Bloomberg U.S. Aggregate Bond Index has increased 4.2%, driven by an early-year rally and elevated yields.

The current equity risk premium is closer to the long-term historical average of 1.62 points since 1957, which implies that stocks may still outperform bonds over the long run. However, the narrowing premium presents a challenge for equities going forward.

Some investors advise to focus on stocks with resilient profit margins and strong earnings growth while steering clear of overvalued companies. Additionally, value stocks, which trade at a discount to their book value, may be worth considering due to their current low valuations relative to growth stocks.

Despite value stocks outperforming growth-oriented peers during last year's market downturn, growth stocks have regained the lead in 2023. The Russell 3000 Growth Index has jumped 13% this year, while the Russell 3000 Value Index has edged up only 0.1%. Historically, value stocks have outperformed growth stocks when annual inflation ranges from 4% to 8%. With February's consumer prices rising 6% year-over-year, value stocks may hold potential for investors seeking opportunities in the current market conditions.

To conclude, the current decrease in equity risk premium underlines the evolving relationship between equities and fixed income assets.

India Seeks to Capitalize on China-West Tensions and Boost Economy

With a 6.9% expansion in the financial year to March 31, as estimated by the OECD, India's economy has experienced significant growth, becoming one of the fastest-growing among larger nations. Indian equities have also gained international recognition for their strong performance since the pandemic started. India's geopolitical influence is growing, and as tensions rise between the West and China, Indian Prime Minister Narendra Modi aims to capitalize on this situation by promoting India's potential as an alternative investment destination.

To achieve this, the government has announced plans to increase capital spending by a third to Rs10tn ($122bn) in the fiscal year from April to improve infrastructure and drive growth. The budget also includes tax breaks for young companies and measures designed to support start-ups. Despite successes in the IT sector, India's manufacturing industry has lagged behind, and analysts emphasize the need for more manufacturing growth to create mass employment similar to China's recent decades.

India did receive a boost last year when Apple began manufacturing its latest iPhone models in the country. However, the operations are still in the early stages and face challenges. Other businesses are considering following suit, but concerns about India's infrastructure and lower purchasing power compared to China remain. Indian authorities are working to change this perception, and some state governments, like Karnataka, have made efforts to become more business-friendly by liberalizing labor laws to allow for two-shift production. However, manufacturing still has a long way to go.

India's economy is partly shielded from global shocks due to its large domestic market, but it is not entirely immune. The country's growth is expected to slow down in line with global trends, with export-oriented sectors, such as IT, being particularly vulnerable. Indian equities have struggled recently, and research firm Capital Economics expects them to remain under pressure.

Additionally, Indian start-ups are exposed to slowing global growth, which has led foreign investors to redirect funds away from emerging markets. Foreign venture capital funding of Indian start-ups fell by 40% to $25.7bn in 2022 compared with the previous year, according to data provider Tracxn. Despite these challenges, India stands out as an outlier amidst global economic gloom, with more clients looking to hire and invest in the country.

Adapted from WSJ, Reuters, CNBC, NYT, Forbes

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