Financial assets in India are looking much better than physical assets in terms of potential returns given the risk taken. Investments in Indian equities and bonds are likely to generate much better returns going forward than investments in gold and real estate. Domestic or NRI investors are much better off investing in equities and bonds in the present market environment. Investments in gold and real estate are not likely to generate the oversize returns that were seen in the last few years and may in fact not generate any returns at all.
In terms of risk, equities bonds and gold (gold in ETFs or Exchange Traded Funds) carry low liquidity risk while real estate carries high liquidity risk. Equities, bonds and gold markets are highly transparent and prices are market determined. Real estate market is opaque and prices are not wholly determined by demand and supply forces. Real estate requires leverage and carries that much more risk than unleveraged investments in equities, bonds and gold.
The reason equities and bonds are likely to perform better than gold and real estate going forward is that there is more value in the former than in the latter.
In simple terms equities and bonds have reacted to negative factors in the economy, while real estate has in fact thumbed its nose to an economic downturn and has actually reacted positively to the negative factors in the economy. Gold prices moved higher on risk aversion trades but are now falling as risk is abating in the markets.
Equities and bonds having factored in the worst for the economy and are poised to trend higher as prospects of economic stability and growth improves. Time frame for the markets performing is at least three years for equities and one to two years for bonds.
The Sensex and Nifty are still in negative territory over the last five and half years. The current price earnings levels of the Sensex and Nifty at around 18x twelve months trailing earnings are down from levels of over 25x seen at market peaks. The growth outlook for the index companies earnings is not very positive for this year with estimates down from 12% to 14% levels to 10% to 12% levels. However growth is likely to pick up in momentum post 2014-15 as the economy comes out of a slump on the back of both domestic factors of interest rates coming off and global factors of better prospects for growth in the major world economies.
Government bond yields at 7.50% levels on the ten year benchmark bond have come off from levels of 8.50% seen last year. RBI repo rate cuts of 125bps coupled with WPI (Wholesale Price Inflation) coming off from levels of over 7% to below 5% levels have brought down government bond yields. However with the economy growing at decade low levels of 5% and with growth expectations coming off, bond yields will have to trend down further if growth has to stabilize and pick up. Interest rates in the economy must come off for companies and consumers to borrow and invest.
The current volatility in the Indian Rupee (INR) that has seen the currency touch all time lows against the USD notwithstanding, RBI will have to ensure that monetary policy is accommodative rather than neutral for growth to pick up. Inflation outlook is not negative given domestic and global growth issues and that should give RBI room to ease rates down the line.
Gold prices that had doubled in INR terms over the last five years (as of end 2012) has come off by 25% from highs over the last eight months. Gold prices rose on the back of inflation that was trending at close to double digit levels and worries of financial market instability. Gold prices are reacting to falling inflation expectations and stability in markets. Outlook for gold is more negative than positive largely on the back of falling inflation expectations and on the back of lower risk premium in markets. Volatility indices are down sharply over the last few years.
Real estate prices have risen over the last five years despite a weakening economy with GDP growth coming off from 8.4% levels to 5% levels. The weakening economic growth has brought about a slowdown in growth in income as well as a slowdown in fresh hiring. Hence residential prices have gone up from levels of 3 to 4 times income to levels of 6 to 7 times income.
Income levels are not likely to trend higher going forward as the economy first has to come out of a slump and then show growth. Real estate prices are not likely to trend higher on a broad basis unless income levels start rising. There will always be pockets where real estate will do well but unlike equities, bonds and gold, it is not easy to transact in real estate across geographies.