Elections over, now stick to stocks witnessing recovery in earnings growth

The equity markets were volatile both around the exit polls and on the day when the election results were announced. The Sensex rose 3.75 per cent on the day after the exit polls (May 20) were published, but lost 0.97 per cent the next day. On the day the election results came (May 23), the Sensex zoomed to an intra-day high of 40,100.5, but then gave up those gains during the second half and ended 0.76 per cent lower by the end of the day. Unless a trader was able to time his entry and exit around these events to perfection—which is no mean feat—he may well have ended up making losses in such a volatile environment. 

For most retail investors, who also hold a day job, punting on such events as exit polls and election results can be risky. A long-term, fundamentals-based, buy-and-hold approach will serve such investors better. Those who do not have the time to do their own research should take the mutual fund route. 

Expect a near-term pullback: The markets’ quest for political continuity, which has been fulfilled by the Narendra Modi-led Bharatiya Janata Party’s (BJP) return to power, will provide a feel-good factor. However, now that this major event is behind us, expect a pullback. “We may see a sell-on-news kind of phenomenon. Participants may book profits as the key event is over and there is no further trigger in the near term,” says Rajesh Cheruvu, chief investment officer (CIO), WGC Wealth. Expensive valuations could also lead to a correction. Cheruvu expects the markets to rally next from mid-June in the runup to the Union Budget.

While the longer-term prospects of the Indian equity markets remain positive—Morgan Stanley expects the Sensex to touch 45,000 by June 2020—one can expect the fundamentals to assert themselves in the near term. “This will continue only if it is backed by revival in earnings growth,” says Sampath Reddy, CIO, Bajaj Allianz Life Insurance. 

Policy continuity: With the same party returning to power, there is an expectation that it will get down to the task of dealing with problems, such as the economic slowdown and crisis in non-banking financial companies (NBFCs), faster. Earnings recovery, though not broad-based, has been witnessed in select stocks. “Over the past year and a half, banks have recognised their non-performing assets (NPAs) and cleaned up their books to a large extent. As credit growth picks up, we expect earnings of banking and financial services sector, which has over 35 per cent weight in the Nifty, to recover sharply from a low base,” says Vaibhav Sanghavi, co-chief executive officer, Avendus Capital Alternate Strategies. Reddy expects the slowdown in consumption to be a temporary phenomenon. 

Globally, with economic growth remaining weak, central banks are expected to maintain low interest rates and ample liquidity — conditions that are positive for risky assets like equities. 

The Reserve Bank of India (RBI), too, is expected to chip in. “We expect rate cuts of 50-75 basis points in the current financial year,” says Garima Kapoor, economist, Elara Capital. She adds that steps by the RBI to infuse liquidity into the markets, such as forex swap, or cash reserve ratio (CRR) cuts, could also help. Measures like opening up of a liquidity window for NBFCs and bank recapitalisation would also help address the dislocation in the financial sector. Quick transfer of cash benefits by the government will also provide temporary relief to those in rural areas facing distress, and could jumpstart consumption. 

Local and global headwinds: Experts warn that the markets will have to negotiate several hurdles to be able to make a decisive upward move. The much-awaited earnings recovery has not yet materialised. Consumption slowed about nine months ago while the economy as a whole turned sluggish about three months earlier. The rural segment has been in distress for a couple of years now owing to low realisations by farmers on their output. The monsoon, too, needs to be closely watched as it will have a bearing on rural income and consumption revival. 

Globally, the US-China trade war continues unabated. The Brexit issue, too, has the potential to cause disruption within the European Union. Crude prices remain firm despite slowing global growth due to the sanctions on Iran, and heated exchanges between the US and Iran over the nuclear issue. “If any of these issues flares up, it would have the potential create a risk-off environment, which would affect investments by foreign institutional investors (FIIs) in emerging markets, including India,” says Kapoor.  

Mistakes to avoid: In a market that will be driven primarily by earnings recovery, investors should avoid a top-down investment approach. “Even in the past few years, when aggregate level earnings growth was muted, select companies across sectors and market caps delivered growth of 15-20 per cent. It is likely to continue to be a market where one needs to be selective in choosing companies,” says Karthikraj Lakshmanan, senior fund manager–equities, BNP Paribas Mutual Fund.

Prudent investors should also avoid concentration risk in their portfolios. First, decide on your equity allocation based on your risk appetite, then build a diversified portfolio. “Avoid going overboard on a particular sector or stock even if you like it very much,” says Cheruvu. 

Avoid trying to time your entry and exit from the markets as doing so consistently over the long term is a near-impossible task. A more prudent approach is to invest systematically (a limited amount every month) so as to average out your entry cost in the stocks you like. Having a short-term orientation can also prove costly. Experts say that most direct stock investors lose money because they trade in and out of stocks. With a long-term horizon of at least three-five years, they say, it is difficult to lose money in equities in a growing economy like India if you have picked your stocks carefully.

With select large-caps having run up and mid- and small-caps having corrected over the past year, do not make the mistake of shunning the latter completely, despite the pain you may have witnessed in these stocks in 2018.