Move money that you might require over next three years out of equities

But avoid becoming excessively conservative as only equities have the ability to produce inflation-beating returns over long term

The Sensex fell 1,688 points, or 2.9 per cent, on Friday (November 26) on concerns that a new mutant strain of the Covid-19 virus could lead to a resurgence of the pandemic in Europe. Even prior to this episode, the equity market has been volatile. The Sensex is down 7.5 per cent from its peak of 61,765 on October 18, 2021. The unidirectional, upward trend seen in the market since April 2020 seems to have ended.

Stretched valuations causing jitters    

After the dream run lasting 18 months, equity valuations are on the higher side. “People are discounting FY 23-24 earnings. Now we need strong earnings growth to justify valuations. We will have to wait for the earnings of the December and March quarters. Until then, the market will be edgy due to high oil prices, inflationary pressures, and talk of interest rates going up,” says Jinesh Gopani, head of equity, Axis Mutual Fund.

Liquidity withdrawal plans of Western central banks is also playing a part. “The announcement of gradual withdrawal of Quantitative Easing (QE) in developed markets, particularly the United States, and a few data points over the past couple of months that point to stagflation are also contributing to volatility,” says Trideep Bhattacharya, co-chief investment officer-equities, Edelweiss Asset Management Company.

News of the resurgence of Covid-19 in parts of Europe has made investors nervous. “At current valuations, any news that is perceived to be a hindrance to earnings growth makes investors wary and prompts them to take profits off the table,” says Nilesh Shetty, fund manager, Quantum Mutual Fund.

The rush of initial public offerings (IPOs) has also played a part. “The Indian market has added IPO market cap of above Rs 6 trillion, with more in the pipeline. That has led to the absorption of a lot of liquidity from the secondary market,” adds Bhattacharya.

In the last earnings season, the possibility of earnings upgrade, particularly among commodity users within the listed universe, came into question. The sharp spike in commodity prices will impact margins immediately, while any price increase they undertake will get reflected only in subsequent quarters.

Big sell-off unlikely

Market experts, however, say that while small corrections may happen, a major sell-off is unlikely. Gopani is optimistic on account of the current momentum within the economy.

Liquidity withdrawal by the US and other Western central banks may not be disruptive. “Liquidity conditions will remain fairly easy as most central banks are trying to support economic recovery and employment. Interest rates will not move up so sharply as to materially affect the earnings cycle or cause capacity expansion to be deferred,” says Shetty.

The upward earnings trajectory could provide a cushion. “We have seen a seven-year earnings downcycle. The banking system is cleaner and interest rates are on the lower side. These factors could trigger consumption demand and capital expenditure resulting in strong earnings growth,” adds Shetty. However, near-term returns are likely to be moderate.    

All these expectations could, however, be upended by another strong wave of the pandemic.  

Don’t try timing the market 

Investors must rebalance their portfolios and realign them with their long-term asset allocation. “With equities doing extremely well over the past year, investors’ weight in this asset class has risen beyond their strategic allocation. They must rationalise their portfolios by booking some profits in equities and moving money into fixed income,” says Vaibhav Porwal, co-founder, dezerv., a wealth-technology firm.

Any money that could be required over the next two or three years should be moved out of equities. Only investments earmarked for longer-term goals should be kept there.

Knee jerk reactions should be avoided. “Some investors want to move 100 per cent into equities while others want to be zero per cent in equities. Such extreme moves should be avoided,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

Avoid moving out of equities completely in anticipation of a correction. Investors would be deluding themselves if they believe they can time their exit and entry to perfection. By putting long-term money into fixed-income, they could lose out if the markets recover and they are left on the sidelines. So, keep long-term money in equities as only this asset class has the ability to produce inflation-beating returns.

Diversify geographically

Being geographically diversified can also protect your portfolio. Indian markets tend to have low correlation with developed-market equities. Funds based on indexes like the MSCI World Index, S&P 500, Nasdaq 100, and MSCI EAFE Top 100 Select Index are good options.      

According to Gopani, investors should stick to funds with quality portfolios, which tend to be more resilient in a down turn. 

To counter high inflation, take exposure to assets that can provide a hedge. “Investors should take some exposure to real estate investment trusts and gold,” says Porwal. 

Preserve your gains  

Experts say investors are falling prey to recency bias and are not prepared to rebalance. “This always happens whenever a particular asset class far outperforms others. But when that asset class has become expensive, it is fine to go into a lower-return asset for the purpose of preserving capital gains,” says Dhawan.

Porwal says investors should avoid being significantly overweight on mid- and small-cap funds. Large-cap funds, he says, tend to be more resilient in volatile conditions. Similarly, he says, exposure to longer-duration bonds or bond funds should be avoided as an increase in interest rates could cause their prices or net asset values to correct.

Direct investors: Over-exuberance could prove costly

> Don’t invest in unlisted securities without doing adequate due diligence

>Avoid excessive bets on micro-caps, where issues related to accounting standards, corporate governance, and management quality can arise  

>Don’t trade in stocks that show momentum, but are not fundamentally sound

>Avoid investing in IPOs of poor-quality franchises or aggressively priced ones