Strategy in bull run: Time to book profits, protect equity market gains

Sell and bring allocations back to original levels in those segments of your portfolio that have become bloated

With the Sensex closing above 80,000 on July 4, retail investors' mood is buoyant, even euphoric. Experts say there is a need to tread with caution in such an environment.    

Several positive drivers are supporting this rally. “Currently, the Nifty or the Sensex looks slightly at a premium compared to historical standards. But that is supported by good macros (sound GDP growth, government sticking to fiscal discipline) and the expectation of a decent monsoon. Both domestic consumption and capex — including the Make in India story across sectors like railways, defence and heavy engineering — are doing well,” says Sonam Udasi, fund manager, Tata Mutual Fund. According to him, the current re-rating is also supported by well-rounded earnings contributions from various sectors.

Key risk: If earnings disappoint

Earnings in mid and small caps, hit hard by Covid, have bounced back from a low base. Cyclical sectors like capital goods and defence now enjoy premium valuations once reserved for the consumer space because of a significant turnaround in earnings.

“However, to assume that this level of earnings growth will continue indefinitely and pricing stocks accordingly is a mistake. There could be disappointment if projected earnings do not materialise,” says Vidya Bala, co-founder, PrimeInvestor.

Prices of many stocks are not supported by fundamentals. “In the next round of market volatility, many will drop permanently, leading to irreversible loss of capital for shareholders. Only stocks backed by genuine earnings and cash flows will bounce back,” says Jatin Khemani,  managing partner and chief investment officer, Stalwart Investment Advisors LLP, a New Delhi-based Sebi-registered Portfolio Management Services firm. 

Many sectoral and thematic mutual funds (MF) in categories like PSU, infrastructure, etc have given returns between 50 and 100 per cent over the past year. “Many investors are ploughing more money into these funds, expecting the returns to continue,” says Bala.

Udasi points to geopolitics—wars breaking out at periodic intervals around the world—as a risk.

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Market not in bubble territory yet

One big mistake investors are prone to during a bull market is to view it as a bubble market. Experts examine four broad indicators to decide the zone the market is in.

Earnings cycle: It passes through three phases: early, mid and late stage. The late stage of the earnings cycle is a red signal.

“Corporate profits as a percentage of GDP move in the range of 2 to 8 per cent. Currently, we are close to the 5 per cent mark. Only when it moves to the 7-8 per cent level will there be reason to worry,” says Arun Kumar, head of research, Fundsindia.com.

Valuation: Experts use multiple parameters to determine valuation: market cap to GDP, price to earnings, price to book, and bond yield to earnings yield. “Based on these parameters, valuations are clearly in the red zone,” says Kumar.

Fund flows: Currently, domestic investors are buying heavily. They have invested above Rs 6 lakh crore over the past two-and-a-half years. But foreign investors have pumped in less than Rs 10,000 crore over this period. “If the market were in a bubble zone, both would be buying heavily. So, the fund flow parameter is not signalling red,” says Kumar.

Sentiment: This parameter tries to assess whether market participants are in greed or fear mode. Many new, untrained investors are engaging in futures and options (F&O) trading. Lots of new fund offers (NFOs) are being launched. Investor preference has tilted towards riskier funds like sector-thematic and small caps. “This indicator is signalling that the market is entering the greed zone and is almost in the red territory,” says Kumar.

Thus, of the four indicators, one is in red, another is entering that zone, while the other two are in green. According to Kumar, this indicates that while the market is witnessing a bull run, it has not yet entered bubble territory.

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What should MF investors do?

India’s per capita income could grow from $2,400 level now to $10,000 in 10 years. “Investors must participate in this story by part-owning growing businesses,” says Udasi.

Since the market has not yet entered the bubble zone, investors should neither exit equities nor lower exposure to it. Instead, they should stick to their asset allocation. If the original equity allocation was 60 per cent but has now moved up by 5 percentage points or more, bring it back to the same level. “Avoid panic selling and exiting equities entirely because re-entry becomes difficult,” says Kumar.

To curtail risk, sell those segments of the portfolio that have become bloated. “This is the time to preserve profits. That will only happen by selling outperforming assets, even if it means paying a capital gains tax,” says Bala.       

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What should stock investors do?

Using a horse-racing metaphor, Khemani points to the need to stick to the basics of successful long-term investing.  

“Remain focused on the quality and growth of the underlying business (the horse), the quality of management (the jockey), and whether the price offers a margin of safety compared to its value (odds),” says Khemani. Retail investors must avoid speculating in the F&O segment without proper knowledge.