Place your weights on the scales of equity before 2017
Even if you have some equity holdings, keep adding in this market situation to lower the cost of acquisition
These may seem like worrying times for some since global and domestic stock prices are witnessing a correction. But what seems like a problem fits well within our four key frameworks for equity investing—flow, trigger, valuation, and sentiment. And these principles can be your guiding light in making the right portfolio moves in the year ahead.
The first is fund flows. For foreign investors, a key component that determines their asset allocation toward global asset classes has changed since 2012-13—oil prices have plunged to levels of around $30 per barrel. Since foreign institutional investors (FIIs) are selling across the globe, domestic markets have been affected. But do keep in mind that this selling has nothing to do with the fundamentals of the Indian economy, which remain favourable. It’s when this type of selling happens that emergency cash and quick money has to be raised. One should not look at these times as panic selling moments, but instead as opportunity-buying moments.
When foreign flows turn negative, it’s not necessarily bad news. History has proved, time and again, that whenever foreign investors have exited domestic equities, stock prices have always bounced back handsomely over subsequent years. Take a look at 1992, 2002, 2008 and 2011, when stock prices fell 15-20% and more. Investors who checked into the markets during these years, made reasonable returns in the subsequent years.
Therefore, this correction does not worry me because it’s not because of fundamental reasons. Whatever happens on the global front, retail investors must remember one important rule for the Indian equity market: Buy when FIIs are selling because of global reasons.
The second parameter that investors should keep an eye out for is a trigger. One can see this happening in the oil market, which is showing signs of bottoming out. As crude oil price recovers, equity markets should respond positively.
The third principle for investing in equities is valuations. The correction has brought down prices of large-cap companies to comfortable levels. About this time last year, equity market valuations were much higher. Those who invest in such deeply discounted values are likely to have a better investment experience once the economy recovers.
The fourth key factor that swings the scales in favour of equities is market sentiment. A weak sentiment in market offers a good case for investing in equities because stock prices are on sale. Sentiments may not change overnight, but may not last long either.
What may also not last long enough is the opportunity to accumulate enough equities before the recovery begins. Equity prices don’t wait for company profits to show first as prices discount the future earnings much in advance.
Over the next two to three years, the economic recovery, especially on the investment cycle, will boost corporate profits. At 7.4% growth in gross domestic product, the Indian economy is one of the fastest growing in the world. The government has announced various projects to spur economic recovery. A lot of this activity will show results in the next two-three years by around 2017-18.
The real interest rates are positive. Inflation is lower than current interest rates, and such conditions augur well for financial assets. In the shorter run, low inflation and lower interest rates will reflect positively on debt assets.
Before the year-end, investors should scale up their equity positions rapidly. Indian households are drastically underweight on equities, with just around 2% of their wealth in equities. The time has come for investors to make a meaningful change in their asset allocation.
In the longer run, though, a lower interest rate improves corporate profitability and tends to raise capital investments. In the next year or two, capacity utilisation of Indian companies will improve from present levels of around 70%. And sooner or later, Indian companies will then begin to add capacities, which will boost credit growth and turn the investment cycle favourably by 2017-18.
From that perspective, FII selling has come in the nick of time. A change in the holding pattern of Indian companies towards domestic investors at lower prices will bring a virtuous shift in household assets. Even if you have some equity holdings, keep adding in this market situation to lower the cost of acquisition. It’s not too late to start now as these opportunity-buying conditions may not last long. So, in the present environment, to invest with a near-term view of one-three years, hybrid and dynamic asset allocation funds such as equity-income and balanced funds present a good opportunity. With a longer view of three years or more, pure equity funds with a large-cap bias present a good opportunity.
This article was published on February 08, 2016 in Mint
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