How should investors respond to this euphoric market?

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Balance board on white background with blue spheres.

Elevated prices and valuations are the key concerns of the equity market now. If we have a consolidation, either on a time or price basis, it will provide a breather to the future performance, of next 6 to 12 months. On the  contrary, if the trend continues in the same euphoric momentum, it will be a challenge to sustain this trend during Q3 and Q4 FY22. In such a pricey market, long-term investors should churn their portfolio into a balanced model, to lower volatility risk. In equity, the mix of mid and small caps should be reduced by booking gains and investing in large caps. And one can invest outside equity through MF debt schemes, corporate and government bonds of short durations. Investment in Gold and Sovereign Gold Bonds can also be made, up to a maximum of 10% of the portfolio, given rising inflation and bond yield risk.

India Price Performance and Valuations

Nifty 50 is 33% above long-term average while key mid and small caps indices are 20% and 58% higher,     respectively. This is not the best time to invest aggressively in equity market, in which small caps are extremely overvalued.

Large, mid and small indices price performance

Key benchmark P/E valuations

At the same time, it is forecasted to be a good time for the economy to rebound in 2022 and 2023, which will provide a calm to the equity market and maintain its premium valuations. Competent large and mid-caps should do better on a medium to long-term basis. The key point to know is what to do in anticipation of a   transformation in the economy and its transmission to a premium valued equity market.

We foresee correction in mid and small caps

Mid and small caps were outperforming the large caps during the year and from the lows of March 2020. In the last one-month, broad market is weaker than the main market due to correction in mid and small caps. Some of the factors for the good performance of mid and small caps were rising number of retail investors, high-quality IPOs, mutual fund buying, high liquidity and buying in anticipation of growth from unlocking. These reasons will continue to help the market, but we can presume that a good part of these benefits have already been priced in. It is time to be rational, book part of your gains in mid and small caps, be selective and increase the mix of large caps in your portfolio. In August, the key reason for the sudden fall in mid and small caps was the price movement curbs announced by the BSE. A quick clarification that this regulation is applicable only for small companies with market capitalization of less than Rs. 1,000 cr has provided a big relief to the mid and small caps. Apart from this, the high volatility of global market,    especially selling in Asian peers due to clampdown in Chinese tech sector added to the weak trend.

We can expect mid and small caps to improve in the near to short term after stability returns. Use this upside to book the gains as the segment can underperform the large caps in the medium-term, which we have been suggesting during the last 2-3 months. Don’t completely sell good quality midcaps as they have room for improvement in the long-term, as indicated in the valuation table.

Broadly large caps look more attractive

Economic data like sales volumes in realty and auto sector, PMI, GST, Q1 corporate earnings and exports suggest a strong recovery in the domestic economy. Recent data has indicated that the second wave and possible third wave of Covid will have a reduced impact on the economy. The best companies in India with good brands, excellent penetration, operational efficacy,   quality products and technology are likely to benefit from the improving economy.

Globally too, continued accommodative stance by central banks, huge infrastructure package in the US and rest of the world have made strong companies stronger. While the possibility of a fall in liquidity has reduced in the short to medium-term, global bond yields have subsided heavily. Recently, it has triggered a risk-on in emerging markets, changed FII inflows to India from negative to positive. FIIs have turned net buyers in  August and are expected to increase in the short-term. FII inflows have helped the main indices (heavyweights) to cross into the new zone. Nifty 50 has moved above 16,000 from the narrow range of 15,900 to 15,500.

Where to invest in equity

Invest in large caps (mostly) and in quality midcaps, which stand to benefit from unlocking. Put money in sectors where the government is undertaking policy reforms. Invest in companies, which have the skills, products, and platforms to capitalize on high domestic and global demand. Also, in such a premium market, value buying will be a theme in the future. The market is turning more cautious in the short to medium-term. Invest in defensive sectors like IT, FMCG, Pharma, and Telecom.

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