There is a near consensus that market valuations are rich and, therefore, the returns for the next 1-year will be modest. All parameters of valuation – Market cap to GDP, PE ratio, Price to Book, Dividend yield – indicate very high valuations. In some segments, valuations are frothy. This calls for a rethink on investment strategy. An investment strategy based on the following suggestions can help in minimizing risks and maximizing gains.
Diversify across geographies
Even in normal times, geographical diversification makes sense. It is more important in the present context of higher valuations in India. At 18000 Nifty is trading at 24 times FY 22 earnings while S&P 500 is trading at around 21 times earnings. India’s valuations vis-à-vis EM peers are at a historic premium. This means, in the event of a sharp correction in the market, India might pullback more than others. This risk can be mitigated through diversification across geographies. Now, it is possible to invest in stocks abroad directly. A simple way of investing abroad is to invest through mutual funds. Investing in mutual fund schemes investing in foreign stocks or investing in Fund of Funds would be a good strategy.
Increase the exposure to gold
Gold has proved to be a safe haven during uncertainty. Equally importantly, gold does well during inflationary times. Inflation has started rising globally and 2022 may witness higher inflation. Also, a higher level of INR depreciation of 5 to 7 percent is likely in 2022 triggered by FPI outflows in anticipation of the Fed normalizing policy rates. Therefore, gold can be a good hedge, going forward. In many portfolios’ gold exposure is less than 5 percent. This can be raised to at least 5 percent. Investing in Sovereign Gold Bonds or Gold ETFs would be a good strategy. Gold ETFs are highly liquid and transaction costs are low.
Avoid stocks with bubble valuations
A major driver of the rally in India is the growing number of newbie investors. These young tech-savvy investors are chasing the newly listed consumer digital stocks without any concern for valuations. Loss-making companies, which are likely to burn cash for a few more years are being accumulated at excessive valuations. Some profit-making companies are being bought at irrational four figure valuations. Some of these stocks would certainly do well in future and generate wealth for investors. But that doesn’t justify these gravity-defying valuations.
During the euphoria of the Y2K bonanza during the late 1990s, some IT stocks were traded at lofty valuations of 100 and above. When the markets crashed globally following the dotcom bubble burst, these stocks with lofty valuations crashed disproportionately. History may repeat. Investors have to be careful.
Prefer large-caps to mid and small-caps
In a bull market, the mid and small-caps outperform. But when the trend reverses, the reverse would be true. Therefore, going forward, safety would be in large-caps. However, investors should continue to invest in the broader market, preferably through mutual fund SIPs.
In the large-cap segment, preference should be given to companies with pricing power. Since input prices are rising, only companies with pricing power to pass-on the increased costs to customers will succeed in protecting their margins. For example, recently some paint companies have raised prices and passed-on the higher input costs.
Experience has taught us that it is difficult, almost impossible, to time the market. More important than timing the market is to spend time in the market, i.e., to remain invested. Stopping SIPs in anticipation of market corrections has, time and again, proved to be a wrong strategy. So, continue with SIPs.