The last few days have seen positive sentiment returning to Dalal Street to some extent. There are tentative hints that the market now feels confident enough about moving on from the major blow to sentiment dealt by the war in West Asia and the disruption of the oil trade.
As the US and Iran agreed to continue talks and have even made progress on some major issues, financial markets have heaved a sigh of relief.
But this does not mean that a new bull market has started. Investors should not forget the painful lessons learnt during the last two years of market volatility.
When the stock market peaked back in September 2024, no one could have predicted the losses that investors would suffer in 2025 and 2026.
But that is the nature of financial markets. No one can predict the future. Anyone saying they can is lying to you.
Just like the volatility of the mid-2024 to mid-2026 period was impossible to predict, the next two years (or even the next two months) will be impossible to predict.
The best course of action for Indian investors is to avoid speculation and focus on building a watchlist of fundamentally strong stocks to buy and hold for the long term.
Having said that, we will share our thought process for evaluating the Sensex and Nifty from a market sentiment perspective.
Context
Over the last few years, whenever the stock market declined significantly, domestic mutual funds and insurance companies, such as LIC, were ready to buy.
On the other hand, whenever the market rose, foreign investors ramped up their selling.
Ever since the market peaked back in September 2024, the benchmark indices struggled to find a clear direction, either up or down.
We have seen periods like this before. Good news and good prices don't go hand in hand.
If you have cash to deploy in stocks and have your watchlist ready, you should welcome bad news. After all, bad news will dampen sentiment, resulting in falling prices.
The lower prices, due to market sentiment and not due to fundamental reasons, offer a margin of safety to buy high-quality stocks.
You should also sell stocks, even in a muted market, if prices have risen a lot. This is because high prices offer profit booking opportunities.
This is an investing discipline that will hold you in good stead in the stock market.
Now, there are hints of the uptrend resuming. This could happen if the recent understanding between the US and Iran actually holds.
In that case, the market sentiment could turn positive again.
Market sentiment and valuations
The Indian stock market is no longer expensive. Of course, it's not inexpensive either. The Nifty’s price-to-earnings (PE) ratio is about 21. A PE of 25 is considered expensive and a PE below 20 is considered reasonable.
But there is a change in how the market assigns valuations to specific stocks and sectors.
The time when the market would assign high PE ratios to any stock based on narratives is behind us. Now the market wants to see results… and this point is at the heart of the matter: Narratives.
For too long, entire sectors were being re-rated just because of a new government scheme, a new technological trend, or growing order books. Even the stock prices of companies with questionable fundamentals were going up.
That is no longer the case. Investors are more sceptical about narratives now and that's a good thing. The focus is now on margins, profit growth, order execution, and cost control.
Also, with signs pointing to an end to the hostilities in the Middle East, the market will shift its focus to the future. In other words, a new narrative will emerge sooner rather than later.
Investors should be careful about blindly believing in this new narrative, whatever it might be.
Our View
If the Nifty rises to 26,000 or above, then you should seriously consider profit booking in the stocks that have risen a lot in your portfolio.
But that's something to watch out for in the future.
For now, follow these points:
- Get rid of junk stocks in your portfolio.
- Keep your watchlist of fundamentally strong stocks ready.
- Identify those stocks in your watchlist that are trading at reasonable valuations.
- Maintain a long term horizon when making equity investments.
We think the upcoming earnings season will be very important in deciding the direction of the Nifty and Sensex. Not the financial numbers itself which are expected to be bad, but the management commentary about the future.
After all, bull markets climb a wall of worry. If the market perceives light at the end of the tunnel, stock prices could go up.
That said, the bull market has not resumed. The market could fall again at any time.
Also, aggressive buy activity does not make sense at this time. That should happen when prices are deeply discounted and investor sentiment is negative, and not when investors are expecting a revival.
However, you should start buying stocks selectively. You should identify those stocks with strong fundamentals that the market is still negative about.
These are the ones where the valuations, like the PE and PB ratios, are still depressed, but the companies are doing well.
Such stocks are not hard to find. There may not be many of them, but you can still find them because valuations have not fully recovered yet.
And that will happen only when the bull market returns. That implies a Nifty level above 26,000 and rising. So, there is still some time before stocks become expensive again.
Use this period to review the stocks on your watchlists first before searching for new stocks. You may realise that you had already identified a winner and were just waiting for the right timing.
Don’t speculate on fundamentally weak stocks or any stock with only narratives driving the price.
Stick to the basic principles of investing, and you will do well in the long run.
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com