BackStrategic portfolio rethinking can help navigate the changing dynamics of Indian stock market
Indian equity markets no longer offer the same kind of risks and rewards that they did a year ago due to factors such as high inflation, a spike in crude oil prices, a high-interest rate environment, general elections next year and elevated valuations.
PremiumIndian equity markets no longer offer the same kind of risks and rewards that they did a year ago. Why? The reasons here are factors such as high global inflation, a spike in crude oil prices, a high-interest rate environment, general elections next year, elevated valuations, a rush in the primary market, and a significant increase in midcap and small-cap share prices have meaningfully changed the investment dynamic.
Further, on top of the Russia-Ukraine war, the world is now closely watching the Israel-Hamas conflict and its possible spillover on commodity prices and global inflation.
While the Israel-Hamas conflict is still confined to this region and probably not escalating much because of the intervention of the other developed nations, globally, investors have started to price in higher geopolitical risk.
As Warren Buffett once said, "What the wise do in the beginning, fools do in the end." Wise investors today could begin rethinking or restructuring their portfolios and allocations to accommodate the changing dynamics.
High valuations and froth in certain pockets of the markets
Generally, small-caps and mid-caps trade at a discount to their large-cap peers, which are much more solid and safer bets apart from the quality and sustainability of their business.
But that hardly seems to be true in the current context. The trailing twelve-month price-to-earnings ratio of Nifty is currently around 23.2 times.
In comparison, the Nifty midcap index is trading at 30 times, and the Nifty small caps index is at 25 times.
Both mid and small-cap valuations have surpassed the Nifty valuations, which is a growing risk. Listed stocks in the SME space have gone even beyond.
The year 2023 has been a blockbuster year; during this period, the BSE SME IPO index has delivered a staggering year-to-date return of about 57 per cent, far outstripping the 7.7 per cent return of the BSE Sensex.
Are investors paying too much for the future?
Many IPOs are launched at 50-70 times their trailing earnings, yet they are oversubscribed simply because investors are ready to pay for the earnings that could be earned over the next three years.
This is typically a bull market phenomenon where sentiments and liquidity keep investors busy buying at every level.
The margin of safety, a concept where investors are advised to buy securities at a discount to their intrinsic value, is no longer available in many cases.
Stocks, particularly midcap, small-cap, and SME stocks, are trading well above their intrinsic value.
The lack of fresh ideas is pushing investors to buy the next hot stock, diluting the basic investing hygiene required to earn decent returns.
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Little room for error
While the fundamentals of Indian corporates are improving, supported by government policies, an improving capex cycle, and higher demand, considering the challenges highlighted above, it would be prudent to have reasonable expectations.
Investors have started to pay too much of a premium for the future in the case of many smaller and mid-size companies. State elections and general elections next year could lead to a spike in volatility.
Most market pundits predict a stable government. However, during elections, it is seen that the volatility in market returns could hit portfolios.
Also Read: IREDA IPO: Financials, Peer Comparison, Loan Book, Risks, among 10 key points from RHP
Too much liquidity chasing too many stocks
Liquidity is entering all segments of the market. Investors, in a bid to chase the next big stock or make quick returns, have possibly started to lose investment prudence.
Data suggests that currently, close to 99.5 per cent of the market's total volumes are derived from derivatives.
Derivatives volumes are now 900 times more than cash deliveries (volumes) per day. Mutual fund SIPs have hit the highest monthly inflows of around ₹16,000 in September 2023.
How could investors deal with the situation?
Investors need to exercise caution and conduct thorough research while making fresh purchases or participating in any of the themes or other influences that are impacting the markets or stocks.
In times like these, many stocks and themes may look attractive. In good times, everything looks promising.
But at the same time, if something appears promising, others will also sense it, and that would already be reflected in the price, limiting your returns. Another pertinent point is to have reasonable return expectations.
The hyper returns that we saw in the last two years may not continue. Thus, staying humble and investing in high-quality companies could help protect capital and provide portfolio durability.
If you have exposure to low-quality stocks, risky bets, derivatives, cyclicals, interest rate-sensitive or marginal businesses, whose margins and returns are susceptible in an environment of high inflation and commodity prices, it is time to rethink.
Even if you choose to continue holding them, partially reducing exposure could limit the impact on your portfolio.
Finally, keep cash and emergency funds because you might require liquidity to help protect capital or make prudent purchases whenever the opportunity arises.
(The author is the founder and CEO of SAS Online – a deep discount stock brokerage platform)
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Disclaimer: The views and recommendations above are those of the expert, not of Mint. We advise investors to check with certified experts before making any investment decisions.
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