Exuberant stock markets need sensible handling

There are times when markets seem fully on their own trip and in no mood to look at what is happening today, as they anticipate a golden tomorrow. As the market hits new highs every day, up an unbelievable 75% from the March 2020 lows, investors are asking the question—how high will markets go and is this rally sustainable?

Other than global liquidity, some reasons for markets being happy are related to the better-than-expected recovery of the Indian economy. The Reserve Bank of India (RBI) has projected a contraction of 7.5% in financial year 2020-21, better than the minus 9.5% projected earlier. The central bank estimates that the first quarter of the next financial year will see a positive growth of 21.9%. The market is also blending in the argument that this recovery is possibly being built on a different base than earlier.

The last few years have been a pivot for the Indian economy from the old way of doing business to a new way. Two major trends have been a push towards formalization and raising the cost of funds misuse by rich promoters of poor companies. One, even though it is far from perfect, the GST (goods and services tax) framework has been important not just for the one-nation-one-market reason, but also to nudge firms to formalize. The system so steeped in cash and invoice fudging is still trying the old tricks, and succeeding many times, but the overall cost of a non-formal transaction is going up.

Two, there is a multi-pronged, multi-agency war against misuse of public funds for private gain. The fact that promoters can now lose their firms if bankruptcy proceedings were initiated under the new bankruptcy Act has been a good enough threat to trigger repayment of some debts. Data for FY19 shows that recovery rates of non-performing assets under the bankruptcy law were more than double that under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 or SARFAESI Act (see page 136 here: bit.ly/36WtLM1). The central bank too has been tightening its rule book to deal with obvious routes followed by default-minded borrowers. This can be seen from the current account regulation changes that hope to prevent the diversion of funds away from the lending banks. You can read about it here: bit.ly/2VQmC9z.

Some analysts are postulating that as growth returns to the Indian economy, it could be built on a very different underlying structure than before, making the growth trajectory higher and with much stronger foundations than the boom and bust of the past few decades. But even before we get there, there is a big ditch in the road ahead. The current bounce back is pent up demand and the higher profits are due to a wage squeeze. You can read about it here: bit.ly/3mUvKpH. While profits can look good if based on lower rents, real estate costs, labour and other contingent costs, the hit on demand will show up in the next few quarters. Economist Sajjid Chinoy argues (in this piece: bit.ly/3gmDuy6) that unless the Union government ramps up spending for the next few quarters, the lack of demand has the potential to derail the growth trajectory.

How should you decode these events that can either keep taking your net worth up or tank it? I will talk to investors who have remained invested and did not pull out of the market in March (those who pulled out in March, I really have nothing to say!). There are no definite answers about the future of this recovery and it would take a brave person to predict the trajectory of the Sensex.

I would use this rally to rebalance my portfolio, and here is hoping that you had an asset allocation in mind when you set out on the journey of investing. If you started out being comfortable with a 60% equity allocation and you see that has run up over the past few months to a 70% allocation, you need to rebalance. There are two ways of doing this. One, sell equity and invest in debt—bonds, debt funds, fixed deposits (FDs), Public Provident Fund (PPF), whatever is your mix. Two, use incremental flows to invest in debt and stop equity investing till you are back at your desired asset allocation. This is not market timing—you are not redeeming your entire portfolio to wait for a market dip—you are simply doing what it takes to come back to your comfort zone. We’ve been through a market yo-yo. Remember how you felt when markets crashed 30% in March and what allocation to equity felt safe? That is the allocation you need to have in mind today, when the markets are in an exuberant phase. We can’t control the direction of the market, but we can control our reaction and action.

Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation.