Normally the best investment decision when the stock market is at a new high is to simply do nothing. After all, the worst investments are usually made in a bull market — going overboard on equities, buying over-heated sectors and betting on poor-quality stocks.
But doing nothing can actually hurt your wealth today, because this bull market has been so different from the ones before it. For one, if you are a typical retail investor, you are likely to be severely under-invested in equities, missing this rally. All available data on shareholding patterns and household savings show that incremental retail savings have flowed mainly into gold, real estate and bonds in the last five years, while money has been withdrawn from equities.
Two, while the index is at a new high, stock valuations aren’t. The price-earnings (PE) multiple for the Sensex stocks currently rules at about 18 times trailing earnings. Previous bull markets, including the ones in 2008 and 2000, peaked out at PEs of 24-26.
With Foreign Institutional Investors (FIIs) staying with Indian stocks despite a rash of challenges, a continued rally has now become a live possibility. After all, while the Indian market isn’t cheap, it isn’t in bubble territory either.
Three, recent Sensex gains have been driven by a very narrow set of stocks and sectors, leaving large swathes of the market untouched. Stock price returns between January 2008 and November 2013 show that 70 per cent of the stocks trade below their 2008 levels.
Three choices
These trends suggest three courses of action for you, the investor.
If you have been avoiding stocks over the last five years, resume investing in equities now. How much you should invest should depend, as always, on your age, risk profile and investment horizon. If you are in your 20s or 30s and can hold on for five years or more, ensure that at least 40-50 per cent of your portfolio is in equities. Top up your portfolio with investments in equity funds to attain this allocation. Don’t invest all your surpluses in one go but route the money through systematic investment plans. If your equity allocation is already higher than 40-50 per cent, do nothing. Invest in tax-free bonds, which are offering mouth-watering returns, instead.
While selecting equity funds, avoid those which have topped the return charts in the last three years. Themes and sectors such as multinationals, consumer stocks and large-cap FMCG and IT, and pharma have been front-runners in this bull market and now trade at a stiff premium to the market. They, therefore, carry the most downside risk in the event of a correction. Avoid equity funds that piggyback on these themes.
Instead, go for the pockets of real value in today’s market which are to be found in PSUs, dividend yield stocks, energy, and capital goods. Invest in the best funds (by track record) focussed on these themes. Or keep it simple and go in for Value and Dividend Yield funds which can do the stock selection on your behalf. This bull run has been dominated by bluechip stocks, with mid- and small-caps hardly participating. This argues for investing incremental money into multi-cap or mid-cap funds with a good track record.
Follow the same tenets if you invest directly in stocks. But when scouting for inexpensive ones, don’t compromise on fundamentals. Avoid highly leveraged companies and those with governance issues; it will take more than a bull run to revive their prospects.