Property, gold back on radar

Reducing equity exposure and rebalancing into other asset classes may be sensible

The past year has been great for investors. In rupee terms, the National Stock Exchange’s Nifty has returned 24 per cent since January. It has returned more in dollar terms. Mid-caps and small-caps have beaten big stocks. At the same time, valuations have outpaced fundamentals by huge margins. 

The Nifty is trading at a price-to-earnings (PE) of 26. Earnings have grown by five per cent absolute in the past eight quarters. The Nifty Midcap index is trading at 32 PE and earnings have grown 14 per cent over eight quarters. The optimists expect earnings to catch up and there seem to be few pessimists. 

Next year might not be so good in terms of capital gains. In the long term, valuations equalise with earnings growth. This can happen if earnings growth accelerates, or if valuations drop due to price corrections. To justify PE 26, the Nifty basket would need to see earnings growing at rates of 26 per cent plus. Even the most optimistic analysts are projecting mid-teens EPS growth, despite the Q2 pickup. 

We cannot expect interest rate cuts. The central bank’s latest estimate is that inflation would run at 4.3-4.7 per cent. If it isn’t willing to cut rates when inflation is 3.6 per cent (October 2017), it’s unlikely to cut at four per cent plus. The Reserve Bank of India (RBI) has flagged higher food prices, fuel costs, housing costs and the likelihood that manufacturers will pass on higher costs of raw commodities as possible inflationary factors. Higher food costs may be transient if there’s a good rabi crop. Higher housing costs (due to higher allowances for government servants) are projected to plateau by end-December. But, global commodity indices are up over 20 per cent, with crude oil and industrial metals looking set to go higher. 

Apart from inflation, consumption is still muted. The growth in private final consumption expenditure hit an eight-quarter low in Q2. Fiscal slippages, meaning a higher fiscal deficit, are likely. Tax collections from goods and services tax (GST) will take a while to stabilise. Expenditure on populist measures are likely to spike, given elections scheduled through 2018. This could mean an uptick in consumption, which would be a good thing. 

On the external front, exports dipped in October, after 14 months of growth. This is partly GST-related but it will mean higher current account deficit if it persists. Deterioration in macro-numbers could also mean foreign portfolio investors turn cautious. 

This would be a good time to review portfolios and shed deadweight. All active investors pick up some under-performers and the best time to let them go is during this sort of bullish market phase. The current high valuations will enable investors to book losses with minimal pain. 

It is also worth looking at other details of portfolio hygiene. For example, many investor end up owning a basket of mutual funds, which have very high levels of portfolio overlap. Checking how much actual diversification there is can be a useful exercise. This is true for direct equity portfolios too. If you’re heavily overweight in some sectors and underweight in others, this is a good time to rebalance exposures across sectors. If growth is genuinely picking up momentum, sectors which are currently underperforming should rebound. 

For example, the rupee could experience some pressure due to several reasons. Foreign portfolio investors may cut emerging market exposure, if ‘home markets’ see higher growth and central banks cut excess liquidity. This seems likely across Japan, Euro zone and the US. Energy prices are also likely to rise, if only due to higher First World demand. Again, that puts pressure on the rupee. A weaker rupee would help exporters. 

Returns from debt won’t improve much if interest rates are stable. Commodities may cycle up. Playing the commodity market is possible only for experts. But, India has some firms that benefit from higher primary metal prices although this hits the margins of automobile makers. 

More broadly, it may be a good time to review asset allocation across different classes. Reducing equity exposure by selling some deadweights and rebalancing into other classes may be sensible. Real estate is in the doldrums — will prices move even lower in 2018? Gold is up eight per cent since January but it has seen a correction of seven-eight per cent after peaking in September. Both these asset classes may be worth a look.