It's time to trade carefully as equity markets hit lifetime highs

With the markets trading at above fair valuations, investors should eschew risky bets

The leading stock indices have been hovering around their lifetime highs. The BSE Sensex crossed the 53,000 mark in intraday trade this week for the first time in its history. The Nifty 50, too, is trading close to the 16,000 level after hitting a lifetime high recently.

Meanwhile, retail investors have entered the stock markets in large numbers over the past year. A State Bank of India Economic Research Department study has pointed out that the number of individual investors in the market increased by 14.2 million in FY21, with CDSL gaining 12.25 million new demat accounts and NSDL 1.97 million. Another 4.47 million demat accounts were added in April and May 2021.

Investing in equities when the indices are trading near all-time highs poses a few challenges. Even as the markets continue to scale new highs, every time there is a dip, investors fear it might be the end of the current bull run and the start of a long and deep correction.

March earnings provided a boost

The markets have reacted positively to the fall in Covid cases. The March quarter results also provided a boost to market sentiment. “Corporate profitability remained on track and most expectations were met. Buoyed by this performance, the forecasts for the next year have gone up, albeit marginally,” says Rahul Singh, chief investment officer-equities, Tata Mutual Fund. He expects the impact of the second wave of the pandemic on earnings to be limited to the June quarter.

Inflation has emerged as a key threat. High fuel prices could raise transportation costs and result in generalised inflation. If inflationary expectations get embedded, they could affect consumption and delay the economic recovery.

How the US Federal Reserve tackles the inflation threat will have a bearing on the markets. “If interest rates in the US move up in response to a spike in inflation, the Indian market could also see a correction. If not, then our market will remain supported and any correction here will be shallow,” says Singh.       

Another risk could arise from the fact that demand may not bounce back quickly after the second wave as the rural economy has been affected more this time than during the first wave.

Stick to long-term goals

Investors must tie their equity investments to their long-term financial goals. Instead of getting swayed by market gyrations, they should stay invested for the long term. Cashing out early in a bull market can lead to disappointment if the market continues to move ahead. “Do not lose track of your financial goals. Equities move upwards over the long term, so link your goals to your investments to reap the benefits over the long term,” says Sanjiv Bajaj, joint chairman and managing director, Bajaj Capital.

Past returns unlikely to be repeated

Investors should not enter with a short investment horizon expecting the gains of the past year to be replicated. “We do not see the markets replicating those kinds of returns in the near term. At this stage, markets are trading above their fair value. Clearly, investors need to temper down their expectations,” says G Pradeepkumar, chief executive officer, Union Asset Management Company. According to Singh, equity returns are likely to track earnings growth and the scope for re-rating is now limited.  

After such a significant run-up, many new investors are worried about a steep correction eroding their gains. One way to deal with this issue is to have an investment horizon of at least five years in any equity fund you hold. If the expected cyclical recovery in the economy materialises over this period, it will lead to improved earnings, and that would translate into good returns from equities.  

Those who are worried about a steep correction in a pure equity fund should shift to a hybrid fund. “The optimal choice for most first-time investors who would like to see lower volatility in their portfolios is to invest in hybrid categories such as Balanced Advantage Fund. These funds are built on asset-allocation principles. When the markets are expensive, they reduce their allocation to equities and vice versa, so investors are spared the worry about timing their investments,” says Pradeepkumar. More conservative investors may opt for Equity Savings Funds. Investing systematically will also help investors deal with the current high valuations in the market by averaging their cost of purchase.  

Avoid sector and thematic funds

Some sector funds have done very well over the past year. Technology funds have given a category average return of 103 per cent while infrastructure funds have given around 70 per cent.

Experts, however, say that predicting which sector will do well in the future is difficult, so it is better to invest through diversified-equity funds and let fund managers take sector-related calls.

Stay with quality companies

The BSE Small-cap Index is up about 100 per cent over the past year, outperforming both the midcap (71.5 per cent) index and the Sensex. In a market rally like the current one, stocks of many smaller companies with weak fundamentals also start attracting investor interest and begin to run up. Investing in such stocks is fraught with the risk that if and when the markets correct, these stocks tend to be hit the hardest. And often these stocks don’t recover when the market recovers next. “Investors should be mindful of focusing on the fundamental strength and growth durability of the business,” says Anand Radhakrishnan, chief investment officer-equity, Franklin Templeton India.

Trade only if you have skills

Many investors have taken to stock trading. If you are one of them and are making money out of it, then do make the distinction between luck and skill. If you have been earning on someone else’s advice or out of sheer luck, it is time to be careful. Also, avoid leveraged bets.

Finally, invest in line with your asset allocation. Split your investments among stocks, fixed-income and gold according to your risk appetite. If your equity investments have run up significantly and you have become overweight on this asset class, book profits.

Table: Top performing balanced advantage/dynamic asset allocation funds over five years                  

Fund	Returns (%)
	1-year	3-year	5-year
HDFC Balanced Advantage Fund

49.8 12.9 14.6 Edelweiss Balanced Advantage Fund  35.9 14.9 13.8 HDFC Balanced Advantage Fund (Adjusted-NAV) 49.8 12.9 13.8 Nippon India Balanced Advantage Fund  33.3 11.9 13.2 Aditya Birla Sun Life Balanced Advantage Fund 33.5 12.8 12.8 ICICI Prudential Balanced Advantage Fund 31.4 12.1 12.3 Invesco India Dynamic Equity Fund  25.6 8.2 11.7

Category minimum

14.3 3.0 5.1 Category average 28.4 10.3 11.1 Category maximum 49.8 14.9 14.6

Greater than 1 year returns are compound annualised. These are direct, growth funds; Source: MFI Explorer