Avoid going overweight on equities, especially hot themes and sectors

Also refrain from exiting the market in the hope of re-entering at a lower valuation

The Indian equity market is currently witnessing a strong upswing.

CLSA’s proprietary Bull-Bear Index is showing a sharp improvement in investor sentiment: from the extreme bearishness of 8.2 per cent in the middle of March 2023, it has soared to an extremely bullish reading of 95.9 per cent.

Retail investors need to maintain a cool head in a market that could heat up further.

Start of a bull run?

Some analysts are of the opinion that the Indian market is on the threshold of an extended bull phase.

“Following an annual growth rate of less than 6 per cent from 2010-11 to 2018-19, earnings growth has improved significantly over the past three years. The consensus expectation is that it may continue to grow at 12-15 per cent over the next couple of years,” says Arun Kumar, head of research, Fundsindia.com.

Previously, due to soaring commodity prices and higher interest rates, the profit margins of Indian companies had squeezed.

Rohit Karkera, co-founder and head of investments, Cervin Family Office and Advisors, sees a positive shift: “The Reserve Bank of India’s (RBI’s) rate hikes have reached their peak and commodity prices have become more benign. These developments are likely to contribute to improved margins.”

A favourable macro-economic environment is likely to support the bull run.

“Inflation and current account deficit (CAD) are under control. The banking system has been cleaned of non-performing assets (NPAs), and credit growth is on the upswing. Corporate capital expenditure (capex) is expected to accelerate,” says Kumar.

After underperforming in 2022, the Indian market is catching up. Says Karkera: “Several uncertainties from last year are getting resolved, such as the path of global inflation, the scope of Fed rate hikes, fears of a US recession, and the potential deep recession in Europe.”

The current rally is being fuelled by robust foreign institutional investor (FII) flows attracted by India’s strong economic fundamentals.

Looming risks

A few global issues persist. Says Kaustubh Belapurkar, director-manager research at Morningstar Investment Advisor: “Inflation in developed countries needs to be monitored closely.”

Global geopolitics continues to pose risks. Says Karkera: “The Russia-Ukraine war or US-China tensions over Taiwan have the potential to escalate.”

A sharper-than-anticipated global economic slowdown could impact inflows. “Moreover, if the Indian market is perceived as overvalued, FII flows could be affected,” warns Kumar. At present, the market anticipates two rate hikes of 25 basis points each by the US Fed. More hikes could dampen sentiment.

Belapurkar says, “With India’s general election slated for next year, many investors may hold off on investments until the results are known.”

Expensive valuations

The substantial FII flows of the past three-four months, coupled with steady domestic institutional investor (DII) flows, have pushed valuations up.

“Although valuations have risen, we are currently in the initial to mid-stages of the earnings growth cycle. There is ample room for earnings to grow further. And, market sentiment is positive but not over-exuberant,” says Kumar.

Belapurkar adds a note of caution, particularly for smaller stocks. He adds, “All three market segments — large, mid, and small — have turned more expensive than their long-term historical averages. Mid and small caps have become more expensive than large caps.”

Navigating a bullish market

Investors should remain focused on their asset allocation and rebalance, if required.

 “If, say, your original equity-to-debt allocation of 70:30 has moved to 80:20, book profits in equities. And, restore the equity allocation to 70 per cent,” says Belapurkar.

Karkera advises profit booking in small caps for those who have made good profits and investing the gains in large caps.

Investors should stay diversified across asset classes. And those with a lump-sum amount should stagger their investments.

Avoid overheated segments

Investors should be cautious not to become overly invested in equities, especially in segments that are performing well, such as mid and small caps.

Finally, avoid market timing. “Don’t exit the market in the hope of re-entering at lower valuations. If the market does not return to current or lower valuations any time soon, you might capitulate and enter at even higher levels,” says Kumar.