Too much sweetness elicits an aversion for sweets. Considering the way the are markets turning out to be, this dictum seems to have a reigning aptness. After endless claims that of the peak that the markets is yet to achieve, and the harangue of experts on the powerful bull-run, of late one observes a gripping pessimism and cautiousness.
In fact, after the unravelling of the subprime mortgage issue, which is yet to get demystified completely, signs of the US recession, the Fed cuts, dismal January IIP growth, and lower growth estimates ahead, have reinforced a perceived belief ? Are we in a bear phase? Here is an analysis to gauge the signs of a bear market and the steps you should take to stay afloat or at least affected by these markets.
Signs of recovery
If one looks at the statistics of the BSE indices as of January 7, 2008, the Sensex was down by 28%, mid-caps crashed by 41% and small-caps plummeted by 48%. A comparison of these numbers with the previous crash in May 2006 demonstrates that the May 2006 decline was less steeper in terms of percentage, except for the Sensex. The Sensex, midcaps and smallcaps declined by 29%, 38% and 41% respectively from their all-time highs.
The volumes in the recent crash also showed sluggishness and lesser involvement of the high networth investors (HNIs) and institutional players, due to uncertainty about the near-term trend. Also, considering the lower estimates ahead and overstretched valuation, there was a need for a healthy correction. And subsequently, a lower price-earning multiple as compared to 22(x) when the index was at an all-time high was expected.
No doubt the Sensex is at a six-month low, the charts don?t show any signs of recovery. Volumes are dismal and most of the time, the markets open with a gap-up or gap-down. This suggests volatility and uncertainity in the near-term. This may signal a bear phase, but the fundamentals of the economy are intact due to higher consumption and investment.
However, this correction can also be considered as a temporary phenomena and a period of consolidation to set aside room for the market to rebound with new sectors and stocks. It is true that the total asset size of mutual funds and insurance companies have grown dramatically over the period and particularly in the bull run. The present size could be enough to sustain the market at a certain level. But this is a known fact and history signals that FIIs (foreign institutional investors) are the biggest triggers of India?s equity markets. And looking ahead, growth will be dependent on global liquidity.
The most important question remains ? what to do now? Should we liquidate our portfolios, is down by around 30%-40% or hold on for some more time? In this uncertain period, investors can use a few strategies, depending on their risk for appetite and preferences. Here are few of them:
High growth & momentum
Every investor wants to earn higher returns in lesser time. This has always attracted investors towards growth-oriented companies and momentum stocks as both move faster than defensive and dividend-yield stocks until the markets are good and going up. When the market declines, moementum stocks take a much more sharper decline and plummet faster due to higher price-earnings multiples. No doubt, growing companies are smart investments, but one must look at the past run-up in stocks. If the stock has delivered quick returns in less time, then the chances for its rise would be less. If you want to take exposure then one should book profits in the short-term.
These stocks can be bought after a heavy correction and by checking the price-earning multiples. If the price-to- earning growth ratio (PEG) is less than 1.5, it is said to be fairly valued and can be bought at this level. However, you cannot afford to ignore checking the track record and ability of the management to deliver the good results year-after-year.
Momentum stocks tend to be affected more by technical and herd mentality rather than actual fundamentals. In the bull phase, you will find lot of momentum scrips going up tremendously by almost 10-20 times. Your broker may have recommended some of the scrips and may not tell you the story behind the market runup. If you ignored a scrip and suddenly saw the same scrip having gone up by five times, and bought it to avail of the returns, You’re in trouble. You may just become a victim, because that might be just the end of the run-up. Sometimes this may not be the case, and you could actually be lucky and get rich. But the point to be observed here, is that if you desire to buy these stocks, then watch the stock price run-up on the charts. Set a price target, and offload the stock when your stocks reach the target levels.
Dividend yield
In this financial markets, a company which declares continuous dividend to its shareholders signals good track record and strong business fundamentals. This also shows the confidence of the management and increases the predictability and stability of the business. There are various companies delivering very good dividends every year.
These companies mainly cater to pharmaceuticals, auto ancillary, banks and the FMCG sectors. Though, these companies have slowed down over the years due to maturity in the markets, they are stronger in terms of generating cash flows and disbursing more dividend. Investors can go for companies with net yields in the range of 5% – 9%.
However, from the market point of view, they are less volatile and have lower beta. ?With moderation in growth and high volatility in the markets, it will be good for investors to allocate around 10%-15% for dividend yield stocks,? advises Mahesh Patil, fund manager, Birla Sunlife Mutual Fund.
The recent crash has seen a decline in a large number of scrips including those of high-dividend yield companies. Most of these companies command a price-earning (P/E) multiple of less than 10. Now, the prices have declined much more than the previous year which would ultimately increase the net dividend yield receivable. In addition to this, is the closing of books at end of the financial year on March 2008, when the companies declare final dividend which is tax-free in the hands of investors. Investors can expect a dividend within four to six months depending on the companies? book closure and annual general meetings.
The flip side is that companies falling into this category do not provide good capital appreciation as compared to momentum or high-growth scrips. Investment in high dividend yield stocks should be for more than five years.
Some more strategies
For those who are risk-averse, the best strategy is to invest systematically. A majority of the investors neither have any idea or the necessary skills to invest. For them, mutual funds are the best route and they should go for a SIP (systematic investment plan) despite the lump sum investment required, considering the present market conditions. An SIP can mean investing ona monthly, quarterly, half-yearly and yearly or on a specified fixed-day basis. This averages the cost price per unit over the specified period and minimises the impact of risk during volatile periods.
Investors with little interest in equity can now go for liquid- and money-market mutual funds which give them annual returns anywhere in the range of 6% – 9%. There are some investors who bought scrips at higher market levels and are still holding on to them.
There are number of mid- and small-cap stocks with correction in the range from 30% – 50% with some having a correction of 50% or more. So, investors may have seen their portfolio value declining by around 40%. One should avoid selling at these levels, if there is no immediate requirement. If the investor is in need of funds, it is advisable to take a loan rather than liquidating his portfolio of which he will lose 40%, which is not a smart decision. Investors are better advised to take a personal loan which is available at 12% -15% interest rates and give time for their portfolios to grow. However stocks, with no track of good fundamentals and having been bought for short-term gains, could be liquidated on a case-to-case basis.
Lessons and markets ahead
The current market environment reflects a high risk-high reward kind of opportunity. Do not invest by taking loans from banks. If you have idle money, then it is best invest in this type of market. Don?t take exposure in futures and options if you do not have adequate knowledge. Build a portfolio like you make friends. Over a period, retain the good and helpful ones and discard bad or unused stocks. This requires complete dedication and comes only from a continuous tracking of a portfolio and its specific stocks.
If you want to invest now, make a wishlist of companies and the approximate price range you can afford to buy them at. This will open up a lot of opportunities at comparatively lower prices. If you wish to invest in stocks of you choice, then try to keep as much cash as you can in your account to buy the stock when it reaches the appropriate price point.
Recovery in the market requires some positive news from the March-quarter earnings which would provide a complete picture of the current year. Uncertainty about elections due to disagreement by the Left on the Indo-US nuclear deal may prove to have a negative impact on the market, irrespective of good corporate earnings.
