Ride through stock market bubble with ease
NEW DELHI: It must be tempting for many retail investors, who stayed away from the equity markets even as markets churned high double-digit returns amid a crashing economy, to take a plunge in the equity and make quick bucks.
The temptation to make hay while the sun shines may even make them ignore the warnings of a likely asset bubble by none other than the Reserve Bank of India (RBI).
If you are sitting on the fences, waiting to enter the market or make additional investments, the contrasting sentiments coming from a rather bullish equity market and a gloomy economy with RBI warning of a possible bubble, may confound your confusions.
How should retail investors, then, wade in a market that seems to disregard the turmoil on the economic front?
The answer is to not let exuberance get the better of old school investment fundamentals and keep their eyes open for obvious risks.
Ignore the bubble at your own risk
The equity markets have been rising as if there’s no tomorrow.
The NSE Nifty is inching towards the record 16,000 level, while the 50-stock index BSE Sensex is all set to scale its previous high of 52,516 in coming sessions. While Sensex rose over 100% from its 23 March 2020 (when lockdowns were announced) levels to the peak of 52,516 on 15 February 2021.
In 2020-21, Sensex returned 68 per cent, even as India’s GDP contracted 7.3 per cent. The ‘irrationality’ of the market was evident when Sensex gained over 3,154 points, or 6.5 per cent, in May 2021 amid one of strict lockdowns with almost all business activities operating at a limited scale. This was the sharpest gain seen in May during the past seven years.
Amidst this sheer contrast between negative economic growth and asset price inflation, the RBI warned investors about a possible stock market bubble in its annual report for FY21.
“The deviation of the actual Price/Equity ratio from its long-run trend shows that the ratio is overvalued. Measures of dividend yield also signal that markets are getting overpriced,” the RBI stated in its annual report. The Sensex is currently trading at a P/E ratio of 32 against a 5-year average PE of 24.53.
Expect a correction
“If you look at the current relations between the stock market and the fundamental value of companies, it resembles a bubble scenario,” says HK Pradhan, professor of Finance and Economics, XLRI, Jamshedpur.
However, he explains, investors are mostly driven by the prospective corporate earnings, a likely demand pull supporting a robust economic recovery as well as an improvement in profitability as many companies have responded with several cost cutting measures and digitalization.
Nonetheless, he sees markets to fall by 10 per cent from current levels in near future as there are significant downside risks such as expected higher inflation, rising global commodity prices, particularly crude, and the US treasury yield due to higher inflationary impact as well.
Deepak Jasani, head of retail research, HDFC Securities, says there could be pockets of bubbles in our market and whenever corrections set in, these pockets could see a sharper fall than the rest.
Siji Philip, senior research analyst, Axis Securities feels that the current market rally has been supported by ample liquidity through high foreign portfolio investment (FPI) inflows and sharp rise in direct participation of retail investors.
Foreign institutional investors have brought in $37.6 billion into Indian equity market during 2020-21.
While Philip continues to be bullish, she feels the key risk in the near term will be delay in unlocking beyond June.
Stick to investment fundamentals
No matter how the equity markets are behaving, retail investors should stick to basic tenets of investments - diversification, asset allocation, rebalancing of portfolios.
According to Dhirendra Kumar, CEO of Value Research, the sharp corrections are a normal feature of equity investing so no one should be surprised by them.
“Sensible and thoughtful investors know this well and are always configured to deal with them through their asset selection, diversification and reallocation strategies,” said Kumar.
Jasani of HDFC Securities said that retail investors should check whether their current equity allocation is higher than what they had planned and if they have, bring that down to the planned ratio.
Investors should also not go down the quality ladder as the market keeps rising and avoid penny and so-called turnaround stocks.
Philip of Axis Securities added investors should follow a stock-specific approach and invest in fundamentally sound companies with good corporate governance.
Market corrections should be used as an opportunity to build a portfolio of such stocks, she said.
Understanding “Bubble”
The term "Bubble" generally refers to a situation where the price for something—an individual stock, a financial asset, or even an entire sector, market, or asset class—exceeds its fundamental value by a large margin.
Because speculative demand, rather than intrinsic worth, fuels the inflated prices and the bubble eventually but inevitably pops, and massive sell-offs cause prices to decline, often quite dramatically. In most cases, a bubble is followed by a crash.