From uncertainty to confidence is what the markets went through from January till date in 2014. And that change of mood is what triggered a 15% rally in the Sensex year to date.
With the BJP-led alliance securing a clear mandate to rule the next government, one expects the alliance to undertake its reform agenda and find viable solutions to macro-economic challenges in as fast a mode as possible. It is for this that the markets have reacted positively and will continue to respond to every single move from here on. If you wonder whether expectations can turn economies, they probably do.
When expectations spur reality
You may have heard of various expectation indices and how they trigger action on the ground. There is the inflation expectation – a survey taken by the RBI;, Purchasing Managers’ Index, a survey of what purchasing managers expect to buy as inputs to produce specific output; Business Confidence index, a survey of how industries expect to perform. These expectations are known to often spur action. Higher inflation expectations for instance, are often known to spur inflation!
So is the case with market sentiments. Expectation of implementation of reforms and policies may well spur corporate investments and therefore corporate earnings.
So how should you tune your expectations to the political and economic events that will unfold in the following weeks, months and years? Here’s our take on it and also on where to put your eggs now:
In the near term, chances are that markets will respond to events such as cabinet formation and announcement of policies and perhaps partly ignore macro-economic indicators, even if they look lack luster.
Also, favourable market valuations could well help many companies raise funds increasing IPO/follow-on/institutional placement offer activities in the market.
But then overall, with earnings numbers coming intermittently, it is possible that markets will react, even negatively, as fundamentals are not going to improve overnight.
Such negative reactions could only be opportunities to buy into the market in our opinion.
What to do – accumulate your existing equity funds on short-term negative reactions by market. Do not try to pick and choose the chart busters. Chances are you may pick the wrong one or worse still, miss the short opportunity while you search for the right funds.
Most analysts have a consensus that there could be no meaningful contribution by companies to the earnings pie until FY-16. That means, earnings would come in later and valuations would stop looking cheap.
However, history suggests that as long as valuations are around the averages, (see graph below on MSCI India 12-month forward P/E), there could be less possibility of returns being capped as a result of valuations running too ahead of earnings.
Now, typically sectors such as banks, auto and industrials are those that are known to benefit from the first sign of a market/economic recovery. Why? First, a market recovery typically gets companies to raise funds to deleverage.
This could in turn provide some relief on the burgeoning NPA size of banks. Markets may take notice of such events given the far-from-high valuations of banks.
Also, often times, logistics activity in the economy, with commercial automobile demand uptick, is a key indicator of economic recovery; so also the purchase of industrial or capital goods an indicator of capex spending. Hence, these stocks are the ones to be re-rated first.
Next, mid-cap stocks that look less expensive and also form part of the cyclical upturn could also be candidates that would participate in the medium-term recovery. Why is this so?
FII money mostly goes into liquid large-cap stocks leaving domestic investors such as mutual funds or other local institutional investors looking for less expensive options but with potential. As is the case, the not so high liquidity in these stocks would often lead to quick upmove in such stocks.
What to do: While most equity funds will likely benefit from a banking rally, we have identified funds that will also benefit from sectors such as auto and auto components and industrials and have recommended the funds in March (see link further down this article for our call). For those who can spare additional sums, this may be a good time to start taking small exposures to such funds.
Over a longer time frame we expect the ‘reforms’ effect to start kicking in. And we picked a few key areas of reforms that could potentially benefit specific cyclical sectors.
What to do: Read this article to know how reforms would help certain segments: Equity strategies
We list down the key sectors that could form part of the reforms effect.
The three funds we had recommended (see article above) – HDFC Top 200, Franklin India Prima and ICICI Pru Discovery– hold good to ride what may be a long-term sustainable rally albeit with short-term corrections.
As suggested, use your existing funds to accumulate over short bursts (or funds we recommend if you do not hold equity funds) and the funds we recommended in March for long-term SIPs.
As fund portfolios change colour, we will, through our weekly call bring to you more funds that are well placed to ride the long-term wave.
Just three points to note before we close this: One, the holding period of your funds need to be for at least a 3-5 year period. While you may use triggers or time your accumulations based on our short-term expectations, you should ideally be running SIPs if the medium to long-term expectations make sense to you.
Two, it is best to refrain from fund chart busters that were never seen earlier, if you were to invest based on the above expectations. You could get yourself hurt especially in sector funds or mid-cap funds. Three, do not lose grip over your asset allocation strategy. This equity strategy does not mean you stop investing in debt.
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