Equity Investor? Don’t Panic… Realign!
If irrational exuberance about stocks within retail investors is a sell signal that’s as accurate as any other, extreme pessimism within the same “control group” would be one of the best indicators that it’s time to increase one’s allocation to equities. In fact, studies have repeatedly shown that smart money comes in at the expense of retail investors dumping stocks at or near the bottoms of market cycles.
Anecdotal evidence would suggest that we are starting to experience that kind of extreme pessimism today. Stoppages in equity SIP’s have gone up, and so have panic driven redemptions. Retail investors are getting iffy about their flat to negative returns over the past 18 months or more.
After all, post its stellar show from December 2016 to January 2018, the Indian equity markets entered a challenging period which saw the frontline indices (NIFTY and SENSEX) stagnating and staying range bound – a phenomenon known as a “time correction”. The SENSEX, which was trading at 36,000 levels in January 2018, is still trading at similar levels even 1.5 years later. However, this statistic doesn’t quite capture the bloodshed that’s taken place within the broader markets – small and mid-cap stocks are down 30% to 60% from their January 2018 levels, on average.
This correction has been driven in part by the government’s efforts at mopping up up past messes -cleaning up of bad debt and other financial sector reforms, reforms in the NCLT, allowing mismanaged companies to “fail” instead of propping them up through artificial means and endless lines of credit, the exposing and uprooting of fraudulent corporate activities, reforms in direct and indirect taxes, real estate and land, labour, and so on. This has impacted both earnings as well as sentiment negatively in the short run.
The result is that mid and small cap companies, which have by and large improved their corporate performances in this period, have been beaten down to extremely attractive valuations. Forward P/E ratios of leading indices in mid-caps are now trading at barely 16-17X.
Other indicators, such as the NIFTY’s Earnings Yield Spread with respect to G-Sec Yield trading at 2 standard deviations below the mean, speak favourably for large caps too. In fact, 100 out of the BSE500 stocks are trading below their book values at current prices, making them no less than a steal!
Keeping all these points in mind, it is entirely possible that we are at the cusp of an impressive rally within small and mid-cap stocks.
Interestingly, history supports this hypothesis too. Note how poor years in small and mid-cap stock performances are followed by stellar returns not just on a one-year basis, but on a 3-year basis as well.
The lesson is quite clear: be a smart equity investor. Don’t be swayed by emotions such as fear and panic. Now is an opportune time to display resilience and stay put in the markets. Realign your portfolio towards small and mid-cap stocks and hold on patiently. Switch off the “bubble-vision” and don’t fall prey to doomsday theories that will start floating about en-masse! There’s money to be made, but if and only if you can sidestep your own behavioural traps during this phase.
