How To Invest For Next Diwali
In the last year, Samvat 2073, financial investors have been awash in a steady, ever-rising stream of good news. Equity assets have consistently delivered that kind of superior returns that delight moderate risk-taking investors. The bellwether BSE Sensex returned a steady 15 per cent last year, not earth-shattering but nothing to sneer at, either.
Considering that stocks were in a corrective mode at this time in 2016 as earnings appeared wishy-washy and companies were sailing on moderately choppy waters, the markets surpassed investor expectations.
Mid-caps fared better. But the segment has not lived up to much of the hype. The BSE Mid-cap Index returned a mere 18.7 per cent, not too much of an outperformance in this booming market. It is the small-cap stocks that have seen plenty of action – and investor returns. The S&P BSE Small-cap Index returned a whopping 26.1 percent in the past year.
Mutual funds also painted a similar rosy picture. Small-cap funds, on average, reaped a return of 26 per cent. Large-cap funds, at 15 per cent, captured the same returns as the bellwether index, while mid-cap funds slipped a step on the return front, to 17 per cent, compared to the mid-cap index.
But now the larger and wider question is: Will financial assets continue to deliver superior, or extended, returns? Which sectors will deliver the most returns? For those of you scouting for where the party might play out in Samvat 2074, this article could be your guide.
Let us get started. Given where we are set on the earnings graph, stocks may not run up too fast. Ultimately, stock prices are directly proportional to earnings growth, but earnings growth has not been really picking up.
But despite the run-up in stocks, thankfully, the markets are far from the over-valuation yardstick. Says Sankaren Naren, ED and CIO, ICICI Prudential Mutual Fund, “Indian equities are yet to reach the bubble stage because, in a bubble, it is generally seen that both foreign institutional investors (FIIs) and domestic institutional investors (DIIs) are buyers. But currently FIIs are selling while DIIs are buying — a healthy sign for the markets.”
Naren continues to add that “the Indian equity market is in mid-cycle as various parameters such as credit growth, capex cycle, earnings growth and capacity utilization, are at its cyclical low points. In light of this, we believe that from a corporate earnings perspective, we are at least two years away from the earnings top. As a result, earnings will prove to a trigger for the market in the days ahead.”
Stock prices directly reflect the quantum of inflows and the amount of liquidity, and on that front the market has been having a ball. Domestic investors have been pouring in money into the stock markets. At first the inflows started off as a trickle and many thought that the pipe would dry up. But now, the trickle is turning into a torrent.
In calendar 2017 till date, domestic investors poured Rs 67,945 crore into Indian markets. SIP money, currently amounting to about Rs 5,200 crore a month, is expected to rise 50 per cent and more in the next two years as investors look for better avenues to deploy investments as interest rates are low. 
Domestic investors poured nearly $8 billion in August and September, and much of it is going into equities. But as foreign investors are pulling money out of the table, there will be bouts of volatility. For you, that should be a signal to make some significant purchases.
So where could investors invest now? Small-caps have run up, mid-caps are pricey. So the only place where there’s a bit of valuation upside given that the earnings growth is reviving is the large-cap space.
“For investors looking for avenues to deploy fresh money should ideally consider dynamic asset allocation or large cap schemes,” says Naren. “Large caps mainly because in the event of a correction, large investors generally tend to buy into large cap names, thereby performing relatively well when compared to mid and small cap names,” he adds.
In the mid- and small-cap space, stocks have dashed ahead of fundamentals. So, here investors will have to exercise caution and make lesser allocations to these sectors. Small-cap stocks expanded in price because of the better operating-performance metrics after the gut-wrenching slowdown in FY13-14 have resulted in huge gains in these sectors.
But in the future, returns may undershoot investor expectations. If you are expecting 20-plus per cent returns, as in the more recent past, you should reconfigure your over-expectations.
Consider the price you are paying for the earnings that companies are at present generating. For large-caps, you are paying a stiff 24.3 times earnings, close enough to the highs of the past. In January 2008, the price-to-earnings multiple hit a high of 28 times before stocks nose-dived.
Second, in mid- and small-caps you are paying 40.6 and 80.6 times over earnings, which is a huge and hefty premium to pay.To be sure, some stocks delivered superior returns following better operating leverage. A slightly higher capacity utilisation has had a multiplier effect on profits, and boosted earnings. But, anticipating the same multiplier effect from earnings to play out now is expecting a little too much from the heated, and further hotting-up, markets, according to analysts. So you need to double the caution this side of the market. 
Yet, there is no denying that equities is still the place to be. The earnings yield on the fixed-income side has dipped to single digits, with returns from traditional bank deposits as low as 6-7 per cent. The simple fact is that most senior citizen investors are seeing a drop in income levels. Simultaneously, stocks reflect interest rates in the market. The lower the interest rate, the higher stock prices can rise. For now, interest rates in India are low, and expected to continue subdued.
To be sure, there are pockets where corporate profits are still likely to throw up a few unexpected surprises. The consumption story is playing out wonderfully as autos continue to deliver on volume growth. Car sales have accelerated in September, despite GST. But here, too, multiples are appreciably high. Consider Maruti Suzuki. The stock trades at a hefty 32.5 times earnings.
Economically, it is not as if the markets were taken by surprise with the hiccups the initial days of GST implementation. “Everybody knew that GST would have teething troubles. Hence, earnings may take some time to pick, but we will see a gradual improvement,” Aashish Somaiya, MD, Motilal Oswal AMC. “If you factor in earnings improvement, valuations are not too high,” he adds.
Sure enough, in sectors such as consumption, earnings buoyancy and steady inflows in investor liquidity would keep stock prices buoyant. In oil and gas, earnings expectations have yet to be reflected in stock prices; hence, that sector may just prove to be good enough to invest in over the coming months. Oil prices are inching up. But with end-consumer prices now market-determined, profitability of oil companies will only turn brighter. Mutual fund investors, however, must continue with their systematic investment plans because of the averaging benefits that occur over long enough periods. If you are considering fresh investments now, perhaps a bit of prudence on your part might not be at all misplaced. In this pricey market, consider balanced advantage funds. These typically tend to slow down, booking profits when markets are rising and adding stocks when markets are falling.
The one thing investors need to be mindful in the boom phase is that investors should respect asset allocation and refrain from opting for any one particular theme.”
Investors aware of the risks in the markets could consider looking-up sectors such as banking or infrastructure. With the economic needle expected to slowly tilt toward growth, banking and infrastructure funds seem to have the potential to amp up investor returns in coming years.
These sectors are still much beaten down and scrips here are going for a song, though with hope that the upswing materialises.
All in all, investing in the present situation is all about weighing risks against returns, then making the right calls. While the risks are not too great, investors must not yet throw caution to the winds – and plunge in. There is no reason to throw good money after stocks that have run up significantly. Instead, look for market corrections, then invest. In the long term, buying on dips has always proved profitable enough for the long run.
The mindset that investors have now to adopt is “downsides are good”. Experts say that investors must avoid chasing those stocks that have already run up quite significantly.
In fact, in the short run, stock markets prove to be dangerously shifty, and jump from one fad or beat to another, ramping up stock prices in the short run. For us, small investors, what is important is to know when the big sharks are dumping good stocks, then buying them in heaps.
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