With Nifty at around 15,200, the market is tantalizingly poised. FIIs have resumed buying, the bulls are in control; the Fed is likely to remain accommodative for long; the economy is strongly bouncing back and Q4 results are expected to be good.
The setting is positive. But valuations are high. FIIs are sitting on huge profits. Profit booking, on large scale, can happen any time. For retail investors, money making has been rather easy in this bull market. But blindly betting on all kinds of stocks at high valuations may not be the right strategy now. So, what should investors do? Let us get the issue in perspective.
We had one of the fastest crashes in market history when Nifty declined by 32 percent in March 2020. Then we witnessed sustained capital inflows that pushed the markets steadily up. As the inflows gained momentum the rally gathered pace and in a spectacular burst, Nifty crossed 15,200 marking 100 percent rebound – a very rare feat in less than a year – from the March lows. All valuation parameters – PE, Price to Book, and Market-cap to GDP – started flashing red.
Bond bears smash equity bulls
A runaway market without much valuation support need only a trigger for correction and that came from the bond market. It is important to understand that the US 10-year bond yield is the single most important financial indicator that can move all markets – bond, equity and currency. And when inflation fears emerged, the bond bears pressed Sell button pushing the yields up.
On February 25, the US 10-year yield spiked to 1.61 percent leading to a sell-off in US equity markets. In EMs, FIIs sold heavily spreading panic and bears charged-in to exploit the opportunity. Nifty crashed 568 points on February 26. The bond bears did succeed in delivering some big punches and the equity bulls were pushed to the corner.
But, that was not a knock out!
The market has a clear logic: Bond yields and stock prices are negatively correlated. That’s why Warren Buffet famously said that “interest rates act like gravity on stock prices”. The bull run following the market crash of March 2020 was largely driven by the ultra-loose monetary policy pursued by the leading central banks, which resulted in historically low interest rates. So when interest rate reverses direction, equities have to decline, because higher interest rates can support only lower PEs.
Equity bulls are back
But there is another interpretation of the rising yields. The Fed chief Jerome Powel was quick to explain that rising yield is an indication of growth recovery. The bond market is discounting the imminent rebound in growth. The Fed chief went on to emphasize that the Fed rate will be kept near zero through 2023 and that the Fed will tolerate higher inflation, if need be. That took the wind out of the sails of the bond bears and the 10-year yield came down and is presently consolidating around 1.41 percent levels. The equity bulls seized the opportunity to charge again ferociously, pushing the badly mauled bears into a corner.
At the end of round one, equity bears are licking their wounds.
Many more rounds to go
This match is hardly over. Bears will stage a come back. At high valuations, risk is high. Retail investors, merrily trading in low-grade stocks, will become sitting ducks in a major bear ambush. So, investors have to be careful in their investment strategy. Since investors are sitting on spectacular profits, some profits may be booked at every leg of the rally. Move some profits to fixed income even if returns are low. Remain invested in quality stocks particularly in financials, IT, cement, metals and segments of autos. Continue with SIPs.
The forward trajectory of this market is likely to be decided by the recovery in growth and earnings. FY22 is likely to witness around 12 percent GDP growth and above 30 percent earnings growth, thanks to the base effect. If we can sustain good growth in GDP and earnings, beyond FY22, this bull will have more legs to run. But, sure, there will be many bumps on the road, with a major bump emerging when the Fed starts tapering.
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