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What to do in Today's Market

The markets may be volatile but investors should keep a cool head & choose equity as a good long-term bet…

Inflation has crossed 12 per cent. Interest rates are rising. Individuals with home loans are struggling to cope with the higher Equated Monthly Instalments (EMIs) and simultaneously deal with inflation.

In the stock market, the bulls are constrained by concerns over the macro-economic scenario domestically, the grim global scenario, persistent Foreign Institutional Investor (FII) outflows and the possibility of another round of monetary tightening. That does not mean the bears have a free hand. The correction in commodities, especially crude, provides ample ammunition for the bulls to conduct a short-term rally.

Investors who flocked to gold as the 'safe asset' were disappointed at the way the price dropped in August. Real estate rates too have dropped and by all indications will continue to fall. No asset seems to be a safe haven anymore.

The only asset that beckons is debt with interest rates rising. But would it make sense for an investor to move into debt? While this is a good time to reassess one's portfolio, it would not be wise to simply rush to income funds, Fixed Maturity Plans (FMPs) or fixed deposits. Read on to figure out how to make the best in such a bleak market environment.

Don't let market conditions determine your asset allocation

Unfortunately, for most investors, it is often the bull or bear run that will determine their preference for a particular asset. During a bull run, they will all flock to equities and when the market crashes, everyone is suddenly paralyzed by market uncertainty and fear. Which is really ironical, since the risk of losing money at 13,000 is much less than when the Sensex is at 20,000. In 2002, when the Sensex was around 3,200 levels, inflows into equity mutual funds were Rs 4,517 crore. In 2007, when the Sensex was in the range of 14,000 to 20,000, inflows into equity mutual funds totalled Rs 1,07,189 crore.* Investors were far more willing to buy equities at higher rather than lower prices!

Right now, when stocks are getting whipsawed and interest rates appear seductive, the instinctive reaction is to run to a safer haven. But abandoning equities now and moving to debt and cash would be a mistake. Those who under invest in stocks are left flat-footed when the market recovers. And equities, as an asset, must have a place in your portfolio. Irrespective of the state the market is in.

In fact, if your equity holdings have been beaten down substantially, then you could make some refinements to your portfolio. Check to see by how much your portfolio has deviated from your predetermined allocation. If your equity allocation has fallen substantially, you should focus on increasing it. Stay focussed on your strategy. Not on the market.

Now is a good time to consider equity

It would be wise to look at the experience of renowned investor, the late Sir John Templeton. His investing mantra was simple: Buy at the point of maximum pessimism. In other words, as an investor, he relished adversity.

A typical buy-and-hold investor, Templeton identified stocks that were trading below what he estimated to be their actual worth. He then was prepared to wait till the market recognised the value of the stock and the price corrected. In reality, it is always the opposite that takes place. As the market peaks, almost anything is touted as a "can't miss" investment or fund. Consequently, traditional measures of an asset's worth go by the wayside. Instead of running to the hills, investors run in droves to the market. They buy for no other reason than the belief that the investment would go up. When the market tumbles, as it did this year, investors run to debt or hold cash.

The late Shelby Cullom Davis, a New York investment banker, former U.S. ambassador to Switzerland and well known value investor, once said, "You make most of your money during a bear market; you just don't realise it at the time." Wise words for an investor to keep in mind!

Not every beaten down stock or sector is worth buying

In the phenomenal bull run over the past few years, risk has almost been an afterthought as investors plunged headlong into growth stocks and took heavy sector bets. Now the winning formula is probably a more conservative mix that's mindful of heightened volatility. Investors would do well to gravitate towards large and stable companies that have a better chance of weathering a market storm.

But of course, that does not mean there aren't any great stocks in smaller market caps. What we are saying is that nothing will substitute smart, bottom-up stock selection.

Ditto for sectors. Between January 8 and July 15, 2008, the sectors that got hammered were real estate, construction, power, capital goods and banking. But that does mean you should run away from them. Neither does it indicate that you should mindless shop for stocks within these sectors. Only if you find good undervalued picks, go ahead and buy them.

But, if you have not done your homework on investing in a stock, you should not be investing in it.

And, don't just dump your fund if it has performed miserably. Check its performance regularly with its peers. Keep track of the portfolio to see if the fund manager is making any significant changes.

Don't try to time the market

It's difficult to predict when a bull run will peak. By the same measure, it is impossible to call the bottom. All bull and bear markets will exhibit periods that look like reversals, but are just momentary before the bull or bear regains control.

There are three things you should be absolutely clear about.

The first is that you do not know when it is "safe" to get into equity. No one knows that. No one knows when the bull run is ready to resume its pace.

The second is the wrong assumption that it is alright to change your asset allocation guidelines as and when it pleases you, with no regard to a change in your personal situation but with sole reference to the market situation.

The third is that your gut-level feel about the end being near is a good recipe for disastrous investment decisions.

If you have been investing via a Systematic Investment Plan (SIP), please continue. There is no reason why you should stop. If you have not been investing via a SIP, please start. Don't try to invest lump sums when you think the market is at a low.

The same goes for timing the cycles of other assets. When equities are down, investors tend to find solace in what's perceived as "safer" - recently that was gold. When the price fell recently, they were a dismayed lot. If you do not have a valid reason for investing in a particular investment or asset, stay away.

You will be rewarded for staying cool

It's not easy to step back for perspective when you are gasping for air as your portfolio value plummets. But any sensible long-term investor will tell you that bear markets are setting up the next bull market. They are also keenly aware that bull markets don't run forever.

So it is only natural that in a volatile market investors should expect some short-term losses in their portfolios. Even a great company's stock can get banged around in a tough market. But that does not make you a loser (though you may look like one). While the old "buy and hold" mantra may seem like cold comfort at times like this, rest assured that it has a better long-term record than market-timing.

Once again we reiterate our earlier point. Now is a good time to get into equity and you will be rewarded if you have a time frame of at least three years. With the near 30 per cent fall in the market from January 2008, Forward P/Es have fallen sharply and are now at reasonable levels. India's Fwd P/E is now 14.2x (July 2008), down from 20.4x (January 2008). Over the past 20 years (July 31, 1988 -July 31, 2008), equities, as measured by the Sensex, have given investors a return of 17.16 per cent per annum.* So the problem is not with the asset class but with the approach to equities and the investing strategy of individuals.

This too shall pass!

However bleak the scene appears, it is not here to stay forever. Bargain valuations are available only in such times. But the key is to understand whether "such" times are temporary or long lasting.

The current bearish phase has been the result of the spike in the price of crude and steel and commodities. The result was inflation, higher interest rates and the worsening of the fiscal deficit. Over time, these issues will be resolved. But as long as fundamentals remain strong, we have nothing to fear. If the fundamentals deteriorate significantly, the reverse will take place. The structure of the economy, the strong corporate balance sheet, increasing household income without too much debt on their books, rising consumption levels, high savings rate - will ensure that the slowdown in India is not severe.

Equities have fallen before and they will fall again. The last bull run ended in March 2000. The three-year bear market that followed was pushed by the tragedy of 9/11 and a recession. Finally, the market bottomed out in October 2002. From then on, it scaled impressive heights. Along the way, there have been some significant dips followed by a continuation of upward pressure. But in the end, companies with good fundamentals will weather the storms that sweep the market and the economy.

The lesson here is straightforward. Stocks are excellent long-term investments, but dangerous short-term bets.

*These figures have been provided by HDFC Mutual Fund in a note sent out by Prashant Jain.