It is not unusual for the stock index of a growing economy to reach new peaks. While the journey is not linear, an informed and seasoned investor who has set a summit in terms of a long-term financial goal will not abandon the climb just because he has reached an interim peak or has to cross over a trough in between.
In the investing world, those troughs are the pockets of uncertainty and anxiety characterised either by a lack of information or our inability to process it. Exiting long-term equity portfolios during these periods of uncertainty is akin to a climber abandoning his climb only because fogs of uncertainty restrict his vision of the next peak or the final summit.
Currently, we are around 9% higher than the previous market peak during January 2020. For a usual year, this isn't a standout performance yet. However, it's a whopping 77% higher than the March 2020 low point. So, what is driving this rally and what should investors do?
We need to remember that stock markets are forward-looking machines. Hence, they recover and fall faster than the economy. Investors - domestic and FIIs are investing in businesses in India that they believe will come out stronger post-COVID-19 either because of change in consumer behaviour, healthy balance sheets, improving earnings due to cost savings or just consolidation.
Valuations of companies also get a bump up as the rate at which one discounts future cash flows is lower. Above all, the speed of development of coronavirus vaccines across the world and a decline in the growth rates of fresh cases has given adequate confidence that most economies will completely open up by end of 2021.
That's sufficient visibility for the market to look ahead. Having said that, the current market rally has also been aided by global liquidity created by aggressive fiscal and monetary stimulus by all economies. The top 20 economies alone have printed close to 7% of global GDP and distributed it as a direct stimulus.
Money chases growth and with low interest rates and limited options in fixed income, it is chasing equities, gold, distressed real estate, and technology sectors.
For an investor, could all these challenges related to COVID-19 and the sharp recovery have been foreseen? Clearly not. However, one can avoid falling off the cliff during such market corrections or benefit from the sharp rise of the market by employing a safety harness of disciplined asset allocation.
This ensures that you are on an interim perch from where you can resume your journey to the summit once the fog clears. As the peaks or troughs of all asset classes are never synchronous, moving money between asset classes sets the investor on course to the summit in a surefooted manner.
One does not get out completely from an asset class but typically moves money between them depending on the view of each asset class and the overall long-term asset allocation.
Such switching or tactical allocation is restricted only within a narrow range of the long-term predefined strategic allocation as one can see only some distance through that fog and must keep climbing nevertheless.
Asset allocation is nothing but how you divide your financial investments between equities, fixed income, and other asset classes like gold or real estate.
A disciplined approach to asset allocation ensures that you balance your portfolio to handle interim challenges in each asset class from time to time. This also ensures that you don't go overboard or are under-invested in a specific asset class.
For example, when equities slumped in 2019, the bond market was reaching new heights as interest rates were brought to historically low levels.
By going overweight on fixed income in April 2019 one could take advantage of the interest rate cycle. Similarly, by increasing allocation to equities post market correction in April/May 2020, one could have taken advantage of the sharp rise in equities in the last three-four months.
Gold as an asset class too has provided a unique opportunity since last year due to increase in liquidity. A healthy mix of these asset classes limited the downside of even an aggressive equity-oriented portfolio only by -14% even when the equity market corrected by -38% between January to March of 2020.
For a more fixed income-oriented conservative portfolio, the extent of fall was limited only by -4%. Creation of the right asset allocation can be sought from a professional financial planner or a wealth manager.
At present we draw comfort from the fact that the economy is back on the recovery path, although it's uneven still across time and sectors.
Conclusion of the US election and discovery of vaccine has put a lid on the two major event risks that we faced.
The corporate sector has displayed tremendous resilience in posting year-on-year (YoY) growth in profits amidst falling revenue, essentially through a variety of cost-cutting exercises.
The Atmanirbhar Bharat scheme launched by the government is expected to lay the foundation for a manufacturing revival, helping boost the economy and in turn the equity market over the medium term.
However, valuations are clearly on the richer side and a gush of liquidity flow from FIIs has taken markets to historical highs.
Taking all these into consideration, investors should stay invested in equities as per their long-term asset allocation and not get carried away by over investing in them.
Stay away from complex and exotic equity products. It may also be a good time to get your portfolio evaluated by a professional wealth manager or financial planner to move out of poor-quality investment products or stocks. Staying invested is the only way to reach the summit at the end.
(The author is CEO & MD, ASK Wealth Advisors)