Heightened optimism among investors without backing of strong economic data is worrying experts, who say the current stocks rally may not sustain.

The current rally is driven by the liquidity of $17-18 trillion stimulus infused by countries across the world
Indian stock market’s recovery from the lows hit in March 2020 has surprised many. The S&P BSE Sensex, the bellwether index, has recovered around 34% (between 23 March and 22 June), shrugging off surging covid-19 cases, tensions over the India-China border standoff and grim economic outlook. Moreover, April’s industrial production contracting by highest in almost two decades and India’s rating downgrade by Moody’s have failed to dampen sentiment. The heightened optimism among investors without backing of strong economic data is worrying experts, who believe that the market rally may not sustain.

Pricey valuations

The valuations have gone up significantly in a short period of time. “The trailing price-to-earnings (PE) multiple of Sensex has shot up to 26 times from 17 times, while the price-to-book (PB) ratio has gone up from 1.8 times to 2.5 times since 23 March despite weak economic data," said George Heber Joseph, chief executive officer of ITI Mutual Fund.

As per the latest SBI Research report , it might take up to four years to witness the pre-covid growth levels, and a minimum of two years in the best-case scenario. “For India, we project a GDP decline of 6.8% for FY21. India will clearly have a statistical V-shaped recovery in FY22 due to the favorable base effect. Beyond such base effect, it would take at least till FY24, if India replicates the best-case example in history, if not more, before India gets back to pre-covid level growth rate," the SBI Research report said.

Drivers of the rally

The current rally is driven by the liquidity of around $17-18 trillion stimulus infused by the countries across the world to revive their economies.

On the domestic front, the lack of investment opportunities in other asset classes is attracting investors towards equities. Monthly systematic investment plans (SIPs) remained robust at above ₹8,000 crore between March and May. “The influx of first-time investors who seem to be investing in equity in the absence of any other credible avenues of investment is also driving the rally," said Sousthav Chakrabarty, founder and CEO of Capital Quotient, a Sebi-registered investment advisory firm.

Unsustainable rally

Driven by liquidity and hope that the vaccine for covid-19 may soon be discovered and normalcy will return as economies open up, the rally may be cut short if we see a second wave of cases. China has reported a few new cases in Beijing.

“The second wave of covid-19 and possible lockdown, which investors are not factoring in, will bring the market to a grinding halt, and could even see a sharp correction," said Naveen Kulkarni, chief investment officer at Axis Securities.

On the global front, it is expected that the US elections scheduled in November may disrupt the rally as liquidity may dry up. “We expect a lot of volatility in the months going into the US elections. We may see markets going back to the previous bottom (March) near the US elections, as FIIs may pull back," added Joseph.

What you should do

Financial advisers are also cognizant of the fact that the markets are likely to be volatile in the near future. Here is the advice that the planners are giving to their clients to minimize the impact in case the market fall happens.

Increase the STP tenure: Timing the market is not possible even for the experts and staying out of equity can be dangerous as you may miss out on the gains in case the market rally continues. However, advisers are asking investors planning to deploy fresh money in equities to increase the systematic transfer plan (STP) tenure.

Instead of making a lump sum payment, advisers suggest that investors keep their money in liquid or overnight funds and transfer it systematically through SIPs to equity funds.

“We have increased the tenure of STP for our clients from four-five months to eight-nine months, as we expect more volatility in the market in the near term," said Renu Maheshwari, chief executive officer and principal adviser at Finzscholarz Wealth Managers LLP.

“From April onwards we switched to daily SIP instead of monthly SIP for my clients to deploy fresh funds," said Santosh Joseph, founder and managing partner, Germinate Wealth Solutions.

“Given the heightened volatility, we have devised a method to systematically invest 1% of the money on a daily basis. This way the entire money will be invested over a period of four-five months," added Joseph.

A longer STP tenure will also help in better rupee cost averaging in volatile markets. In case the market goes down, you will be able to buy more units at a lower price and subsequently benefit when the market goes up.

Avoid small-caps: The current rally is broad-based and this is what is worrying experts. “As it’s a widespread rally, a lot of stocks which are not fundamentally strong have gone up. It’s the market to tread with caution, especially on the small-cap stocks," said G. Pradeepkumar, CEO, Union AMC. Small-cap stocks have seen a sharper rally despite the fact that the smaller companies are likely to be hit harder than their larger counterparts due to the halt in economic activities because of the lockdown imposed to restrict the spread of covid-19.

The S&P BSE 250 SmallCap index has delivered a return of 38% between 23 March and 22 June. “We are putting in fresh money of our clients in large-caps and are avoiding small-caps completely as of now as we think this is not the time to be in small-caps," said Maheshwari.

The S&P BSE 250 SmallCap index has delivered a return of 38% between 23 March and 22 June. “We are putting in fresh money of our clients in large-caps and are avoiding small-caps completely as of now as we think this is not the time to be in small-caps," said Maheshwari.

Among large-cap funds, following a conservative approach, advisers are asking clients to go for passive funds, as in the recent past actively-managed large-cap funds failed to generate alpha incommensurate to the risk. “ We are opting mainly for the index funds in large-caps due to lower expense ratio and almost non-existent alpha in actively-managed large-cap funds," said Maheshwari.

Cut equity exposure as goal nears: Investors shouldn’t change asset allocation depending on the market performance, as it is decided on the goals of the investor. However, financial planners are advising those nearing goals to reduce exposure to equities. “Those who have less than two years remaining in the maturity of their goals have been asked to shift to an equity underweight strategy to protect the downside risk on their capital," said Chakrabarty.

It is not possible for investors to predict the market or economic cycles. Therefore, they should continue investing and rebalancing their portfolio on the basis of their desired asset allocation. Decide your asset allocation on the basis of your goals and risk appetite and stick to it.