Two major lessons from the extraordinary stock market experience of 2020 are - don't panic in a crisis and two, remain invested in quality stocks. 2020 reinforced the market dictum that 'it is impossible to time the market and what matters is the time you spend in the market'. When the Nifty staged an incredible recovery of 85 percent from the March lows, those who remained invested got excellent returns and those who continued investing during and after the crash got fabulous returns. Those who panicked and fled from the market – unfortunately many did during the crash - lost heavily.
Now, with the benchmark indices at record highs, the relevant questions are: What can investors expect in 2021? What should be the ideal investment strategy, going forward?
Two facts are important. One, the markets are richly valued and, therefore, are vulnerable to corrections. Two, liquidity, which has been the prime driver of the market in 2020, is likely to remain strong in 2021, too, supporting the markets or even taking it further up from here. Since valuations are rich, investors need to expect only modest returns in 2021. So, it is a difficult choice for investors. Let us examine these issues in some detail.
Smart rebound in growth, earnings catching up
Even though the economy is in recession, India Inc has done exceedingly well. Segments like pharma, IT, FMCG and, of late, autos have performed excellently. The hit on banking is unlikely to be as bad as feared earlier. Going by the Q2 trends, FY21 Nifty EPS is likely to be close to Rs 500. Indian economy is likely to stage a V-shaped recovery with a GDP growth rate above 10 percent in FY22. If all positive trends fall in place, FY22 Nifty EPS can surprise at above Rs 600.
Overvalued markets are vulnerable to correction
Even if this bull case scenario plays out, markets would remain overvalued with a one-year forward PE of around 24. This is around 50 percent higher than historical valuations. The market-cap to GDP ratio is above 0.9 percent, which is much higher than the historical average of 0.75 percent. It can be argued, and rightly so, that in the new normal of abundant liquidity and abysmally low interest rates, PE multiples can be higher. The problem is that, when markets are richly valued, they are vulnerable to corrections. 'Known unknowns' and 'unknown unknowns' might trigger sharp corrections.
Liquidity can support the market; may even take it higher, but…
But we should not ignore the power of liquidity. The ultra-loose monetary policy and quantitative easing (QE) by the leading central banks of the world has flooded the global financial system with humongous liquidity. The Fed, ECB and Bank of Japan have expanded their balance sheet by $8 trillion in 2020. The Fed has pledged to keep liquidity benign and interest rates near zero through 2023. The promise of this abundant cheap liquidity is the market consensus now. The risk is the consensus going wrong.
Partially book profit; but remain invested
It's a tough choice for investors. However, there is no harm in erring on the side of caution. Since investors are sitting on good profits, partial profit booking is advisable. However, it is important to remain invested. It is quite probable that India is on the cusp of a multi-year economic expansion cycle. If this pans out, the bull market will sustain and grow stronger. So remain invested in quality stocks in performing sectors like IT, pharma, private sector banking, FMCG and Autos. Invest in mid-small-caps through mutual funds. Continue SIPs. If new developments, like the leading central banks changing their accommodative monetary stance emerge, this investment strategy can be revisited.
(VK Vijayakumar is the Chief Investment Strategist at Geojit Financial Services.)Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.