Investing for a comeback: 88% Nifty stocks trading below 10-year average

Sumit Agrawal

Indian markets have joined global peers in a massive equity sell-off led by fears of a sudden and swift economic slowdown, given the novel coronavirus pandemic.

We have deployed enormous humanitarian and economic efforts to manage and recover from one of the biggest health crisis of our time.

From an investor’s perspective, the sharp fall offers an opportunity to have an equity exposure from a medium to long-term perspective. Historically, markets have always behaved extreme in the short run to any adverse developments led by aggressive investor reactions.

Only when the dust settles, and sanity returns, the prices tend to re-adjust to the new economic realities. In 2008, while the market corrected by 60 percent from its January high, the Nifty EPS for CY2009 was only about 20 percent lower than CY2007.

What followed in CY2009 was a strong 75 percent rally in the Nifty.

Likewise, positioning portfolios accordingly to take advantage of any mispricing and possible recovery, is going to be a key call for any investor today.

Like in cricket, playing the right players for the right pitch is most important, so is choosing the right market segment to take advantage of a comeback.

A realistic assessment of the current situation points to only a gradual recovery after a weaker near-term moderation in growth.

In this context, the large-cap segment of the market seems to be the best positioned to limit drawdowns and recover earlier as normalcy returns.

This is primarily driven by its ability to navigate the near-term cyclical slowdown and at the same time be resilient enough when things improve.

In the year 2008, the Nifty made a bottom in October, quite ahead of BSE Mid Small cap index which made a bottom only in March 2009.

Thereafter, equity markets witnessed a strong rally in April 2009 and the Nifty returned 37 percent in six months from its October lows. The recovery in the BSE Mid Small cap index was however much lower at 22 percent.

Similarly, in CY2011, Nifty contained its worst drawdown to 24 percent versus 36 percent for the S&P BSE Mid Small cap index. This reflects well about the ability of large caps to limit the drawdowns and stage a quicker comeback as well.

After the steep fall from the recent highs in January this year, valuation in the large-cap space has become favourable after a long time.

The 40 percent fall in the Nifty from its January highs to the March lows, took its one year forward P/E to a level close to 11x.

These are the similar valuation levels that acted as the market bottom in the three significant market declines in the past 15 years, except the global financial crisis of 2008, where the market bottomed at about 8x one year forward P/E.

It would also be wise to do a similar analysis based on trailing earnings. Nifty trailing P/E hit a low of 14.7x in March, which is roughly one standard deviation below its 20-year average. Similarly, on a P/B basis, the valuations are closer to its 18-year low.

Going deeper into Nifty constituents, we see that 88 percent of the Nifty stocks are trading below their 10-year average valuations on one-year forward earnings. Of these, roughly 65 percent of the stocks are below their one standard deviation.

Generally, investments at such valuation levels in the past have yielded high teens annualized returns on a two-year horizon. While timing the market bottom has been a holy grail forever, we believe these are attractive valuation levels from a risk-reward framework.

Historically, sector-leading companies are found to be more resilient when in a recovery stage, and hence increasing equity allocation here would be a wiser decision at this juncture.

Lastly, for investors, in such times, it is far more important how we behave rather than how our investments behave.

Not reacting to panic, sticking to asset allocation, timely rebalancing, and positioning portfolios in companies with sustainable competitive advantage would go a long way in minimizing the damage and using volatility to our benefit.

Note: Mutual fund investments are subject to market risks, read all scheme related documents carefully.

(The author is Vice President – Fund Management (Equity) at IDFC AMC)

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