Things that investors should avoid doing when market is at record high

Global markets or global factors drive over 50 percent earnings of companies that form Nifty. Linkages in the form of commodity cycles (steel, oil, coal) and global demand (auto, IT services, pharma) determine revenue growth and profitability of India’s best companies. The following tables explains this:

Rising global demand led by US, Euro-zone and China is likely to propel earnings our NIFTY companies linked to this ecosystem. As a result, a massive jump is expected in profitability of some companies highlighted above. Overall, you will realize fundamentals of NIFTY are likely to significantly improve.

Now, how far can this market rally go? Let’s understand the second most critical factor that’s driving rallies in global markets, including ours.

2. Liquidity is abundant

(a) What we know – foreign portfolio investments: you’ve read enough about all-time low interest rate prevailing across the world (including India, to a large extend) and about the strength of foreign money (FPI) into our stock markets. Here’s a table that summarizes how much we’ve received compared with peers:

While many of us could be skeptical about India, FPIs seem to have taken a very favorable view. A surge of income US dollars into our markets is helping lift prices.

(b) What we may have not noticed – Private Equity investments: a revolution is now taking place in India’s investing landscape that affects the listed markets in several ways.

As you will notice, annual Private Equity flows are now larger than FPI inflows in several years. So what? How does this impact stock markets?
Capital markets are no more the only source of long-term capital for Indian companies - they are now able to strengthen their capital base (new capital or deleveraging) by attracting marquee Private Equity investors. This trend is meaningfully impacting the ability of these companies to invest and grow.

To summarize, India’s ability to attract high quality capital will likely to be a big driver in propelling our capital markets. As an investor, you may wish to follow this trend and watch out for any negative surprises.

Now, let’s grapple with healthy skepticism.

When liquidity is abundance and when expectations are extremely bullish, following risks emerge:
• Oversupply of capital makes money flow to the underserving places (penny stocks, low quality…)
• Investors compete in markets by raising prices and accepting a lower margin of safety (heavy subscription in IPOs, valuations beyond traditional metrics…)
• Over-confidence leads to disrespect for risk (buy at dips, leveraging…)
• Risk usually shows up with swift, sharp impact and not sgradually over a period

Here’s what you can do to participate in a growing market and at the same time, avoid massive risks.

1. Don’t chase momentum and buy at peak of popularity: global markets face several unresolved debates – on growth, interest rates, commodity prices, growth vs. value – and therefore, could continue to be very volatile. In these times, its best not get carried away and over-concentrate your investments into cyclical sectors that may see very rapid moves in prices. Avoid, what’s termed as FOMO (fear of missing out)! Remember, as prices continue to go up – it becomes harder for additional returns to come by!

2. Don’t buy what you don’t understand: recent increase in stock market volumes has been propelled by healthy participation from a class of people called retail investors – euphemism for you and I. While it’s encouraging to see a broad-based participation in stocks for wealth creation, it’s equally worrisome to see this participation also growing interest in areas that likely to be hard to understand, for example: leverage (borrowing against your investments to further invest) and derivatives (another way to leverage). If you understand the derivatives – please go ahead - if you don’t – think very hard.

The same principle applies to every other investment you consider – indulge if you can understand the theme, product structure, likely outcomes and risks.

3. Don’t invest your entire capital at one-go; instead, think of how you can align yourself to emerging trends over a period. This may appear tiringly slow in the face of a raging bull market – but is perhaps one of most important ways to protect you from mistakes.

4. Don’t hesitate to cut your losses: if you are an active participant and get hit by extreme headwinds and see a drop in value in some of your investments, have the courage to book losses. Try to understand the reasons behind loss in value and accordingly decide.

5. Finally, ask yourself these questions before every investing decision:

• What’s your process of selecting investments?
• Why should exceptional returns exist, in spite of presence of millions of other investors?
• What could be the worst potential downside, if you’re wrong? Is this acceptable?
• What actions will you take in the event of a sharp risk impact?
• What are your limits on concentration – conversely, what are your principles on diversification?

Happy investing!

The author is President and Head, Investment Management, Edelweiss Wealth Management

Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.