Investors Running Out Of Money; Time For Capital Protection Is Now

A significant selloff may be around the corner & it’s worth reconsidering your equity asset allocation now.

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At the time of writing this article, the Nifty is back to February 2020 levels. From our perspective, markets were expensive in February. It was a bubble then, and now with reduced earnings after COVID and Nifty back to February levels, markets are even more expensive.

Nearing the End of the Liquidity Rally?

In our June outlook (read here), we had written that the current liquidity rally could take markets higher. The Nifty has rallied about 10 percent since then and can even continue higher for the next month or so. In our opinion, we are now in the last leg of this euphoria. Markets will mostly also make new all-time highs because unrestrained liquidity can pump markets to extremes.

But investors must use this last leg of the rally to take some risk off the table, especially if they have significant exposures to equity on their portfolios.

If you buy/hold onto, at high valuations now, it will only translate into lower returns in the future. All companies, irrespective of quality, correct, when a bubble bursts.

Every time I talk about expensive valuations and worsening fundamentals – whether it was in 2018, 2019, or 2020 – the permabulls always negate it with the argument that the ‘trend is your friend’ – and all the possible negatives have been factored into the price. That’s true. Until it isn’t. The reality is that markets are riskier and frothier than ever before.

Major Concerns Today

• Extremely stretched valuations
• Nifty PE crossed 30 for the first time in the history of the Indian stock markets. Yes, PE can expand during a low-interest-rate environment, but that still does not justify 30-32 PE levels
• Bubble-like characteristics
• Tech stocks in the US: the combined market cap of FANGMAN stocks is higher than the GDP of Japan, Germany, India, etc
• The Indian markets have witnessed a broad rally since the March bottom, but Reliance alone has contributed to 29 percent of the Nifty rise
• The CNN Fear & Greed Index is inching upwards towards extreme greed. At the time of writing this article, around 70/100 (check here)
• Selling by promoters
• Aditya Puri sold about Rs 840 cr worth of HDFC in July (his entire stake in the bank)
• Shibulal’s family sold their family stake of Rs 778 cr in Infosys
• Jeff Bezos sold Amazon worth around USD 3 billion in August (this was over and above the USD 1 billion that he usually sells every year)
• If the medium-term outlook was promising in their minds, why would these people sell?
• Bears are going extinct
• Markets are extremely overvalued, but the put and call ratio shows that more investors are bullish in their positions, shorts are disappearing, and greed is returning to the markets
• Until a few weeks ago, people were concerned about the markets. Now they’re neutral, inching towards optimistic. The market wants you to get slack. That’s when most mistakes happen
• US elections
• With the US elections in November, the government will try its best to get reelected and will direct its best energy to have good things happen to the market. However, eventually, the price of all the money printing needs to be paid and any slight disruption to the existing situation can blow this house of cards away.

The current frenzy is fuelled by liquidity and the conviction that quality stocks can never correct, and that the worst is behind us. Generally, at the peak of a bubble, investors are willing to buy at any price because they think the stocks can never go down and valuations don’t make a difference. Today, we are witnessing a bubble formation in the stock markets with worsening fundamentals.

Rethink Large Equity Positions

It is tough to tell when this speculative rally will end, but when it happens, it will happen fast, almost paralysing investors from making sound decisions for their money. We have seen that in February and March 2020 itself.

We have more than ample reason to get out of these frothy markets. What we have right now is a powerful bear market rally and a brilliant exit opportunity.

All corrections don’t give this second opportunity to exit. In 2007-08, investors never got a chance to get out. It would be a missed opportunity to not sell off some equity as the market inches upwards. One must begin profit-booking in parts with every decent rise in the markets, and keep strict stop loss triggers.

‘Markets Are A Repetitive Cycle Of Fear & Greed’

The unwind – in whatever fashion it takes – is going to be messy. I am incredibly concerned about what the state of the market and the entire world is going to be when the bubble bursts.

Because whenever that correction happens, perhaps even in the last quarter of this calendar year, investors aren’t going to have the kind of cash that people had in March 2020 to invest in the markets.

COVID has put all of us in a tight spot; investors are running out of money. Times can get so difficult that even if you have the money, perhaps you might not dare to invest in the markets, especially if you have significant losses in your existing positions.

All I am saying is we are close to the top; what you want to focus on now is capital protection, it is time to become extremely conservative. All existing equity exposure should be carefully revalued at this point since the risk-reward ratio does not favour having significant equity positions.

And of course, many will say: ‘this time it’s different’. But “markets are a repetitive cycle of fear and greed, and you need to figure out which template is at play (Jim Rogers).”

(Disclaimer: This article was first published by the author on her blog and has been republished with permission.)

(Panna Bhandari is Founder, Emerald Investments, Ahmedabad, Gujarat. She tweets @Panna_Bhandari. This is an opinion piece and the views expressed are the author’s own. The Quint neither endorses nor is responsible for them.)