How to play on a bullish Stock Market

Since the Modi government came to power, the domestic stock market has been moving in the upward direction. This movement was based on expectations of improvement in the macroeconomic situation of the country and, consequently, in corporate earnings led by lower inflation, easing interest rates, capex revival and enactment of key reforms. 

Three years later, we have already started seeing the benefits of these in the high-frequency indicators, which suggest things are improving in the economy. Reforms that have been put in place have seen results finally percolating to the ground level, albeit at a slower pace. And a result, the stock market has soared to new highs. 

At these levels, investors are in two minds: whether they should invest or book profit. They are getting worried about the risks looming over the market, such as geopolitical worries, pickup in corporate earnings, revival in private sector capex and high liquidity levels. 

Just last week, a risk that worried the market was the low volatility reflected by the VIX, the volatility indicator which fell to 8.5. Given that the VIX has averaged between 13 and 14, this low level of volatility in a bull market could be taken as an indicator that the bull run may be coming to an end. Since then, the VIX has increased to 11 and although markets have shed some gains after hitting all-time highs, the decline has been a marginal one. 

This has brought investors back to their original fear: whether they should invest at current levels or book profits. The point is, we are never going to get a clear signal or even a get-out-now signal from the market. Time and experience has taught us that timing the market does not yield any result. 

Even in times when risks appear to be high or when there is noise related to risks, it is best to revisit the basics of investing to understand whether it is time to invest or exit. And in our view, this is definitely not the time to exit the Indian market and is actually a good time to stay invested. 

The market is on an upward trend and this is expected to continue. The biggest driver for this would be improvement in corporate earnings. Although earnings growth was disappointing last quarter, it was on the expected lines, given the residual impact of demonetisation. More importantly, a persistent decline in earnings seen till a few quarters ago has definitely eased. 

We expect earnings to gain strength over the next 2-3 years. This growth would be supported by macroeconomic improvement and growth, which is in turn based on four pillars – revival and growth in rural and urban demand; public sector-led capex with higher expenditure at Centre and state levels; stability in commodity prices and continued reforms in the economy. 

All these factors should help stimulate demand and, consequently, lead to top line growth for India Inc. Higher growth should help further boost margins, complement stable commodity prices and improve operational efficiencies that most companies have already put in place. Add to this, the benefit of lower interest rates would lead to growth at the bottom line level as well. 

Valuations, on the other hand, do look stretched with PEs for both Nifty and Sensex trending higher than their historic averages. 

However, there are two things that one needs to keep in mind with regard to valuations. First, the indices have undergone changes in composition as a result of which there is a higher weightage now for higher beta and higher PE stocks.But more importantly, valuations are not at all stretched if we factor in the earnings growth, annualized average of which could very well be over 18 per cent over the next two to three years. 

Factoring in this kind growth in earnings, we believe people who remain invested would see healthy returns in the years to come. The biggest gainers would be the companies that are investing on the use of technology and analytics, which could be one the biggest disruptions that we are most likely to see in the way business is done. 

We have already started seeing signs of it in most sectors, particularly in auto, auto ancillaries and banking. Therefore, companies that are ahead in this technology curve and/or are investing in it are most likely to stand out as potential multibaggers. 

As pointed out earlier, it would be futile to try and time the market. Rather it would be better to invest in a systematic and disciplined manner. A good way to do this is by investing a certain portion of funds through systematic equity/investment plans. This can help eliminate the nuances of reading market levels on a daily basis.