Is this a good time to Invest?
Updated: Dec 29, 2020
I wrote a similar article in April. Things were gloomy and we were all restricted to our homes. Journalists were busy writing on the subsistence level of the economy.
In less than three months, the tone of the same journalists is changed to economic growth concern.
Subsistence to economic growth concern in less than three months is quite a feat.
We have seen that interest rates have fallen and the stock market has zoomed. Is this a good time to invest in equities?
The equity market is driven by the share prices of various companies. But what moves the share price? Understanding this aspect can give us a better view of when to invest and what to invest in.
"In the short run, a market is a voting machine but in the long run, it is a weighing machine." - Benjamin Graham
In the short-term, mood of the market defines where the prices would be going. However, in the long-term, a company's performance defines the performance of the share price.
One of the indicators that I prefer to use is to compare broader market earning yield (NSE500) with government security yield.
Earning yield represents what the market is expected to deliver.
Government security represents a safe return.
What we see here is that the government security yield has fallen but earning yield has fallen more than government bond yield.
Last time when I wrote this article, these yields were quite close. April 2020 was a great time to invest, I recommended the same. I even quoted Warren Buffet:
“Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” - Warren Buffet
Now I will quote Buffet again but not in the same tone.
"Be Fearful When Others Are Greedy and Greedy When Others Are Fearful" - Warren Buffet
The market has skyrocketed in the last few weeks. Most of the traders have parked their economic growth worry in name of COVID 19 vaccine and discounting 2020-21 earnings.
As per me, it is time to apply extreme caution.
We must acknowledge that we are a highly populated country with high domestic demand. Therefore, a portfolio consisting of companies that have an Indian supply base as well as consumer base may have and will continue to do fine.
A lot of these companies have risen to high price levels, any price fall should be used to accumulate.
There are high-quality companies in small and mid-cap space. It is time to build a portfolio in small and midcap space. Here is an article that will explain the method to identify great companies. Click here >>
Mutual fund investors should continue to invest in SIPs. Get rid off average performing mutual funds and stay invested in good funds within the categories such as large-cap, midcap and small-cap.
Yields are expected to go down further but the major fall has happened. We are probably still away from the rise of inflation. What does this mean?
The rates will come down further and stabilize for the time being.
In these situations, a lot of companies with debt may default, especially those that are not backed by cash flows. Even if they do not default, declining cash flows may cause credit downgrade, leading to mark to market losses in your debt portfolio.
It is advisable to move into government security-based mutual fund(s) (short term/liquid) or a fixed deposit with a solid bank (SBI/HDFC bank etc).
Be prepared to see a lot of volatility in the coming weeks to months in both equities and corporate debt. Three months back, a category based investment would have done well. Now, you should be selective and cautious.
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