Keep Your Head Above Water: Invest Wisely in Volatile Times

The wave of recent market fluctuations has been such that it can leave even the most experienced investors feeling a bit unsettled. Let’s be honest: the past year has been quite a rollercoaster ride with the broader market indices witnessing a staggering growth of over 50 per cent. To contextualise this return, consider that since 2005 only for about 15 per cent of the time have the broader indices generated such high returns within a one-year period. These periods of exceptional returns include the aftermath of the global financial crisis and the rebound following the pandemic in 2021.

On an average, the broader indices have historically yielded returns of around 20 per cent, significantly lower than the current levels of return. The unprecedented surge in returns has caught the attention of regulators, prompting warnings to investors, particularly retail investors who often join the party late and exit even later. Madhabi Puri Buch, the Chairperson of the Securities and Exchange Board of India (SEBI), has cautioned retail investors about a potential bubble in the Small-Cap and SME IPO space. Following these warnings, the broader market index experienced a decline of more than 5 per cent in the subsequent days.

While this correction was somewhat anticipated, SEBI also instructed mutual funds to limit inflows into small-cap and Mid-Cap schemes and mandated stress tests to assess the liquidity of these funds. While such regulatory measures are necessary, they can exacerbate market uncertainty and lead to volatile swings in market sentiment, oscillating between optimism and pessimism. Thus, while regulatory actions are crucial for market stability, they can inadvertently contribute to increased volatility, flipping the switch from greed to fear in the blink of an eye

There are several valid reasons why investors should exercise caution with their exposure to broader indices. For instance, consider the price-to-earnings ratio (PE ratio), a commonly used valuation metric by investors to assess stock attractiveness. In the current financial year, the PE ratio for the BSE 250 Small-Cap index has surged by 63.5 percent, climbing from 18.04 to 29.5. Historically, this index has typically peaked around 30 times, with similar trends observed in the BSE 250 Mid-Cap index. In an article on this topic, you will learn about how these inflated PE ratios have expanded without a meaningful increase in return on equity, typically influencing PE ratio expansion.

For investors considering where to allocate their funds amidst the current market conditions, Large-Cap stocks emerge as a compelling option. Over the past year, they have significantly underperformed the broader market, and historically, their performance against broader indices is among the lowest. Thus, there may be a potential reversion to the mean, with large-caps poised to outperform the broader market going forward. Our cover story in this issue arrives at a timely juncture, offering an in-depth empirical analysis of large-cap stock performance and why it’s an opportune moment to increase exposure to this segment.

Additionally, you will find a comprehensive databank of large-cap stocks categorised into three distinct buckets: Turnaround, Improving and Thriving. In the grand scheme of things, there’s nothing inherently wrong with focusing on the long term. If you are willing to exercise patience and hold steadfastly for the next few years without succumbing to market fluctuations, there should not be any cause for concern. All you have to do is keep a close eye on the emerging trends, as for example, large-caps taking the lead in the midst of volatility. It is also important to take into account the various regulations that time and again impact the market. Have a profitable year ahead!

RAJESH V PADODE
Managing Director & Editor