How to Invest when Stock Market is High

The equity market is near its all-time high. Given the phenomenal rise and expensive valuations, is it the right time to invest in stocks?

Trading just shy away from its all-time high, lately the equity market is on a joyride. Though a recent short and shallow correction has pulled down the indices, most equity analysts are of the view that the market is trading at expensive valuations. The market is indeed expensive, at least at the index level as well as in specific sectors like banking and consumer goods, for instance. At the current forward price-to-earnings multiples, not only the market is trading well above its historical average but currently Indian stock market is also one of the most expensive markets in the world.

The current exuberance and irrational prices are expected to remain on higher side of the curve and the market is expected to remain in the present expensive trading zone till the end of year, unless some unforeseen global factors spoil the party. Last year, the market rose by 17 per cent; this year so far it has appreciated by about 19 per cent. Given the phenomenal rise, the question that most investors must be asking is: Should they continue to park their excess money in stocks? Or is it wise to wait for a meaningful correction?

While equity investment is a personal decision, different people follow different investing strategy.  There are two kinds of investors: short-to-medium term and long term. The time horizon for short/medium term investors – don't mistake them for traders – could be anywhere between three to six months. Most of the long-term investors believe in being invested for a couple of years at least.  But equity market rewards long term investors the most. What's more, long term investment is exempted from capital gains tax. So, long-term investing works better.

Now to the question: is it the right time to invest? It may not be, if you are a short-term investor. However, for long term investors it also may not be the ideal time, given the valuations. But long term investments are not determined by valuations alone but time horizon as well. Since timing the market is not easy, waiting for realistic price correction may or may not prove to be the right strategy. The market may or may not correct substantially – at least 1,000 points on the Nifty – in foreseeable future; equity analysts are also of the view that the market may not undergo deep correction.

However, if the market does correct, nobody knows how deep the correction would be. Sometimes market also remains overvalued for longer period; it is also possible that it may not correct much but may remain in a narrow band of a couple of hundred points in absence of support from corporate earnings, slow pace of economic reforms or uncertainty in global macro-economic factors. It is also quite likely that the market may ignore these negatives and refuse to go down because of strong liquidity.

One of the reasons for the surge in indices over the past six months is strong liquidity, both global and domestic. The other reasons are low interest rates and money shifting from real estate to equity market after demonetisation. Interest rates are likely to remain benign. Low interest rates regime has shifted the balance in favour of equities. It is true that the fundamentals of Indian economy have improved since the past decade. Stable GDP growth, improved macro-economic conditions, low inflation, shrinking current account deficit and rising foreign exchange reserves augur well for the economy as well as the equity market.

However, it does not mean that investors should rush into buying shares at current levels. Ideally, it would be prudent to wait for 5 to 10 per cent correction. If that does not happen short terms falls should be utilised as a buying opportunity. Equities have the tendency to outperform other asset classes in the long run. Hence it is important to have a long investment horizon. Stock selection is equally critical – ignore the market noise and weed out companies that have weak fundamentals; focus on companies that have historical track record of strong growth. Quality of earnings and market leadership are equally critical in choosing stocks.

While valuations play a key role in determining returns, time horizon also plays an equally important part. For instance, it is true that investments made at lower levels give better returns as compared to investments at higher prices if the investments are held for about five years. However, if the time horizon is 10 to 15 years, the impact of valuations on returns is minimal. Does it mean that one should wait for the right valuations and avoid investing at other times? It depends a lot on your investment objective and end goal.

However, it is important to mention here that valuation parameters differ from person to person and sector to sector. Market does not give same valuation to all sectors and equities within each sector. For instance, the uncertainty in growth since the financial crisis of 2007-08 has brought down the valuations of technology companies. On the other hand, some of the FMCG companies that have visible growth prospects on the back of strong domestic consumption are trading at expensive valuations. Even within the banking space, some of the top performing private sector banks enjoy premium valuation as compared to most of the public sector banks which are beleaguered by NPA problems.

So what should individual investors do?  If you are a long-term investor, choose the right stocks where there is clarity on earnings and growth as well as minimal impact of disruption and competitive pressures.  However, if you don't understand the market well, it is better to take the mutual fund route through systematic investment plan (SIP). Participation from retail investors in equity mutual funds has been increasing. For instance, so far, this year, mutual funds have invested about 52,000 crore in equities. According to reports, retail investors put in about 5,000 crore into mutual funds through SIPs.

As SIPs inculcate discipline in saving and investing, they also help avoid uncertainty and endless debate on the 'right time' to invest in equity market.

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