Strategy for investors before May 2014

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Sentiment should rank as the most misused word when it comes to markets and investing. Any serious investor in markets will know the complex play of underlying fundamentals that should ground market prices to intrinsic value. But without the liquidity and actual buyers, even the best stocks will languish at low prices. Sentiment comes into play when just one or a few of the several hundred underlying factors supersede everything else, bringing in liquidity. The behaviour of markets on the basis of exit poll results last week is one such event: a surge in liquidity that places possible change in the governing party at the centre, much ahead of everything else that impacts prices and value of stocks. How should investors play this period from now until the results are known in May 2014?

1) Lose the laggards

The sell-off, when there is a rally after a prolonged downturn, is indicative of eagerness of investors to quit losing stocks. Investors dislike loss-making stocks in their portfolio, but they mistakenly wait for the same stocks to recover with the market. A rallying market will take good stocks up first and bad stocks may continue to languish. The loss from a laggard can be recovered by investing in a stock that is recovering faster, rather than waiting endlessly for the lagging stock to begin to post gains. At the start of the recovery, the pace of fundamentally good stocks is typically higher. This might be a good time to sell what is not working and move the money to what is.

2) Tighten the holdings

Most investors buy into stocks and funds without adequate homework. Many of these decisions are also made with haste, as if an opportunity would be missed if they did not act immediately. This results in an unwieldy portfolio. A large number of IPOs and NFOs had been launched when markets were bullish the last time around. Since most of these were poor quality products designed with the sales motive, and since they 'succeeded' in mobilising large amounts, it is very likely that a large number of investor portfolios hold these poor quality issues. A mixed bag of IPOs is not going to get better with time. Fewer holdings, both funds and stocks, will release some liquidity and prepare the portfolio for better participation in the upswing.

3) Take the time to understand sectorlevel differences

 When liquidity returns to the markets amidst mixed fundamentals, institutional investors are cautious about recovery, and tend to buy those stocks that hold lower downside risks. In an economy that is still reeling under pressure to create good infrastructure and attract investments, sectors that require revival of the investment climate will lag those that depend on consumption demand. Businesses have been down and out for a variety of reasons: lack of growth, slow demand, low pricing power, high debt burden or unfavourable policy environment. Not all of this will get fixed immediately and in the short run. Sectors that have seen a revival of revenue growth such as technology might do better than those that have been battered down by several negatives, such as iron and steel.

4) Take the time to select

 If you are a serious long-term investor who likes to participate in the market for sustained return, not quick gains, you will keep away from tips, rumours and rushed buying. New information that matters comes close to the quarterly earning results season. Take time to study the results for September, to see if there are sectors and stocks that have followed up the recovery in profits earlier with a recovery in revenue. Look for those that have reduced their debt burden. Identify those that have improved their operating margin. These are the stocks that will steadily benefit from a changing cycle. Before the results for March are out, you should have your homework in place, buying all along the way.

5) Learn to deal with and shut out noise

 Event-based buying is risky, and if the way Indian markets behaved after election results in 2004 and 2009 are any indication, volatility will be high. Becoming eager to 'be there' before others and being worried about news 'already factored in' are problems for the common investor. It always looks like yesterday was the best time to have bought stocks, but today remains indecisive. At a time when sentiment rules while fundamental stories are still a mixed bag, the markets will remain edgy. There will be opportunities between now and May 2014, when markets will correct on news or refuses to surge breathlessly. There is no need to lean in completely, rushing to book every other investment. It might be a better idea to focus on your selected list, and keep buying every time the markets seem edgy.

6) Remain humble about markets

 It is easy to make a few quick gains and feel smug. At a time when everyone is craving for a change, it is easy to overdo the enthusiasm and assume that everything will be fine from here on. Real changes in the fundamentals of businesses happen at the bottom. They lie in the hands of those that rework what will be produced and sold, at what costs, in which markets, and in what volumes. These decisions undoubtedly are aided immensely by good governance and policy environment.

Markets will run ahead of themselves when sentiment rules the day, and the stocks that will stand and shine are those that are fundamentally good anyway. Keep focus on what you buy; when you buy is only one part of the equation.

Happy Investing!!

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