How to ride out stock market volatility

The Indian equity market has been on a strong footing the past year, largely backed by a strong earnings cycle and a robust macro-economy. Several policy initiatives such as lower corporate taxes, production-linked incentive (PLI) schemes and increased spends on infrastructure among many more, have ensured that corporate profit as a share in GDP has steadily improved. Also, prudent policy measures helped India Inc. weather the pandemic crisis deftly leading to better than expected earnings performance. Along the way, the RBI too has been supportive with its policy measures.

From an economic perspective, the government has already set the ground for a strong economic growth over the next decade through passage of bold reforms across several sectors. It is estimated that over the next five to seven years, the PLI scheme is likely to generate approximately Rs 35 trillion of additional production value. Also, the China+1 strategy adopted by various global manufacturers will help expand private capex creating more employment and consumption demand. This was further bolstered through Budget 2022, wherein the government with its stable tax policy, focused on programmes to encourage capex in infrastructure (multiplier effect) as well as on new age, sunrise sectors, all of which was very well accepted by the market.

Another heartening development is that a new profit cycle seems to be taking shape. In the past year (April 2021 to January 31, 2022), while the Nifty 50 index has rallied 17 percent, the Nifty PE is down 30 percent but the Nifty EPS is up over 67 percent. Thus, it would provide pivotal impetus for long-term wealth creation for investors. This is important because earnings-led equity market performance is more sustainable and less prone to a major slide from external factors.

Currently, the corporate return on equity (RoE) has reached a seven-year high of 12.5 percent. It is widely anticipated that earnings growth is likely to continue upwards of 25 percent annually over the next couple of years. Improving profitability may prompt an increased risk appetite and kick-start credit growth. Given that banking and NBFC stocks are index heavyweights, any sharp incremental profit addition lifts the benchmark index EPS significantly. At the same time, the debt burden of non-financial companies has slid to 0.7 compared with more than one about five years ago. Lower debt on the balance sheet could potentially kickstart the next economic upcycle, a setting which looks very similar to the previous upcycle seen in FY06, when debt-equity ratio of corporate was 0.6.

What should an investor do?

Since global markets are likely to remain volatile as investors will watch out for the US federal reserve’s rate hike trajectory, we remain cautious in the medium term. The optimal approach at such a time would be to adhere to asset allocation and opt for multi-asset strategies. This, along with a combination of active management, is likely to provide a better investment experience over the next one year.

Historically, data shows that no asset class is a constant winner as the winners keep changing every other year. For example: Over the last two years, while equity was a clear winner, in 2018 and 2019, gold topped the returns table generating 24.6 percent. Similarly, from 2014 to 2016, debt delivered stellar returns. Hence, a multi-asset approach is recommended. By investing in a multi-asset fund, an investor gets exposure to several asset classes in one go.

Depending on the market situations and various other factors, a multi-asset fund changes its allocation to ensure investors get the best out of the investment opportunities offered by various asset classes. Most often such funds have exposure to equity, debt, gold and some other asset classes. In case of select funds, the equity exposure is further diversified with exposure to international equities. The basic premise here is that equity provides the growth element through capital appreciation while debt renders the much needed stability to the portfolio. Gold, meanwhile, provides a hedge against inflation.

Risk factors

Interest rates are edging higher in most parts of the world. One of the ways to moderate its impact on India was through its anticipated inclusion in the Bond Markets Index, but there were no such steps announced. Since the slated borrowing plan for the next fiscal has been sizeable and more than the Street’s expectation, the bond market witnessed a sharp reaction which pushed the yields northwards. Therefore, we are of the view that challenges to the equity market may probably be triggered from the bond market in the foreseeable future. The rising crude oil price is another risk factor which holds the potential to impact the economy in an adverse manner.

The writer is MD & CEO, ICICI Prudential Mutual Fund.

The thoughts and opinions shared here are of the author.