Feel good and you

Let's rewind to March 2003. The stock markets (represented here by the 30-share Sensitive Index of the Bombay Stock Exchange, the Sensex) are struggling to hold up above the 3,000 levels.

There is fear of war, problems at the UTI and issues pertaining to divestment. There is also uncertainty about the monsoon.

The pessimism is underscored by the fact that leading stock market players polled by a business magazine forecast the index to be about 3,700 by the end of 2003!

We all know that these 'experts' turned out to be wrong. But then, is there anyone out there who was right?! Nevertheless it is important to understand what was/(were) the 'factor(s)' that contributed to this unusual surge in the stock markets.

Two factors, which were hard to predict then, come to mind.

First, a 'very good' monsoon lifted prospects of economic growth over the remainder of the financial year (the year started with a GDP growth forecast of 5.5 per cent for FY04; currently the forecast is at slightly over 7.0 per cent).

The monsoon dependent agriculture sector is expected to account for much of this incremental growth.

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Second, foreign institutional investors' fancy for Indian stocks undoubtedly gave the much needed lift to sentiment.

Not to say that there were no other positive developments in the markets -- there was some progress on divestment, corporate bottomlines started to respond to lower interest rates and better productivity and, of course, the IT sector once again started to gather pace.

But then these developments were expected. Like now, for example, we expect the boom in agriculture to positively impact demand for consumables (already reflected in the rising interest in stocks of FMCG companies).

These two factors contributed in great measure to (or possibly triggered) something called the 'feel good factor' (the other phrase for it these days is India Shining!).

It is difficult to expect the optimism stay in the absence of either of the two. And this is what investors should keep in mind when reviewing their assets/portfolios.

The happenings over the last 12 months have resulted, for most individuals, in an increase in exposure to the stock markets.

Those who invest in stocks (or equity funds) have seen the value of their holdings grow much faster than other asset classes, resulting in stocks accounting for a higher percentage of their assets.

For those who were predominantly invested in debt, declining interest rates have pushed them towards the MIPs (monthly income plans) from mutual funds.

This has brought with it exposure to the stock markets (most MIPs have exposure to the stock markets, ranging from 9 per cent to about 20 per cent).

Unfortunately, many investors have loaded onto MIPs with equity exposure of over 20 per cent believing that MIPs are 'safe.'

This increase in exposure has increased the 'riskiness' of portfolios of investors. As long as the markets move up, this factor will be ignored.

But if things were to change for the worse (i.e. the feel good factor were to disappear -- triggered by a poor monsoon or a slowdown in FII money inflows), investors may have to take a much bigger hit than they had bargained for.

A lot of investors have already got bruised by the volatility witnessed in the markets over the last couple of weeks. While it is impossible to say with certainty, one can expect the same to continue for some time.

Coupled with the fact that general elections are around the corner, it would be unwise for us to expect the markets to do wonders.

So what should you do now?

Rebalance your portfolios in line with your objectives and risk profile (Visit our Asset Allocator).
Do not get greedy. Cut any excess exposure to stocks.
Do not exit the debt markets completely, just because it is expected that interest rates are, according to some, going to rise. In fact choose your schemes carefully and consider investing in two innovative debt schemes -- floating rate funds and funds which also invest in low grade corporate paper. The latter will deliver good returns if the economy does well, as a healthier economy means better profitability, which in turn, could help lift credit ratings (when the credit rating of a company moves up, the price of its bonds tends to appreciate).
Remember that stocks do not always earn better returns as compared other asset classes over the long term. You can earn a relatively better return over the long term only if the 'price' at which you make the investment is reasonable (for example, if you had invested in Zee at Rs 1,500 in year 2000, that is about four years back, you will still have to wait for a considerable period of time to earn some return given that the stock is presently trading at about Rs 150). Here's a fact - If you had invested in the Dow Jones Industrial Average (DJIA) at the peak of the boom in 1929, you would have to wait for about 26 years to recover your money!
Finally, if you are not an 'expert', opt for mutual funds as an investment vehicle. The industry is maturing fast and there are a few fund managers (and asset management companies) out there whom you can entrust your money to.