Stay invested but hedge your bets

In 2014, the BSE benchmark Sensex rose 30 per cent over the previous year to post its best show since the post-Lehman relief rally of 2009. The investors who had a greater risk appetite and placed their bets on the mid-caps made even more money. The top two stocks - TVS Motor and Eicher Motors - tripled in value.

In contrast, other competing asset classes - gold, commodity and real estate - gave negative returns. So, retail investors were drawn back to the stock market. That should be good news for existing investors, as a greater retail participation would lessen the blow if foreign institutional investors were to sell in the event of global shocks.

The rally this year was led by rate-sensitive and cyclical stocks, such as those of banking, capital goods, automobile & auto ancillary companies. The defensives - shares of information technology, pharmaceutical and fast-moving consumer goods companies - played only a minor part, unlike the previous three years. This broadened the rally and gave it multiple feet to stand on.

The risk going forward, though, would be that financial stocks now account for 30 per cent of the market, making it vulnerable to financial shocks. Also, having risen for three years in a row, the market has progressively become expensive.

The Sensex is now trading at 8.5 times its underlying trailing earnings - the highest in four years. This increases the odds of a sharp correction, such as the one seen in 2011, if gross domestic product or earnings growth fails to match up with rising expectations and valuations. The risk has been heightened by a volatility in the global currency market and the recent drop in crude oil prices.

Stay invested in the New Year but hedge your bets and have a Plan B in place if the tide turns against you.