Markets have reached a stage where nothing seems to deter a buying idea. Neither a dubious past, not dubious promoter seem to matter. The momentum in the small- and mid-cap space is so great, that a mere mention of a stock name on the social media is enough to set fire to its price. Everyone is a hero. And some serious investors too do not mind going along, as there is a big fear of ‘being left out’.
If I am an ultra high networth individual (HNI), with no financial worries, I can speculate on the thinnest of reasons. Losing some part of my money is not material to me. The excitement of always having to make a trade is sufficient compensation.
In this market, most of the ideas or recommendations that are now popping up, have the one or more of the following traits:
- Absurd valuations being justified by optimistic expectations;
- Poor quality of promoters overlooked and justified on price;
- Commodity stocks getting valuations like pharmaceuticals used to get;
- Forgetting the debt on the balance sheets;
In general, the nature of trades that are being done now, put your capital at risk. You have to be absolutely swift in taking money off the table.
In investing, there is something that is called as ‘potential’ rewards. It generally is an inverse of popular sentiments.
In other words, when I am buying at a high valuation in a bull market, my return depends on the same conditions persisting or improving when my stock has to be sold. If sentiments change, then price can be dented severely and even the recovery of principal can be a big issue.
Thus, it all boils down to risk management at a personal level. At this juncture in the stock markets, the risk reward is clearly unfavou-rable. It does not mean that you sell everything and go.
Keep high quality in to your investment portfolio and treat the not-so-high quality as opportunistic trades. Play the market according to what you can afford. Also, remember, in the midcap space, buying is a lot easier than selling. When a small stock trades a couple of hundred shares a day, the price moves up rapidly when a few buyers emerge. On the flip side, when people want to sell, you will see the Lower Circuits in operation for many days.
So, how does one address the issue of investment risk in these uncertain times?
For the mutual fund investors, I would think that this is a good time to be in to Balanced Funds. The automatic cap on the equities will ensure better risk management. It will give you some upside of a raging bull market, while protecting you from a big fall. And I am not even betting on a decline in interest rates. If you want to invest a large amount, I would urge caution. You may not always be lucky in the midcap stock that you buy. One way to check your risk in a new idea, is to see how the price of a stock has behaved over the last couple of years. If most of the rise has been in the last one year or so, then your potential upside is low. Most of the jump could have already happened. Yes, of course, there would be some exceptions, but I would still err on the side of caution.
Fundamentals of investment do not change. Valuations are a function of market moods and momentum. As an investor, I would like to buy when things are to my advantage. I am yet to see any market that has run away forever. In the late 1980s, the Japanese stock markets ran away as if there was no tomorrow. The Nikkei was in shouting distance of 40,000. Just have a look at where it is now. In nearly four decades, the index is nowhere near that peak. Of course, not every stock would have done it. But the odds are that most of the stocks would have followed a similar fate.
People tell me that I am too negative on the markets. I am simply paranoid. I see risk at every corner. I am happy to preserve my capital and put money when I am happy with my assessment of risk and reward.
Remember that if something loses half its value, it would have to double from there, to come to status quo (not to mention time value of money).
The writer is a veteran investment advisor. He can be reached at balakrishnanr@gmail.com
