Navigating Market Volatility During Elections

As we approach the final stages of the elections, the markets have turned volatile. This is expected, yet some political voices in India predict a significant rally in equities post-election results, which might tempt investors to over-allocate to equity markets. While equity is a vital component of investment portfolios, it raises the question: is there a limit to how much one should invest in equities?

Recent Performance of Nifty 50 and Broader Market Indices

Since the outbreak of the COVID-19 pandemic, the Nifty 50 index has experienced remarkable growth. Both headline and broader market indices have delivered exceptional returns to investors. The ongoing bull run in India, which has spanned over the last four years (2020 to the present), has been driven by government capex initiatives, healthy corporate earnings, and consistent policy momentum. This period is unprecedented in terms of wealth generation, with the value of India’s listed companies recently reaching an all-time high of Rs 400 lakh crore.

From March 2023 onwards, Indian markets have seen a steep upward trajectory, with minor setbacks. This is particularly evident in the substantial rally seen in mid-and small-cap stocks. Although the indices appear overheated after relentless gains over the past year, several factors indicate the possibility of a significant correction in the near term.

The Nifty index has seen only shallow corrections in recent months. Since March 2023, the Nifty has not experienced any major declines from its all-time highs, with the steepest drop being a mere 6 percent last October. The Nifty Midcap 150 index, which generally exhibits more volatility than both Nifty and Sensex, mirrors this trend.

Globally, the Nifty has outperformed over the past year, soaring 25 percent and outpacing many emerging and developed markets. Only US indices (S&P 500 and Nasdaq) have kept pace with Nifty’s one-year returns. With over 50 percent returns in the last three years, the Nifty has significantly outperformed all other global indices.

Potential Impact of Tight Monetary Policy

The countercyclical effects of tight monetary policy and potential delays in interest rate cuts are likely to impact the sustainability of this rally, which relies on money supply, liquidity, and market flows. With nominal GDP growth slowing, earnings disappointments could weigh on market sentiments. The upcoming election results, whether it leads to Modi 3.0 or even a mild negative surprise, could be a pivotal moment for the Indian markets, potentially triggering overdue profit-taking across sectors.

Importance of Asset Allocation

Asset allocation is crucial for achieving optimum returns in any portfolio. Empirical research shows that over 90 percent of portfolio volatility can be managed through asset allocation rather than by chasing one asset class like equity or debt.

The primary asset classes include equity and debt. Equity leads to wealth growth over the long term, while debt provides stability to the portfolio. Other asset classes such as gold and real estate are also available. Judicious allocation, based on an investor’s risk-return profile, horizon, and investment objectives, is key. However, portfolios often become skewed toward one asset class due to a preference for higher returns (equity) or relative stability (debt).

Over time, uneven growth in various asset classes can alter the initially decided allocation ratio. For instance, a rally in the equity market increases equity allocation. The mutual fund industry’s asset allocation trends can offer insights. As of March 2024, the industry’s AUM stood at Rs 55 lakh crore, with equity funds at Rs 23 lakh crore (plus ETFs and hybrid allocation), debt funds at Rs 14 lakh crore, and gold ETFs at Rs 30,000 crore (0.55 percent of Rs 55 lakh crore). While this isn’t an absolute indicator due to other investment avenues for gold, it provides perspective.

Fluctuating Returns in Asset Categories

Returns in asset categories like domestic equity, international equity, gold, and debt fluctuate annually. Equity can yield phenomenal returns in certain years and negative returns in others. The same is true for gold. Within equity, the winners can vary, with large caps, small caps, or specific sectors like FMCG, IT, and metals outperforming at different times based on economic and global factors. In debt, it could be long bonds or short bonds.

To smoothen out the impact of volatility in various investments and earn optimum returns, focus on allocation. Holding investments over a long period allows asset classes to perform according to market movements, reducing portfolio volatility.

Investors can allocate through pure-play equity or debt funds, or allocation-based hybrid funds. Avoid the common mistake of allocating to an asset category or a specific fund based on recent performance—a concept known as recency bias in behavioral finance. Instead, be clear about your risk profile, the investment’s risk profile, and your time horizon.

Conclusion

As the markets navigate the closing stages of the elections, volatility is expected. While the potential for a post-election equity rally is enticing, prudent asset allocation remains key to managing risk and achieving long-term returns. Equity investments should be balanced with other asset classes to ensure portfolio stability and growth. Investors should remain focused on their investment objectives, risk tolerance, and time horizon, avoiding the temptation to chase recent performance trends. This disciplined approach will help in navigating market volatility and optimizing portfolio returns.

Market this week

• Indian markets witnessed modest gains during the week shrugging off election jitters. The broader market outperformed frontline indices.
• Market experts attribute the current foreign investor selling frenzy to a global shift in focus towards China’s cheaper markets, not India’s election concerns.
• Analysts remain bullish on India’s long-term prospects.
• On the economic front, India’s industrial output expanded by 4.8% yoy in March slower than 5.6% in February.
• India’s foreign exchange reserves witnessed a significant increase after three weeks of consecutive dips.
• WPI inflation rose to a 13-month high of 1.26% driven by food, electricity, and fuel costs

Weekly Leaderboard

Stocks that made the news this week:

• Delhivery’s shares dropped 5% on May 18 after the company reported a loss of ₹68.5 crore for the March quarter (Q4FY24), reversing a profit of ₹11.7 crore in the previous quarter. However, compared to the same period last year, the loss decreased by 57% from ₹159 crore. The company’s revenue grew 12% year-on-year to ₹2,076 crore, driven by strong performance in the partial truckload (PTL) and full truckload (FTL) segments, which increased by 27% and 60% YoY, respectively.

• A majority of Nestle India shareholders have voted against increasing the royalty payout to the Swiss parent company Nestle S.A., as revealed in an exchange filing. Specifically, 57.18% of shareholders opposed the resolution. This follows the board’s approval of the royalty hike nearly a month ago. Nestle India had committed in 2019 to seek shareholder approval for royalty payments every five years after receiving feedback from investors and proxy firms.

• Bandhan Bank’s shares rose 2 percent to Rs 185 on May 18 after a mixed Q4FY24 performance. Despite a 24 percent stock decline this year, the bank reported a 93 percent YoY drop in net profit to Rs 54.63 crore due to increased provisions and write-offs. Provisions rose to Rs 1,774 crore from Rs 735 crore a year earlier. The bank wrote off Rs 3,850 crore in bad loans from small borrowers during the COVID-19 pandemic, covered by a government guarantee, as a ‘prudent measure.