Book Profits, But Selectively!
Voracious bulls are at play right now and the jumping stock prices are a pleasing sight to many investors. As the stock prices and indices, both local and global, inch higher, a majority of investors and professionals are wondering if it is the right time to book out. Yogesh Supekar and Anthony Fernandes explain why the markets may have not finished with their up move yet and that it may still be a good idea to book profits -'selectively' - in the current market situation
At times like now when the fundamentals do not look that great but the stock prices are climbing voraciously, most investors get confused as to what should be the right plan of action to adopt. In such testing times, conviction is missing to put fresh money at play and at the same time the willingness to sell and get out of the market is also missing. No one wants to sell in a market with prevailing bullish sentiment because there is always this ‘fear of missing out’. In the current market rally there is a tremendous fear of missing out, i.e. what if the stock prices go up after I sell the stocks? Thus, a majority of investors are shying away from selling equity.
After the prices collapsed in March, the sentiment was extremely negative and no one was willing to take a bullish call on the markets. Bears dominated the first three months in the markets. Now the situation is such that the bears have become extinct. The market is actually finding it difficult to find traces of short-sellers in the last couple of months. The market rally has given no hiding place for short-sellers and in all probability the shorts have been squeezed already, leading to fear of losing money amongst the short-sellers. The current market situation is exactly the kind of situation that makes even the short-sellers turn bullish on the markets.
The fund managers become bullish, retail investors become bullish and everyone talks only about buying stocks and no one cares of booking profits or taking some money off the table. Such optimism brings with it an air of overconfidence and casual approach. So, investors need to be careful and start identifying profit booking opportunities in the market wherever and whenever it makes sense. Signs of markets heating up are already visible and indeed the equity markets, especially US equity markets, are now like an old elevator way over capacity. One can’t say for sure if the elevator can pull the total load and carry the investors to a higher floor!
Market Enthusiasm
There is tremendous enthusiasm in the markets right now amongst the investors owing to the performance of the markets in the past two to three months. But just because there is enthusiasm amongst investors, that does not make them right. However, the strong momentum in prices cannot be ignored and it is only natural to feel bullish about the stock prices. If we look at the market performance since March 23 when the Sensex made its 2020 lows, we find that as many as 623 companies listed on the BSE have more than doubled since that date while a good 1,929 stocks have inched up by more than 25 per cent and 2,317 stocks have managed to remain in green. The length and breadth of the current rally is truly impressive and definitely is inspiring for investors. Whether the momentum carries forward for the rest of the year and whether the velocity of stocks price movement will be same as we have seen in the past few months is debatable.
What is Supporting Stock Prices?
The pandemic is refusing to desist, the geo-political tensions are on rise with the Libya-Turkey-Russia situation and the US-China cold war is continuing to impact the global equity markets. Several large economies are still not fully functional and several manufacturing facilities are still not running at optimal capacities. Forget expansion, several companies spanning geographies are struggling to survive. Amidst such an uncertain situation, central banks across the world are managing to keep the markets jolly. In fact, central banks have been the saviour for global equity markets and hence the investors.
One of the investment managers was heard saying, “Moving out of equity markets is basically betting against the central bank – who would want to do that?” Such has been the influence of the central banks on the equity prices! What central banks all over the world, and especially the US Fed, have done is to communicate to investors that as institutions they will do whatever it takes to save the Titanic from sinking. This hope has turned the table for the equity markets along with the aggressive interest rate cuts all over the world, including India.
Those investors who understand the basic concepts of equity valuation will observe a huge fundamental change in favour of equity markets across geographies and in India as well. This pertains to lowering the interest rates and the commentary by various central banks on keeping interest rates low for a long time to come. Equity value is derived not only from the future cash flows but also by the discounting factor which is also known as the hurdle rate. This is nothing but the total cost of capital for any company.
The total cost of capital consists of cost of equity and the cost of debt. With lowering cost of debt dues to the decreasing interest rates, the overall cost of capital stands to be reduced across the board for listed entities across geographies. This explains why the stock prices are not falling even when there is increasing uncertainty over the future earnings for listed companies. That said, not all companies have declared drop in earnings. In fact, India Inc. has surprised the markets with its resilient performance in Q1FY21. Worst was expected by the markets in terms of earnings growth. There are several companies, especially in the mid-cap and micro-cap space, that have declared outstanding results.
Mid-cap companies such as Laurus Labs and Aarti Drugs thrilled investors with growth in earnings while Xelpmoc Design and Tech Ltd., Mangalam Drugs and Organics Limited, PNB Gilts, Geojit Financial Services, Titan Biotech, Lasa Supergenerics, Maestros Electronics, Kilpest India and Balaxi Ventures impressed investors with their outstanding results this season. Bayer Crop Science and Tata Consumer in the large-cap category impressed the markets with the quality of their earnings. The results this season show that it is not just the sentiment that has turned positive for equities but also the sentiment turning positive for a return to growth.
What are FIIs Doing?
In the June quarter, the FIIs invested almost `14,000 crore in the cash segment of equity markets while raising their stakes in at least 200 companies that are listed on the BSE. What is interesting to note in FII action this time around is the preference for small-caps and mid-caps over large-caps. Most of the stocks where the FIIs have increased their stakes are from the small-and mid-cap space. Granules India, Dixon Technologies, Adani Green, Laurus Labs, Aarti Drugs and IOL Chemicals, Aurobindo Pharmaceuticals, Vikas Eco Tech, Opto Circuits, LT Foods, Marksans Pharmaceuticals and Educomp Solutions are just some of the companies where FIIs increased their stakes in the June quarter. FIIs were also seen decreasing stakes in as many as 600 companies. Suzlon, Reliance Communications, JMT Auto, Viabhav Global, Shilpa Medicare, Jai Prakash Associates, Bombay Rayon Fashions, Birla Soft, Tata Communications and HexaTradex are just some of the companies that saw FIIs reduce their stake in the June quarter.
Why Book Profits Now?
With the bulls in charge and the bears becoming extinct in this market, retail investors are seen flocking to unprofitable companies. An article published in Bloomberg mentioned about a custom gauge of sentiment compiled by Citigroup Inc. that showed “euphoria” has just hit the highest level since the dotcom era. When you see that penny stocks are amongst the best gainers in the markets, you know what frenzy mood exists in the market (quality is ignored)! While it can be heartening for adventurous investors who own such stocks, it is a sign of worry for matured investors who know what to read between the lines. Enthusiasm is fine but excessive enthusiasm can be a cause of concern for investors.
Just like it is almost impossible to predict the market bottom, it is nearly impossible to call the market top. It is very difficult to time the top and exit the market just at the right time. Hence, it is advisable that investors start booking profits wherever there are excesses in valuations. It is important that investors identify sectors that have run up without any support in the form of earnings growth. Pharmaceuticals, for instance, is one sector which has shown some real uptick in earnings growth and hence the rally is justified in pharmaceutical stocks.
Says Ratan Singh, a growth investor: “I purchased mid-cap stock Affle India after reading a brokerage report. The brokerage report suggested that one can buy the stock at the `1,700 level and look for targets of around `2,100- `2,150. When the stock price reached `2,150, I booked profits only to see that the stock reach `2,350 in just three days after booking profits. I am happy that I booked profits and earned decent returns but I am not happy to know that the same brokerage house has now revised the price target upwards.”
In a bullish environment it does happen that investment managers revise their targets upward and are forced to suggest a ‘buy’ even when the targets are achieved and the valuations are no longer cheap. They are forced to buy into markets or else they risk underperforming the peers as the stock prices are jumping and the momentum is still steady in stock prices. Valuations take a back seat at times of euphoria. A smart investor know that euphoric times is when one has to start booking profits and market crashes is when one needs to start buying to make a killing in the markets.
One cannot pinpoint exactly when the markets will peak out and whether the euphoria is at its peak in the Indian markets but looking at the price momentum it is safe to say that we are close to the market peak. The Sensex has gained almost 50 per cent from its March lows. That is to say a 50 per cent gain in four and a half months. It is difficult to digest that the markets will move ahead maintaining the same velocity in stock prices.
Consolidation could be on the cards and there is a good possibility of sectoral rotation. The leadership could change hands and hence investors have to be cautious on which stocks they are betting on.
Globally, at 26 times forecast earnings, the S & P 500 is trading at the highest multiple since the dotcom bubble. In the past decade, the average price-to-earnings ratio stood at 18. Almost all the global indices are in an overvalued zone. What is worrying the smart investor in this market is the massive disconnect between fundamentals and markets. Currently, there is just too much of capital chasing investments. The money that is flooded by the Fed in the US is not going to real economy and hence the asset prices, including commodities, are skyrocketing.
Conclusion
The broader market is showing traction and the FIIs are shifting their preference from the large-caps to mid-caps and small-caps. The interest in the broader markets is justified as the valuations are at comfortable levels and the reopening activity in India has increased hopes for the economy getting back on track. Going ahead the markets can be expected to be more volatile. Investors will soon start speculating as to who will win the US elections and the eventually whether the markets will inch higher. Traditionally, the election years in the US have been good for the equity markets. However, divining the US election result and its impact on the markets is an impossible task.
Such an event promises to keep investors on their toes and may allow stock prices to gyrate in an unprofitable fashion for many investors. With US markets at all-time highs there is a consensus building amongst the global analysts that Europe could be the antidote in the current crisis situation for nervous investors. As of now, both individual investors and the money managers are embracing the rally. There are no signs of panic in the market that suggest a blanket exit from the markets. However, it is wise to book profits where the share price rise is not supported by earnings growth. Sectoral rotation is the key and it is difficult to predict that large-caps will outperform mid-caps and small-caps in the coming quarters.
Hence, booking profits in select large-caps which have run up steeply and are not being backed by quality earnings make for a perfect candidate for profit booking. The portfolio stance can be tilted slightly towards broader markets with focus on those companies where the earnings visibility is there. It is next to impossible to stay bearish in these markets for both the professional investor as well as for someone who is new to the markets. However, regularly booking profits at the right intervals is always an important element of long-term strategy.