The equity market posted a remarkable rally after falling sharply last year on fears that the Covid-19 pandemic would present deep and lasting challenges for the global economy and businesses.
From the March 2020 low, the S&P BSE 500 was up 142% till September 3, 2021. The 17 months included an abrupt (and unprecedented) shutdown of the global economy, followed by the eventual reopening of the economy and record levels of fiscal and monetary stimulus. This clubbed with earnings growth expectation, future cash flows discounted at decadal low-interest rates, and investor optimism particularly in the retail segment, created a sharp rebound in equity markets.
Does this resemble a bull market environment? The current investor sentiment signals this with the market scaling new highs every other day.
Investors began to look at the stock market to generate income post-pandemic as it displaced their primary source of income. This is reflected by the number of trading accounts which have almost doubled in the last two years. The share of retail in trading volumes increased from 39% at the start of 2020 to 45% at present. The kind of optimism prevailing in the market is linked to a psychological concept of FOMO vs FOLO; Fear of Missing Out vs. Fear of Losing Out.
Let’s say you are offered a gamble on the toss of a coin.
Tails, you lose Rs 100. Heads, you win Rs 150. The expected value of this gamble is positive as you stand to gain more than you can lose. However, many may reject this as the fear of losing Rs 100 is more intense than the hope of gaining Rs 150, indicating risk (loss) aversion behaviour.
Let’s change the outcome of this gamble. Tails, you lose Rs 100. Heads, you win Rs 1,000.
In both scenarios, the net outcome is positive for the person accepting the gamble. But in the second outcome, it appears more lucrative as the fear of missing out Rs 1,000 overpowers the fear of losing Rs 100.
This is exactly what happens in the equity market.
Early 2020, the fear of losing money and risk aversion behaviour was a lot more prevalent, which led to a market downturn. Post that, regained investor optimism led to investor behaviour swing towards FOMO. Consider this year’s IPO market, for most of the issues, the retail subscription has been a lot more than anticipated as in an upswing market one would weigh fear of missing out on potential listing gains more than fear of losing out if the listing price is lower than the issue price.
So how must you navigate the market?
Equities are benefiting from expectations of an economic rebound driven by the low cost of credit, massive fiscal stimulus with a focus on providing credit, improving farm income, and export attractiveness. Few other drivers that bode well are thrust on capital expenditure, foreign direct and portfolio inflows, and expectations of increased consumer spending as vaccines roll out and economies reopen. These growth drivers are expected to help corporates improve their earnings.
However, in the near term, few factors still linger – the impact of a third wave, high inflation, and concerns around valuation. Investors should be mindful of the drawdown potential coming from extra growth (equity) asset exposure and continue to evaluate these exposures to make sure they balance the risks properly.
The current market cycle makes the multi-asset investing approach a lot more relevant to generate better risk-adjusted long-term performance. Assessment of adequate equity exposure in a portfolio to meet a certain investment goal is critical as higher allocation could expose an investor to the risk of capital loss if markets are to correct. Investors could also consider diversifying equity exposure by investing in international markets. This helps by providing a hedge against rupee depreciation and an opportunity to take exposure to varied international economic & fundamental growth drivers apart from Indian equities.
One should negate short-term market noise and avoid getting into a trap of FOMO vs FOLO as it can have an undesirable outcome on your investment goal. Rather, investors should stick with their financial plan. Investor entered the market with particular goals in mind, whether that meant retirement many years into the future or focusing on nearer-term aspirations, like buying a home or a second car. Whether the market is at a peak or a trough, your financial plan likely hasn’t changed much, and your portfolio choices could still be right for your goals.
This article originally appeared in the Economic TImes
