Choosing the right asset classes to invest is always a challenging process. Presently, in the context of a global bull run in stock markets with forebodings of some sharp corrections in 2018, it has become all the more challenging. However, a conservative approach to investing coupled with a well thought out asset allocation strategy, can prove to be a winner in 2018.
A good investment journey starts with right asset allocation, which, in turn, depends on the financial goals and the risk profile of the investor. This varies across investors. Therefore, asset allocation and investment strategy also has to be investor specific. Leaving such specifics aside, let us look at a general approach to investing in 2018 for all categories of investors.
Smart investors should try to discern the mega trends emerging in the economy and invest to reap the benefits of these mega trends. Two mega trends under way in India presently are the formalisation of the economy and financialisation of savings. These two mega trends have the potential to unleash profound consequences for the economy in general and investment in particular. Formalisation of the economy will substantially benefit the corporate sector, particularly the listed companies. Financialisation of savings, coupled with the emergence of equity as a favoured asset class among investors, is likely to keep the markets buoyant for an extended period of time. Therefore, stocks have to be an integral part of a good investment portfolio.
2017 has been a fabulous year for equity investors. As the curtain falls on 2017, the Sensex is up by around 31 per cent for one year, Nifty is up by around 33 per cent and Nifty Midcap and Nifty Smallcap are up by around 63 and 52 per cent respectively. These are fabulous returns indeed! What is in store for investors in 2018?
There is, indeed, a bull case scenario, in spite of the high valuations. The ongoing global bull run is being primarily driven by the synchronized global economic recovery. All developed economies are doing well and there are no threats to global financial stability. The much-feared threats to the global economy in early 2017 like a potential Chinese implosion triggered by their debt problem, break-up of the Euro Zone following Brexit and increasing protectionism triggered by Trumponomics have receded into the background. Global economic recovery, coupled with low interest rates, has delivered decent earnings growth. The present Goldilocks economic scenario is likely to continue in 2018 and beyond. This can keep the markets buoyant. Robust global growth with financial stability, superior earnings growth and very low interest rates can sustain the new normal higher valuations.
Even though the Fed is tightening, liquidity is likely to be abundant since most central banks are pursuing an accommodative monetary policy. Since most developed market central banks are more concerned about deflation rather than inflation, they are likely to be behind the curve in 2018 ensuring adequate liquidity. This will be another factor favoring the bulls.
The argument against this bull case scenario is that bull markets will experience some sharp corrections at some point. Since markets are highly valued, they are vulnerable to a bear onslaught. This bear strike is likely to be triggered by some unknown and presently unanticipated event. The known risk in the market is the Fed tightening. If the Fed raises the rate thrice by 25 bps each and takes it to 2 to 2.5 per cent range in 2018, that would be on expected lines. But, if the tightening turns aggressive, it might trigger capital outflows from emerging markets, impacting stock and currency markets. Another risk to the market may come from fiscal deterioration, hardening crude prices, rising inflation and RBI raising rates.
India has been an exceptional case in 2017 where the bull run was not supported by growth and earnings recovery. Rather, the Indian bull run was a ‘hope trade’ in anticipation of growth and earnings recovery and this hope trade was powered by strong domestic liquidity. This hope is likely to materialise in 2018. If the recovery in growth, which has begun in Q2 of FY 2018, sustains and earnings growth revives, we are likely to witness a spurt in profitability. This will make valuations look reasonable.
The course of long-term bull markets has never been smooth. 2017 was a year of surprisingly shallow corrections. 2018 is likely to be different. It would be realistic to expect modest returns in 2018. Investors should look beyond 2018 and continue to invest. High- priced small caps driven by momentum are becoming excessively risky. Companies run by managements of suspect and unproven quality should be avoided. In the present context of stretched valuations, investors should prefer large caps, which have a much higher margin of safety, compared to mid and small caps. A bottom up approach is ideal in 2018 since winners are likely to be across sectors. From a sectoral perspective, the winners in 2018 are likely to be corporate-facing banks, particularly private sector banks, oil and energy, autos, cement, aviation and capital goods. Market leaders and large caps in these sectors would be safe bets in 2018. IT and select pharma stocks are good value picks presently. The investment strategy has be a calibrated one with emphasis on buying on declines.
Fixed income is likely to witness another challenging year. Even though it can be safely assumed that the accommodative cycle is over, interest rates are unlikely to rise sharply in 2018, the present spike in bond yields not withstanding. Investors should look for asset classes beyond bank fixed deposits to get reasonable real returns. Here, equity savings funds look good. Investors can expect returns better than bank FDs with superior tax advantages. Since equity savings funds invest around one third each in equity, arbitrage and fixed income they are treated as equity / balanced funds for tax purposes. HDFC Equity Savings Fund, ABSL Equity Savings Fund and ICICI Equity Income Fund are good funds, which may be considered for investment.
Gold performs well during cycles. The last five years have been disappointing. 2018 also does not look promising for gold since global financial stability looks robust presently. But one can never be sure. Some presently unknown factor might trigger a ‘flight to safety’ bringing gold again to the forefront.
More importantly, gold is a very good equity hedge. Gold will perform well when equity under-performs: In 2008 when equity (Sensex) crashed by 52 per cent following the global financial meltdown, gold appreciated 25 per cent. Again in 2011 when Sensex crashed by 25 per cent, gold appreciated by a whopping 32 per cent. Therefore, a small asset allocation for gold may be considered for 2018. Here, the choice should be in favour of Sovereign Gold Bonds (SGBs) or Gold ETFs. Both are well-regulated products tracking the rupee price of gold. SGBs are better from the returns perspective since they yield 2.5 per cent interest. But liquidity is poor since there is a 5 Year lock- in and secondary markets are thin. Gold ETFs have very good liquidity.
Mutual fund investment, ideally through SIPs, should be the preferred investment in 2018. Since markets are likely to be much more volatile in 2018 than in 2017, SIPs should be the ideal investment strategy. SIPs can be done across market caps. A combination of equity and balanced funds would be ideal. In equity, SIPs can be done across market caps. Some good funds with consistent track record, ideal for for SIPs are:
Equity large caps: Motilal Oswal MOSt Focused 25, ABSL Frontline Equity and SBI Blue Chip Fund.
Equity Mid & Small caps: HDFC Midcap Opportunities Fund, Reliance Small Cap Fund and Franklin Templeton Smaller Companies Fund.
Equity Multi caps: Motilal Oswal MOSt Focused 35 and Kotak Select Focus
Balanced Funds: HDFC Balanced Fund, ICICIC Pru Balanced Fund and L &T India Prudence fund.
Conventional wisdom forbids us from putting all eggs in one basket. Therefore, the 2018 investment portfolio should, ideally, include choices from the asset classes discussed above. The investment strategy may be conservative with modest return expectations.
(The author ischief investment strategist, Geojit Financial Services)