Temper your risk for realistic rewards

Tags: News
Investors, whether in equity markets or in entrepreneurial initiatives, often refer to the risk-reward ratio, which suggests that higher the risk taken, higher are the chances of rewards. Inversely, on several occasions, high risks also lead to inglorious failures, particularly when our expectations are out of sync with ground realities.

In equity markets, hig­her the expectation, higher is the attendant risk, and inversely, lower the expectation, lower is the risk at hand. Having said that, it is also true that exp­e­ctations often tend to move ahead of events, without us accounting for the imponderables, incre­asing our risks manifold.

Somehow, in the past six months, expectations ha­ve been gaining pace in the market, both in cor­porate boardrooms and am­ong retail investors, th­at shortly after elections, the economy will turn for the better. While a change of government next mo­nth might certainly per­kup investor mo­od, it is still too early to hazard a guess on wh­ich way the economy will finally move in the months ahead. This is wh­en the latest wholesale and retail inflation numbers that surged to quarterly highs of 5.7 per cent and 8.31 per cent, respectively.

Not preparing for the vicissitudes of time certainly exposes investors to the risks of big failures. So, it may be time to sit and ponder. To understand why we are telling you so, read our detailed sixth anniversary analysis of market trends on pages 4 and 5 of this issue.

The way our stock indices have moved in the runup to the polls, the way the rupee has strengthened and interest rates stabilised, even in a high inflationary environment, they all point to sentiments gaining the upper hand over present market fundamentals. Which is why there is irrational exuberance in the way stock prices have moved even for companies with irredeemably frayed bottomlines.

And then there is the case of infrastructure major Larsen and Toubro. In the bull run of 2010, its share price peaked at Rs 1,422 when order books were full. Today, it is just Rs 125 short of that high quoting at Rs 1,297, though operationally, things are not as rosy. As recently as the first week of April, L&T hinted that it might be writing off orders worth Rs 9,000 crore that it considers as slow moving.

While six months ago, everyone talked of gloom; today they are all busy chattering about an impending boom. But a more realistic assessment, without being unnecessarily pessimistic, should caution us about the perils of runaway expectations.

There is little doubt that India needs a strong government to drive home a much-needed course correction after years of policy paralysis. Yet, we need to ask if that good news has already been priced in by the market before the feel-good factor drives sentiments still higher.

Historically, markets factor in the good news before finally throwing caution to the wind. So, it may be wiser for everyone to reign in their hopes right now when the indices have breached successive all-time highs.

Tempering expectations right now should lower the attendant risks for ordinary investors, and hold out prospects for potentially bigger rewards.

If in doubt, recall the years leading 2007, a year before the great global financial meltdown dragged down all of us on the edge of an economic precipice. That was when several Indian companies, including Tata Steel and Hindalco, went in for aggressive global expansions and mergers, expecting to prosper from an impending consumer boom worldwide. Today, they are staring at massive debts and unrealised valuations. It is another story, of course, for those who were cautious then, and spread their bets prudently.

Which way you swing from now on is for you to choose.

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