Financial advisors always recommend investment in risk assets like equity to overcome the impact of inflation on the investment portfolio. Investors who had invested in equity in the year 2011, following their advice, would have suffered a substantial erosion in their portfolio over the past one year. Many of you would be wondering what went wrong during the past year and what is in store for the year 2012. Let us first try to understand what happened during the past and draw a few lessons from history.
Understanding 'Equity Investment':
- Equity investment is for long term (3 years and above) and should not be judged from a short term perspective of one year. Bear phases in Indian equity markets have lasted typically between 12-16 months, whereafter recovery process starts. The probability of making losses in equity markets reduces substantially as the investment period increases.
- Equity markets always give a chance to book profits as well as losses, an investor should encash on the opportunities provided by the markets. One must learn to accept one's mistakes and should even be ready to book a loss on an investment which has turned negative due to factors like a change in business cycle/ govt. policy or due to unearthing of some negative news related to a particular company.
- Equity investment entitles the investor with the status of 'ownership in the company', and we must exercise restraint if the stock price is impacted negatively in the short run due to extraneous factors, provided we are convinced about the quality of management and future prospects of the business.
- Equity investments involve higher risk and should be undertaken only after proper understanding of the behaviour of the markets. One must be prepared to see a downside in the prtfolio in the short run. However, downward risk to the portfolio can be mitigated by investing in well researched companies and diversifying investments across sectors.
Analysis of the prospects of equity markets in 2012:
- The result season is going to commence shortly, and the performance of India Inc., barring a few sectors like IT and FMCG, is likely to be subdued in Q3. This would put further pressure on the equity markets. The markets, in all probabilty, are likely to bottom out anytime between now and middle of March 2012, as the bear phase that started on 5th November 2010 will be 16 months old in March.
- Equity markets typically thrive in an 'Easy monetary policy scenario'. By this we mean falling inflation followed by low interest rate regime. Inflation has started to cool off and the first trigger for the revival of Indian equity market could be the RBI policy to be announced by end of January, which may signal the start of a falling interest rate scenario. Further impetus would come with the announcement of the Union budget in the middle of March 2012.
- While some positive news is expected from the US, Euro zone will continue to put pressure on the equity markets world over. India will ultimately be benefitted in the shape of lower commodity prices as Euro zone crises escalates. The Indian rupee will start to strengthen, as inflation dips and commodity prices ease. This would indirectly lend a helping hand to the Govt. grappling with the menace of a huge fiscal deficit.
Considering the above factors, equity investments would prove to be the best bet for the year 2012, provided the investors do not panic in market downturns and commit funds to equity investments at every decline. Sectors based on Indian consumption story should be preferred and companies with large exposure to the Euro zone should be avoided for investment. I shall review the prospects of other asset classes in my next post.
