InvestorQ : The Nifty is close to its peak of 12,000 and the Sensex is close to its peak of 40,000. As an investor what are the things for me to remember in this context?
rhea Babu made post

The Nifty is close to its peak of 12,000 and the Sensex is close to its peak of 40,000. As an investor what are the things for me to remember in this context?

2 years ago

There is a certain in-built caution and scepticism associated with new highs in the equity markets. Not only has the Nifty and the Bank Nifty touched new highs, but even the Sensex has touched new highs. It is typical for investors and traders to get cautious at such high levels since the law of gravity is supposed to eventually catch up with the markets. The question, therefore, is what should investors do with markets at their all-time highs? Here are 5 things for investors to remember…

Nifty peak is not always the time to panic; not just because market is at a new high…

The first thing to remember is that new highs are not a time to sell out of markets just as new lows are not the time to buy into markets. The Sensex started off at a value of 100 in 1981. From that point it has consistently grown to a level of over 30,000 currently. During these 37 years, the Sensex has kept consistently making new highs but that has not necessarily meant a reversion to the mean. A structural bull market, for example, will keep making new highs but that need not indicate that the market is overheated or that the market is overpriced. It is more likely a market that is trying to adjust itself to the reality of a new trajectory. Hence investors need not be in a hurry to sell and exit long positions just because the market has touched a new high. For sceptics of new highs, just rewind back to 2005. That was the time the Sensex broke through its 1999 high of 6100. While sceptics expected markets to top out, the Sensex actually went on to scale levels of 10,000 and 20,000 over the next 3 years.

How about seriously considering hedging your portfolio risks now?

A hedge is by now well understood by investors. It protects against the risk of market downsides. If you are holding on to a portfolio of stocks and the index scales a new high, what do you do? You can hedge your downside risk by buying put options on the Nifty. The put option helps you in two ways. Firstly, when the markets correct, then the put option provides protection against a sharp correction in the markets. Secondly, even though your portfolio value may eventually go up, there is no harm in making some money on the downside. Buying put options not only protects your downside risk, but also enables you to make money when the markets become volatile. Remember, volatility is a part and parcel of the market when it is at a new high. For those of you who are not comfortable with esoteric options, you can also look at rolling stop losses.

In fact, this could be the right time to restructure your portfolio for the better

A new high is normally like a major tidal wave. It carries with it a lot of things; good, bad, valuable, frothy etc. That is exactly the case with equity markets too. The new high will bring a lot of stocks and companies that do not deserve to trade at rich valuations. It will also bring mid cap stocks that may be riding the euphoria even without any fundamental backing. That is why you need to use new highs to restructure your portfolio. If you have made a neat profit in a stock that did not deserve to appreciate, then just thank your stars and exit the stock. You can always reallocate that money to another stock that has momentum and a fundamental story going for it. New highs are the perfect opportunity for some skilful restructuring of your portfolio. All the speculative profits can now be put to some fundamental use.

At new highs, it is always smart to stay on the right side of momentum

Remember, sectors that have underperformed during the entire rally are unlikely to be outperformers when the market is at a new high. That is unless there is something drastic that changes for the particular sector; and that is a big if. For example, if IT and pharma have not participated in this massive rally in the Nifty, then it is unlikely that they will be outperformers once the Nifty is at a new high. The outperformance will stay with the sectors that generated the momentum in the first place. In the current scenario, the momentum was generated by sectors like private banks, downstream oil, automobiles and capital goods. That momentum is unlikely to shift just because the market is at a new high.

Always keep one eye focused on that one factor that drove up the markets…

What actually breaks a massive rally? It could be a variety of things, but essentially it is when the fundamental assumption of the rally is questioned. In 1992, the rally broke when the fundamental premise of replacement value was questioned. Similarly, in 2000 IT stocks had almost reached a point of no return. In 2008, the US sub-prime crisis exposed chinks in the India real estate story. For the last 8 years, the big driver for markets has been relentless liquidity. Therefore, watch out for signals that liquidity is tightening. If other central banks follow the Fed strategy of hiking rates, you have to be careful. If central banks decide to absorb liquidity by buying back bonds, there could a worry. Finally, if the RBI decisively shifts to a hawkish monetary policy, then there could be a worry. That is the one signal that you must always keep your eye on.

The good news is that a new high is not a time to sell and scoot. It could also be the beginning of a new break out on the upside and you never know till it actually happens. It is the time to ride the momentum and make necessary changes to your portfolio. Of course, keep an eye on that one factor that questions the premise of the rally!