Reblog: Market Strategy and the Biggest Risk in Stocks in times of high valuations

The original post is written by Mastermind, Sanasecurities and is available here.

Over the last few weeks, markets have beaten all resistance barriers and have defied the very notion of value. Those waiting for a correction sometime back have now jumped in hoping for newer all time highs.

Anybody who believes in value may not find much for the taking. Certain I am however that many old school value buyers are neck deep in stocks right now. Perhaps for the right reason given the enormous liquidity coupled with strong news flow both domestically and from international markets.

Markets are risky – more so at the kind of valuations they are trading at right now. Nevertheless, from positive earnings, passage of GST, U.S. Jobs data and FEDs almost certain stance of maintaining interest rates, everything looks positive.

If you are already invested, in all likelihood you would have made money over the past 2-3 months. The key question: If you are not invested, should you jump in now?

What’s the risk of investing at high valuations when the sentiment in positive?

The biggest risk in stocks is not knowing how much you can make by staying away from the market.

These days, its – 7% in a savings bank account! (I am not sure how liquid funds are still in business really).

So here’s the question I pose – if you will make 10% in an Income fund over the next 12 months, do you think you can beat that number in equity markets? If your answer is No, then naturally you will stay away. If your answer is YES, then another question – By how much will you beat 10%?

If you can’t beat 10% by much, you’d again be better off staying away.

The Short Term Riddle

Each to their own so I can only answer this for a risk-averse investor. A low risk investor who is certain that the market will (as certain as it gets in short term!) make newer highs in the near term.

For such an investor, instead of going all in and taking stock deliveries, he would be better off investing 20% in futures and holding 80% @10% (or in his long term, never exit portfolio). Net result will be the same as investing 100% in delivery positions if markets were to keep moving higher. If the trend reverses before everyone expects it to, you will have enough cash to jump in. Of course, you will suffer some loss on your future positions. But based on a rising market view at high valuations, this will get you far better results on a risk-reward basis.

The Other Big Risk

Naturally, with the above view, it will be hard to stay out of the market (at least completely). Now if you were to implement the strategy I speak of above, the conundrum you must resolve is – Where to go long, in derivatives or otherwise. Over the last few weeks, I have given out my favourites in terms of stocks to buy, to profit from a further upswing in the markets.

The broad theme being – (i) large cap stocks that have (ii) so far participated the least in the rally (ii) have low debt.

Buying high beta stocks in overleveraged sectors will be a very risky idea, particularly when you are planning to take a position in derivative markets.

I am proceeding on this basis. I will keep you posted on it turned out!