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Sell in May and go away is a common phrase among market traders as markets are usually weak during this period. However, for the past three years, May has not been a particularly bad month for the stock market.
But this does not mean that short term investors—and traders—can ignore the saying altogether, say experts. The Indian market has been rallying since the start of this year and, with the an additional push from the appreciation in the rupee, the Dollex 30 index—tracked by foreign institutional investors (FIIs)—has made an absolute gain of 20% during the first four months of 2017.
Stocks that have gained the most
These BSE 100 stocks have rallied massively since the start of this year
Source: Bloomberg and ETIG Database
A sizeable correction after such a rally is quite possible. The Sensex closing above the 30,000 mark, for the first time, is another reason to be cautious. Though these levels don’t make much difference to long-term investors, the likely increased volatility can be used by short-term investors and traders to their advantage.
Stocks that have tumbled
These BSE 100 stocks have fallen the most since the start of this year
Source: Bloomberg and ETIG Database
Most experts expect some correction in the market and are advising investors to be cautious. The stock market rises because of two reasons—liquidity and fundamentals. The liquidity flow—money coming into the market—both from FIIs and domestic investors has increased in the recent past and has kept the market strong. “There is a euphoric mood now due to these continued inflows,” says Dhananjay Sinha, Head of Research and Strategist, Emkay Global Financial Services.
However, investors need to be careful. “The status quo (market euphoria) can’t continue forever,” says Daljeet S. Kohli, Director and Head of Research, India Nivesh Securities. FIIs have made an absolute gain of 20%, so it won’t be surprising if they start booking profits in the coming months, triggering a market correction. Also, the current rise in the market is not supported by fundamentals, making a correction all the more likely. “Ultimately, valuations have to catch up,” says Kohli. “Since valuations are not cheap, there could be some correction due to disappointments from the fourth quarter results,” says Tanwir Alam, Founder and CEO, Fincart.
Dollex 30 year-to-date returns
FIIs track this index to invest in India.
Though the market has skipped the May effect for the past three years, this time investors need to be cautious
How big could the correction be? “Since the IMF has projected India as the fastest growing major economy in 2017, FII allocation to India has increased. So the correction will be small (around 5-7%),” says Alam. But a 5-7%—between 1,500 and 2,000 points on Sensex—correction will be significant for short-term players. So, short-term investors should avoid putting fresh money into the market. “I won’t put fresh money, but won’t exit my existing investment,” says Sinha.
India Nivesh Securities’ Kohli is more cautious: “Investors should consider bringing down their cost of acquisition by booking partial profit. They also need to maintain a strict stop loss for the remaining portfolio.” Strict trailing stop loss—not far off from current price—helps investors retain part of their profit, if the market starts tumbling. Investors also need to be careful with the kind of sectors and stocks they hold.
Stay invested only in high quality stocks and avoid companies with a huge debt or corporate governance issues. A look at the top gainers—year-to-date—reveals that the market has not distinguished between good and bad companies in the recent rally. For instance, DLF which is quoting at a PE of 48, is among the top gainers. Several other real estate stocks have also rallied. This, despite the real estate sector going through a painful period of demand contraction due to demonetisation. “Though valuations are huge for real estate sector, the earnings growth are not going to be there,”says Kohli. Even with quality stocks, investors need to make sure they are not overpaying. “Since the earnings growth is not happening as expected, make sure the price you pay is commensurate with the stock’s growth rates,” says Kohli. The PE to growth ratio should ideally be close to 1—don’t buy a stock with a PE of 40 that is growing in the 5-10% range.