Big October crash: Try the cockroach portfolio

The Indian markets have been steady for most of the current year but were jolted last week from the uncertainty around the ongoing Israel-Hamas war, which now threatens to involve other state actors in the Middle East. Also, the hardening of US 10-year bond yields, which had crossed the 5%-mark for the first time in 16 years, played on the minds of many investors.

High bond yields indicate a risk-off environment as global asset managers typically rotate portfolios from equity to debt to capitalize on the higher bond yields. So far in October, foreign portfolio investors (FPIs) have net sold ₹20,356 crore worth of Indian equities. Even though domestic institutional investors (DIIs)— insurers, pension funds, mutual funds—have bought shares worth ₹26,585 crore, the benchmark indices, S&P BSE Sensex and CNX Nifty 50, still ended in red in six of the last seven trading sessions, correcting around 4% over this period.

About ₹13 trillion of investor wealth got eroded over the course of these trading sessions. The market volatility index—India VIX—has moved up by 9% between 17 October and 26 October.

The question is who are the investors making the markets so volatile?

The fear

Experts say even though DIIs have usually been net buyers on days of FPI selling, it is the selling by retail and high net worth investors (HNIs) that is putting the markets under pressure.

“The sellers in this market are retail and HNIs,” says Ambareesh Baliga, an independent market expert. “They don’t look at things like valuation but base their decisions on momentum and khabar (news). So, when the bad news starts pouring in, they start to offload because of fear and that’s what we are seeing. The tone of this market has definitely shifted to sell-on-rise from buy-on-dip,” he adds.

On 23 October, the market fell 1.3% even though FPIs purchased shares worth ₹1,801.6 crore while DIIs bought ₹1,111.84 crore. On 26 October, the market dropped almost 1.4% when FPIs sold ₹4,025 crore. On this day, DIIs purchased ₹6,558 crore, which more than absorbed what FPIs sold and yet, the market fell.

“This leaves not an iota of doubt that retail sold heavily both on Monday and on Thursday last week,” Baliga stresses.

Data from the National Stock Exchange (NSE) shows that retail investors had bought ₹21,900 crore worth of equities over August and September, just before the recent correction. This buying came after net selling of ₹21,400 crore by retail investors from April to July.

Retail investors tend to get attracted to rallies in broader markets—mid-cap and small-caps—in the hope of making a quick return. Before the recent correction, the BSE 150 Midcap Index was up 38% from its March lows, while BSE 250 Smallcap Index was up 47%. On 23 October, FPIs and DIIs were both net buyers, but the BSE 150 Midcap Index cracked by 2.5% in a single day and the BSE 250 Smallcap Index was down by 4%. Experts attributed this fall to selling by individual investors. A mix of issues, mostly stemming from geopolitics in the Middle East, is bothering them.

Rates worry

The US Fed has been raising interest rates since March 2022 to rein in inflation. The interest rates have moved from 0-0.25% in March 2022 to 5.25- 5.5% at present, a move of 525 basis points.

There was an expectation of an easing rate cycle after more than a year of rate hikes. However, the Israel-Hamas war has changed things—experts are now bracing for higher rates over a longer period of time.

“What the West is doing now will keep inflation and interest rates higher for longer, something that the market hasn’t seen in the past 15 years,” says Anand Tandon, an independent market expert. “That’s because after all these years of importing deflation from China, the West wants to wean itself away from the traditional supply chain on environmental grounds and reduce dependence on China after the covid-19 pandemic. So, typically, someone who has entered the markets in the last 15 years doesn’t have an idea of the impact of persistently higher rates on corporate earnings and then on valuations,” he adds.

If interest rates are hiked further, it would push up the cost of capital, which can pull down corporate profitability and may impact their valuations. Sensex, which comprises the top 30 Indian companies in terms of market cap, is currently trading at one-year forward price-to-earnings (P/E) multiple of 17.85-times, while its five-year average (one-year forward) P/E multiple stands at 18.71-times. To be sure, the methodology of P/E computation changed from 2020-21—end when consolidated profit replaced stand-alone profitability in the denominator. This had the effect of ‘deflating’ the P/E in subsequent years.

Nonetheless, brokerages expect corporate earnings to remain healthy. “Management commentary has been quite encouraging overall, except for the export-oriented businesses. Here, the outlook remains uncertain due to the ongoing geopolitical issues,” says Pankaj Pandey, head of research at ICICI Securities.

“So far, at the index level, the top line and bottom line growth for 2QFY24 have been approximately 20%-plus. We are expecting around 16.5% earnings growth CAGR (compounded annual growth rate) over FY23-25E (estimated) at the index level,” he adds.

Crude risks

Crude oil prices moved up by as much as 11% after the Israel-Hamas war broke out on 7 October. From rising as high as $93.79 per barrel on 20 October, the price of crude oil has dipped by 3.52%, trading at $90.48 per barrel.

The risk of higher crude price—if Iran joins the Israel-Hamas war— cannot be ruled out as Iran has been expressing its support for Palestinians. Iran, or any other major oil-producing nation joining the war, could push up the oil prices further. That would have negative implications for India as it is a net oil importer.

A sharp jump in oil prices could significantly impact India’s economy. Every $10 rise in oil prices widens India’s current account deficit by 0.5 percentage points. Higher oil prices impact the current account deficit, and by token exacerbate downward pressure on the rupee. As of 27 October, rupee was trading at 83.414 against the dollar. It has marginally depreciated against the dollar by 0.35% since the Israel-Hamas war broke out. The Reserve Bank of India (RBI), India’s central bank, has intervened in the currency market to prevent excessive volatility in the currency rate.

The general election, coming up next year, is another variable that can influence the markets. Experts say that for now, the markets are focused on global factors and not so much on domestic affairs, but if the outcome of this year’s state assembly elections doesn’t favour the ruling National Democratic Alliance led by the Bharatiya Janata Party, market sentiment and calculations might be affected, going ahead.

The broader markets have fallen slightly more than the benchmark indices in the recent correction. The BSE 150 Midcap Index has corrected 4.3%, while the BSE 250 Smallcap Index has corrected 4.4%.

“The writing was on the wall, and I have been hinting that things are looking very dicey for a few weeks now,” says ace investor Shankar Sharma. “The fall so far in the broader markets hasn’t been much. Pan back to March-June of 2022 when the small cap index fell 25% and you knew that we will be grinding lower,” he adds.

Over the next three to four months, the markets will start pricing in the uncertainty around the elections, in addition to the present issues of war and high US bond yields. So, a deeper correction is possible.

“My approach will be to utilize 1-2% of the investable amount at regular intervals with a view on building a very diversified portfolio for the next 12 months. I think diversification could be through adding gold to one’s portfolio,” Sharma adds.

S Naren, executive director and chief investment officer at ICICI Mutual Fund, also stresses on the importance of asset allocation for retail investors.

“India is a structural long-term growth story with strong fundamentals, when compared to other markets because our economic growth, corporate earnings and demographics are much better than most global markets,” he says. “However, we believe that investors are better off recognizing the risks. We believe that asset allocation is the approach one should adhere to when investing. Consequently, investing through hybrid categories like balanced advantage fund, equity savings, aggressive hybrid and multi asset is the way to go for long-term investing,” Naren adds.

Anand Tandon says a ‘cockroach portfolio’ can help investors navigate the uncertainty around markets.

The idea behind the cockroach portfolio is to create an all-weather portfolio by combining all traditional asset classes in equal weights. Such a portfolio is designed to navigate volatility, particularly when there is uncertainty around which asset classes are likely to do well.

“Under these circumstances, a cockroach portfolio is my best bet with 25% equity, 25% gold, 25% debt and 25% cash,” Tandon says.