Things to consider before investing in equities amid recession worries

Before allocating additional capital to equity investing, it is critical to consider one's risk tolerance and short-term liquidity needs

Shailesh Khanduri
29 Dec 2022
Things to consider before investing in equities amid recession worries

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New Delhi: Investors must adopt a multi-pronged approach to equity investing as they deal with increased volatility and lower portfolio valuations. The benchmark Nifty50 index has delivered stellar growth and reached new highs over the last two years. However, its rise was halted at the start of 2022 as the war in Ukraine, rising inflation, and looming interest rate hikes threw a wrench in the works and acted as headwinds to economic growth.

The Indian growth story remains intact, as a number of factors, including a focus on manufacturing, a thriving startup ecosystem, and a clear demographic advantage, have now aligned to provide the necessary impetus to economic growth.

While the longer-term outlook remains positive, the economy and markets may continue to deteriorate in the short term. In such a context, investors must position their portfolios to optimally leverage Indian equities' long-term growth potential while protecting portfolio downside in the short term.

Economic downturns, on average, do not last as long as expansions, as detailed in the history of our country’s economy. As a result, investors should proactively assess their asset allocation strategies and seek out equity investment opportunities at attractive valuations. However, before allocating additional capital to equity investing, it is critical to consider one's risk tolerance and short-term liquidity needs. Before investing in stocks, keep the following points in mind:

  • In such a volatile environment, investors must exercise caution when investing in highly leveraged stocks, even if they promise better growth prospects. This is due to the increased risk of such companies defaulting on interest payments, triggering bankruptcy proceedings that are detrimental to investor interests. Existing equity holdings in such companies should either be booked as losses or have a strict stop loss in place to avoid more and continued capital erosion.
  • In terms of a new equity allocation, it may be better to invest in a mix of growth and value stocks to diversify one's portfolio and weather volatile periods without foregoing the potential for future profits. Growth stocks typically outperform value stocks during bull markets but underperform during bear markets due to their greater sensitivity to economic downturns.
  • Value stocks are companies with strong fundamentals that are currently trading at a significant discount to their intrinsic value. Investors can add them to their portfolios now with the expectation that their prices will converge with their true fundamental value in the medium to long term.
  • Investing in index funds or ETFs is another option for investors to consider. These are passively managed funds that seek to replicate both the composition and performance of the underlying benchmark index. The risks associated with stock selection are eliminated because these funds are not actively managed. Such funds can be a great opportunity for investors who are concerned about equity market volatility to benefit from the long-term return potential of equities while mitigating the unwanted risk factor.
  • While investing in equities directly, investors must look for quality stocks that are trading at lower-than-average valuations and are generally more resilient to recessionary pressures. You must avoid companies facing short-term margins, volume, revenue, or profit pressures unless fundamentally positive changes occur that could propel them to improved financial performance.
  • Furthermore, investors with a long-term horizon take advantage of opportunities to invest in blue-chip companies that are currently available at attractive stock valuations.

Know that holding on to excess cash can be detrimental to generating inflation-beating returns. Take the basic precautions outlined below to protect one's invested capital and potential profit from a recovery with a more diverse portfolio. Investors must consult their financial advisors and carefully plan their equity investments rather than rushing to buy or sell equity during this volatile market phase.

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