Beat the market in 2022 with focused investment in three sectors

A couple of data points that throw light on the unprecedented retail exuberance and its impact on markets would help us to get the issue in perspective. In 2021 alone, US investors have downloaded 15 million trading apps and invested $1 trillion in equity. This investment is higher than the cumulative investment made during the last 20 years. Retail investors in the US now own 12 times more stocks than hedge funds. Cheap money has provided a favorable context for investing/ trading in stocks.

This explosion in retail participation is a global phenomenon triggered by the pandemic. In emerging markets, this trend is conspicuous in India. Retail participation is desirable but the concern is about exuberance and total disregard for valuations.

Massive crashes are followed by sharp rebounds
An important lesson from stock market history is that a sharp crash is followed, more often than not, by a sharp rebound. Stock market often overreacts: both on the upside and the downside. During the euphoria of a bull market, valuations reach unsustainable levels, leading to a sharp correction. The panic during a crash takes valuation to very low levels, which in turn leads to buying, triggering recovery. This pattern repeats. This has implications for investors.

Let’s take the history of recent market crashes and the rebounds from the crashes. During the tech bubble of 1998-2000, valuations reached unsustainable levels triggering a massive crash of 49 per cent from the 2000 peak. The market consolidated for a while, and then, there was a sharp rebound of 140 per cent in 9 months during 2003-04. One of the worst crashes in stock market history happened in 2008 during the Global Financial Crisis. The crash was a massive 65 per cent. Then, from the lows of March 2009, there was an impressive rebound of 180 per cent in 15 months. The crash of 40 per cent following the outbreak of the pandemic in March 2020 was swift and huge. This was followed by a sharp rebound of 135 per cent in 18 months.

What is the lesson from this trend? Stock market returns come in fits and starts. There will be periods of euphoric rise, sharp corrections and consolidation. Big money is made not by buying at the peak of the bull market, but by systematically and patiently investing through a bear market. More importantly, superior returns are generated by a simple investment strategy: Investing in high quality stocks that consistently generate superior cash flows. Smart investment strategy is like running a marathon; not like running a sprint. Timing the market is impossible. Spending time in the market is more important.

It appears that the sprint following the crash of March 2020 is over. This sprint, which took the Nifty from 7,511 in March 2020 to 18,604 in October 2021, generated 135 per cent return in 19 months. This one-way rally has ended with above 10 per cent correction from the peak. Unsustainable valuations and relentless FII (foreign institutional investor) selling has put a cap to the upside now.

Expect moderate returns in 2022
Returns in 2022 are likely to be moderate. Therefore, the focus of investors should be two fold: one, look for segments and stocks that can generate market-beating returns, and, two, invest patiently for the long term. New variants of the virus and rising interest rates may pose challenges in 2022. Market corrections triggered by these challenges may turn out to be buying opportunities.

Beat the market with focused investment
In 2022, the prospects for IT, financials and construction-related segments look good. The valuations of financials, particularly that of leading banks, are attractive thanks to sustained FII selling. IT is in a multi-year upcycle triggered by accelerating digitisation. IT valuations are high, but earnings visibility is very good. Low interest rates are driving a boom in construction, which would benefit all construction-related stocks. Focus on high quality stocks in these segments can generate market–beating returns in 2022. Invest in mid and small-caps through mutual fund SIPs (systematic investment plans).

As a measure of abundant caution, book some profits and move some money to fixed income. Investment in gold ETFs also would be a good hedge against rising inflation and a depreciating rupee. Look beyond 2022 and invest patiently for the long term. Continue with SIPs. The sprint that took the Nifty up 135 per cent from the 2020 March lows is over. Now, the marathon begins.