Ride stocks, but don't ignore debt, gold this year

2017 ended with a bang as the liquidity-driven Sensex closed at a new peak, delivering a whopping 28% yearly return but the next 12 months could test investors' patience if they expect an encore without actual earnings growth justifying lofty valuations.

Asset allocation for the portfolio will be key for investors in 2018, rather than going the whole hog on a single asset. Experts say investors must use fixed income, gold, real estate and plain vanilla cash to position themselves properly for the 2018 movements because all the assets are likely to offer opportunities to double down.

Equity:

After a rip-roaring rally in 2017, equities as an asset class finds itself up against the wall. History shows that if the Sensex gains 25% or more in a calendar year, in 70% of cases it gives a lower return in the subsequent year and there is a high probability of a loss as well. The only exceptions have been 2005 and 2006. Bank of America Merrill Lynch sees Sensex at 32000 in December 2018, saying that large, positive returns for equity indices from current levels are "only possible if the current elevated price/earnings multiples sustain".

Some are still quite optimistic about a bumper 2018. "We believe that market would continue its northward journey in 2018. Our year-end target for Nifty is 11450-11650. Some of the themes that we believe could do well in 2018 are cyclicals like cement, infra, capital goods, GST beneficiaries like jewellery retail, footwear, building materials, rural recovery (sectors like auto, FMCG, vehicle financing, etc)," said Siddharth Khemka, head-retail research, Motilal Oswal Securities Ltd.

While risk factors like oil above $70/barrel and geopolitical tensions can play spoilsport globally, Kamlesh Rao, MD & CEO, Kotak Securities, counts inflation inching up, government expenditure slowing, earnings disappointment and GST collections not up to the mark to be local risk factors.

Debt:

On the debt asset side, bond markets have enjoyed a sharp rally in last four years which has now come to an end. Indian bond yields have increased quite a bit in the last five months. The 10-year government bond is now trading near 7.4%, which was at 6.4% in August 2017.

The past year had been a sour reminder to investors that bond funds do carry market risk and can even return negative in adverse times. "Now with most of the bond yield curve above 7%, the valuations have improved from a medium-term perspective. However, we still remain cautious as yields could rise even higher from current levels amid various uncertainties. We advise investors to have a longer time frame as far as investing in bond funds are concerned and to always consider the possibility of capital losses in short-term," said Pankaj Pathak, fund manager- fixed income, Quantum AMC.

Investors who are looking at debt mutual funds for their short-term savings are better off investing in liquid funds. Debt investors expect short-term interest rates to rise. "The short-term segment of the yield curve is relatively more attractive from a risk-reward perspective. Investments in short-term funds can be considered with an investment horizon of 12 months and above. Investments in medium-term funds can be considered by moderate and conservative investors with an investment horizon of 15 months and above. Income/duration funds can be considered by aggressive investors for a horizon of 24 months and above; though currently preference should be given to dynamically-managed funds," said investment advisory group of HDFC Bank.

Gold & real estate:

Indian gold prices inched up by 4.8% in 2017, while global gold (spot price) clocked 13% gain as it reaped its largest annual gain since 2010. The main reason behind this rise has been US dollar weakness despite Fed rate hikes and range-trading in the 10-year US real yield. But 2018 is not expected to see a similar gold rally due to three main reasons, experts reckon.

"We no longer expect gold prices to rally in 2018. First, it is unlikely that the US dollar will be aggressively sold off in 2018...this brings us to the next dominant driver for gold prices, namely 10-year US real yields. For 2018, our US economist expects 10-year US real yields to stay close to the current level. Third, the largest central banks around the globe are moving towards tighter monetary policy or less accommodation. This is a negative for zero-income assets such as gold," said Georgette Boele, senior analyst - precious metals & diamond, ABN Amro.

Coming to real estate, 2017 was a watershed year, with the roll-out of game-changing policies such as goods and services tax and Real Estate (Regulation and Development) Act, 2016. The impact of demonetisation started to taper off slightly, while real estate investment trusts (Reits) did not take off this year as expected. Affordable housing came out of the shadows and affordably-priced units have been selling like hot cakes in most cities, notes Ramesh Nair, CEO and country head, JLL India.

However, 2018 may not bring the big residential revival, which is key for broader real estate prices to rise significantly. Anuj Puri, chairman, Anarock Property Consultants, said weak consumer sentiment, developers under stress, a possibly lacklustre Budget for real estate sector, hardening of interest rates and restricted new launches will mean that the year 2018 is expected to be no different than 2017.

UNSURE ON STREET

• History shows that if the Sensex gains 25% or more in a calendar year, in 70% of cases it gives a lower return in the subsequent year and there is a high probability of a loss as well
   
• Bank of America Merrill Lynch sees Sensex at 32000 in December 2018, saying that large, positive returns for equity indices from current levels are "only possible if the current elevated price/earnings multiples sustain"
   
• Some of the themes that could do well in 2018 are cyclicals like cement, infra, capital goods, GST beneficiaries like jewellery retail, footwear, building materials, rural recovery (sectors like auto, FMCG, vehicle financing, etc
   
• Investors who are looking at debt mutual funds for their short-term savings are better off investing in liquid funds. Debt investors expect short-term interest rates to rise
   
• Weak consumer sentiment, developers under stress, a possibly lacklustre Budget for real estate sector, hardening of interest rates and restricted new launches will mean that the year 2018 is expected to be no different than 2017
   
• Gold prices are unlikely to rally in 2018. First, it is unlikely that the US dollar will be aggressively sold off in 2018, 10-year US real yields may stay close to the current level and the largest central banks around the globe are moving towards tighter monetary policy