It has been a rollercoaster year for the markets and let us be blunt that no one would have predicted such a year and definitely not such an ending for 2020. But here we are with equity benchmark indices trading at all-time highs not only in India but across the globe. In this article, we try to look at some of the important lessons that markets have taught us in 2020.
Some of the important lessons from 2019 still holds. In case you missed it, here is the link.
- Never try to time the markets – Had you just stayed invested through the crash of March, one would have come out unscathed by December. However, such bouts of high volatility always lure investors into catching the bottom and eventually looking to exit at the top. But to be honest, this never happens, in fact, it can backfire heavily if you are on the wrong side. Hence, it is always better to never try to time the markets. Focus on maintaining a disciplined and systematic approach.
- Liquidity was, is and always be the King – Well, fundamentals can take time to play out or can play out way too early, Charts can be deceptive sometimes but Liquidity was, is and will always be the king. This year has been a peculiar one due to the pandemic and more importantly for the markets was the response of governments and central banks which provided overwhelming support through liquidity. And with zero yields on debt, all it needed was a glimmer of hope for things to return to normal, to find its way into equities. And not to forget, with so much additional printing of money, Gold was not forgotten as an asset class and continued its strong run 2020 as well.
- Price multiples are not the only valuation method – Relative valuation is one of the most popular valuation methods especially amongst new investors. However, it is not the only method. The idea of using a valuation method is to determine the fair value of the company which can be done by discounting the future cash flows / dividends to its present value aka Discounted Cash Flow (DCF) and Dividend Discount Model (DDM). We won’t delve into details but here is the gist – The rate at which the discounting is done is called the cost of capital which is a result of adding the cost of equity and cost of debt based on the capital allocation of the company. Now when interest rates fall, the cost of debt will fall too, but there is an impact on the cost of equity as well. Simply put, if interest rates fall, the overall cost of capital also reduces and the cash flows would be discounted at a lower rate than before which means the fair value would be more if cashflows remain unchanged. The sharp fall in interest rates worldwide is also one of the reasons for re-rating in equities.
- Companies are more resilient than we think – The pandemic has hit several companies in a big way, however despite such unforeseen challenges, most of them have come to life (at least the listed ones). The results posted in Q1FY21 which was the worst hit were much better than expected as we all knew that demand was hit badly but companies were proactive in reducing the costs substantially leading to reduced losses. Even till December, where we see some sectors like Multiplex, Hotel & Travel are severely affected but companies have been resilient in managing cost and liquidity pretty well.
- Manage your equity allocation – The march fall would have definitely given sleepless nights to investors having very high exposure to equities or for traders running leveraged positions in the markets. One thing 2020 has taught us is that equity might be one of the most rewarding asset class but it is also highly volatile. Hence, risk profiling and asset allocation should be strictly followed for all investors.
- Stick with quality companies (not Kwality) – This lesson has been taught by markets to us for years now that we should stick with quality companies. Companies having good corporate governance and sound balance sheet are more likely to beat any storm that has hit them.
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