The markets are currently passing through a volatile phase, unable to decide which direction to take. There are clear reasons for this uncertainty. The macro-economic environment in the developed countries — the US, Europe or Japan — is clouded. Experts are predicting that a sovereign default by Greece is inevitable, that means trouble for the euro-zone. The high debt levels in the US limits its ability to grow, while risking another recession-like situation. Japan, now the world's third largest economy, is yet to recover from the tsunami and subsequent nuclear debacle. Leading developing countries like China and India, too, are witnessing signs of economic overheating.
Overall, the picture is not that rosy and one may wonder if investing in equity at this stage makes any sense at all. However, the situation remains dynamic and one shouldn't assume a catastrophe as the only possible outcome.
How this global turmoil would impact Indian equities is unclear. A section of analysts believes that in case of macroeconomic trouble overseas, Indian markets would retain their lure for foreign investors thanks to steady growth.
These conflicting undercurrents mean that one shouldn't exit the equity market totally. But prudence calls for readying one's portfolio for a rough ride ahead right now when the weather is calm. Following are some guidelines that one can follow to build shock absorbers into one's equity portfolio.
Low Beta
Beta is the measure of volatility relative to the overall market. A low-beta stock will react less to overall market forces on both positive as well as negative sides. During market volatilities these stocks will ensure that your portfolio doesn't lose too much value.
Low Valuation
Mature or steady growth businesses, which typically attract lower price-to-earnings valuations, should be preferred over companies promising high-speed growth and hence commanding a higher P/E in volatile markets. Companies at the bottom of their valuation cycle can limit downside risk.
Cash-rich And Debt-free
A company with high debt — although raised for growth — not only increases risk on its balance sheet, but is also hurt more by rising interest rates. A cash-rich company addresses both these concerns and makes sure it retains the ability to pay a dividend even in difficult years.
Dividend Paying
Capital appreciation is not the only thing to consider when building a portfolio. Dividends bring in regular returns for the investor, which could grow substantially over the years. In addition, they are tax free. Strong dividend paying companies are essential in one's portfolio.
Sectoral Preferences
'Hot' sectors typically represent high valuations on the stock market. But as the economic scenario changes they could find themselves at the top of a cycle turning downward. Investors should weed out such heated-up sectors and opt for sectors that are currently out of fancy
Go for Industry Leaders
Industry leaders typically are the last ones to suffer and the first ones to recover when an industry hits a bad patch. Even though their valuations appear to be a little high compared to peers, they provide a necessary safety net to the portfolio's value.
