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It’s time for intelligent investors to switch over to risk-off mode. Here’s why

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Jason Zweig quoted in his book The Intelligent Investor…The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap).

The Intelligent Investor is the one who knows when to take risks and buy shares when there is pessimism…and avoid risk and sell shares when there is optimism.

After Covid, markets were in a risk-on mode fuelled by cheap liquidity. The low interest rates prompted investors to give up safe assets and take risks to earn higher returns. The valuations too went through the roof.

However, it seems that now it’s time to switch back to risk-off mode. Here’s a ratio chart of MCX Gold to CNX 500, which is at an interesting juncture.

Gold is a proxy for safety or risk-off mode while CNX 500 is a proxy for the broader markets and risk-on mode.

When the ratio is falling, it means we are in a risk-on mode as equities are outperforming gold. When the ratio is rising it means we are in risk-off mode as gold is outperforming the broader market index.

This ratio is currently placed near an all-time low of 3. It means that the chances of reversal in the ratio are high. The weekly RSI is also showing divergence.

We are now entering a phase with higher volatility due to elections. Valuations in the broader market too are not very comfortable.

Smallcap & midcap have shown significant performance since Covid lows, especially over the last year. Currently, both Nifty Small & Midcap indices are at their highest price-to-book levels seen in a decade. Below is the price-to-book value ratio chart of the Nifty small-cap 250.

During the ‘risk-on’ environment, smallcap and midcap stocks are preferred by investors, which pushes up their valuations. When the investors expect uncertainty in the market they switch from aggressive sectors like small and mid-cap to defensive sectors like pharma and FMCG.

Now here’s a ratio chart of Nifty FMCG to BSE Small-cap. The FMCG index has underperformed the BSE small-cap index since April 2020.

The ratio is now taking support at its 10-year low. This indicates that the defensive FMCG index might outperform the aggressive small-cap index. The RSI indicator also shows that the ratio is at an oversold level. It is forming a bullish divergence which suggests a reversal in ratio might be due.

And that’s not all in the past 14 years, the average returns of Nifty FMCG from March to July is 14.26% which is higher than the Nifty 50, S&P BSE Midcap, and S&P BSE Small-cap index returns of 7.19%, 9.18% & 10.70% respectively. In the past 7 out of 14 years, Nifty FMCG has outperformed Nifty 50, S&P BSE Midcap, and S&P BSE Small-cap index during the March to July months.

This indicates that if the markets switch over to risk-off mode now then FMCG stocks are likely to beat smallcap & midcap stocks.

Looking at the upcoming general election in India, the market is likely to be volatile. During such uncertain times, investors must switchover to risk-off mode and prefer safer asset classes like FMCG, gold, government securities, and large-cap companies with low beta.

Technical outlook:

Nifty continued its upward trajectory, registering a gain of 0.57% in the previous week and hitting a new high of 22,353. On a month-on-month basis, Nifty saw a 1.18% surge in February. The Index surged last Friday, propelled by India’s 8.4% Q3 GDP growth which catalyzed the sideways market.

The RSI stands firmly at the 61 level, indicating a balanced market. Support is placed at 22,050 levels while resistance is noted at 22,550 followed by 22,650 levels.

Technically, the Nifty’s primary trend remains positive concluding the third consecutive week with gains. Despite Nifty IT’s underperformance, the overall sector has shown rotational participation. However, mid and small-cap stocks have remained undertone, prompting caution against excessive exposure to them.

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