Markets will be swinging till May 2014: How to gear up for volatility

The next five months starting January 2014 is an uncertain period for markets. Given that equities are at record highs in India and many parts of the globe, the volatility will be high with wild swings in markets. At times of volatility, it is best to lower risk in your portfolios. However lowering risk does not mean selling out of equities and staying in cash. Lowering risk means that your portfolio is comfortable enough to ride out the volatility.

The volatility in markets will stem from domestic and global factors. On the domestic front the country is heading into elections, which are slated for March-April 14. Reports are that the current government at the centre will table a vote on account in January 2014 for running the country until the elections are over. There will be no major announcements in the vote on account and the markets will have to wait for May to see if the new government is committed to lowering deficits and strengthening the country’s finances.

Given that the full budget for 2014-15 will be post elections in June or July 2014, markets will play on the kind of government that comes into power. Election results are always uncertain and with hype on forecasts and predictions, markets will be extremely volatile.

On the global front, the biggest event in the calendar is the tapering of asset purchases by the US Federal Reserve (Fed). Fed tapering off USD 85 billion of monthly asset purchases are being discounted by markets, but when it actually happens, the markets reaction may be extremely volatile. In the longer run, the taper and stopping of asset purchases are positive, as markets will not be driven on the steroid of liquidity. However in the short run, the volatility could easily bleed portfolios that are not positioned for volatility risk.

Apart from political risk and risk of Fed taper, the economy itself is a risk with growth slowing to decade lows and inflation running uncomfortably high. RBI is more inclined to keep interest rates at higher levels than lower it in the face of inflation and global market volatility. RBI keeping interest rates high is positive as it can ride through volatility without damage to the Indian Rupee (INR). Higher interest rates in the economy does keep markets unhappy in the short run but it can help in the long run if inflation comes off and helps growth pick up.

The next five months is not a time to take undue risks in your portfolio. On the equities part of your investments you should be in stocks that you know and understand. At no point of time your portfolio should be leveraged i.e. you should not try and play the derivatives market unless you are a trader and you know the level of capital that you are willing to risk in a volatile market. Traders should be especially careful and lower the amount of capital they want risk on each trade as volatility can wipe out capital in a matter of a few minutes.

On the fixed income part of your investments, you should have a longer horizon for investments in mark to market securities or funds to fulfil their potential. Credit risk should be extremely low in your portfolio as potential for defaults and downgrades are high during uncertainty.

Arjun Parthasarathy is founder Investors are Idiots.com and INRBONDS.com. Follow him on twitter @investorsidiots