Starting from the conclusion, here is the gist of our recommendations, after analysing what markets have thrown at us till now.

Action Summary

1. Move out of large-cap portfolios if the Nifty moves beyond previous peak.
2. For portfolios with little or no mid-cap exposure, build cautiously in a staggered manner over a year. Otherwise do nothing.
3. We prefer allocating to high quality medium-term bond funds, rather than dynamic funds.

Please read on for a review and more detail on why the above recommendations have been made.

November in three charts

The Nifty turned in a robust 4.7% in Nov 2018, while midcaps moved only by 1.8%. Our chosen large cap funds moved by 3.3% in Nov 2018, but the midcap funds have moved 4.5%. Opportunities for stock picking seem to favour midcaps currently, as many stocks outside of the index trade at valuations near their 2013 lows.

The 10Y Government Bond moved down from 7.85% levels to 7.6% levels. This has resulted in our chosen dynamic bond funds moving by 1.2%, the same as our chosen medium-term funds, due to the over 0.3% drop in yields of the latter portfolios in Nov 2018, as the liquidity squeeze brought about by the IL&FS default in Sep 2018 eased up.

The way ahead- Beware following past trends or pundits.

In keeping with the Yogi Berra admonition (“It’s tough to make predictions, especially about the future”), we will set out pointers here, but acknowledge that things can change quickly.The year has seen a shift in performance from mid-caps to large-caps. But while the midcap 100 index is at a P/E of 42 vs 26 for the Nifty, there seem to be far more opportunities among mid and small-cap stocks to pick out growth at reasonable valuations.

The large-cap segment seems to be a momentum story with money chasing a few stocks. Such stories seldom end well.We therefore believe that a push beyond its previous peak for the Nifty, should act as a signal for us to reduce our large-cap exposure.While we are tempted to boost mid-cap exposure, we refrain from recommending this for now, as even stocks that have corrected steeply can still find more downside, in case of a significant correction in mainline indices.

Portfolios under-exposed to mid-caps can boost exposure cautiously through a 50-week STP.

On debt, even though the 10Y GSec has gained as yields have fallen further to 7.4% levels from 7.6% of Nov, we continue to prefer the medium-term bond funds.

To see why, please take a look at the chart above; this shows the difference in yield (‘spread’) between the 3Y AAA bond and the 10Y GSec.This spread narrows when the AAA is falling more (or rising less) than the GSec. So it is better to be in the AAA when the narrowing starts.

After expanding to over 1% in Dec 2018, we believe that spreads are set to narrow.This is why we continue to recommend good credit-quality medium term funds.We also have concerns on whether inflation would continue to be low, and the fiscal deficit under control as we approach an election year, which is another push for us to stay with medium term funds.

We would look at paring significant dynamic bond fund exposures which have crossed 3 years, in a staggered manner to take advantage of falling GSec yields (NAV moves up as yields fall), and move such redemptions into quality medium-term funds.