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Praveen Gurwani
Market correction: This time, it's different!
Corrective phases, when they occur, will be sharp and difficult to predict. It may be prudent to make strategy changes to de-risk your portfolio.
Investors who were poised to hit the `sell' button may have been tempted to hold on just a little bit longer by this week's events. The 977-point reversal in the Sensex was compressed over just two trading sessions; but the recovery was just as swift, with the index back at 13,600 by end of the week. Parallels are likely to be drawn between this correction and the one in May, raising the question: With the market bouncing back from every decline, is it wise to book profits? But understanding that market conditions are now very different could be the key to your decisions.
What's different this time?
The triggers: Global factors were at the heart of the May meltdown, with the Indian market tumbling in sympathy to reversals across the world. Factors such as high crude oil prices, fears about rising interest rates and meltdown in metal prices, all interrupted the flow of liquidity into emerging markets, India included. Foreign Institutional Investors made net withdrawals from Indian equities from mid-May until mid-June, even as the indices hit new lows. The recovery began after interest rate concerns began to abate on signs of a US slowdown and a moderation in crude oil prices.
But the recent decline was purely an Indian phenomenon, with the Sensex tumbling even as it was business-as-usual in the other Asian markets. A surprise hike in the Cash Reserve Ratio by the RBI (resurrecting domestic interest rate concerns) and unexpectedly weak numbers in the Index of Industrial Production for October were key triggers for the meltdown.
Net purchases by FIIs, both on December 11 and December 12, suggest that domestic investors led the profit-taking, with margin calls also kicking in as the decline snowballed.
Mid-caps versus large-caps: Mid-caps bore the brunt of the May reversal. Since the recent rally has been narrower, with the buying focused on the bellwethers, valuations of mid-cap stocks are now at a substantial discount to the large-caps.
The magnitude: May's corrective phase lasted more than a month. When the market bottomed out in mid-June, the Sensex was at 8,900 levels, with 29 per cent shaved off its peak value. This significantly tempered stock valuations, with the price earnings multiple of the Sensex basket at barely 18 times earnings by mid-June. In contrast, the recent market decline barely made a dent in valuations and the Sensex PE now hovers at about 21 times its earnings. Is this corrective phase over? Or is there more pain round the corner? Difficult to say. But here are a few pointers investors need to bear in mind while deciding on their course of action.
The fundamental picture
The steady appreciation in stock prices over the past few years has been supported by strong growth in such macro-indicators as GDP growth, industrial production and infrastructure growth. On this count, the unexpected blip in the October IIP numbers is a cause for concern, provided it was not triggered by seasonal/one-off factors, such as the "Diwali" effect. Quarterly earnings numbers from Corporate India for June and September re-affirmed that companies have so far weathered higher commodity prices and rising borrowing costs well. But will these trends continue if domestic interest rates, and thus borrowing costs, keep rising? With companies on a fund-raising spree, what impact will an expanding equity base have on earnings? Therefore, while both the macro and earnings picture does look positive, uncertainties remain.
As investors, we are often assured that nothing can go wrong with stock market investments so long as long-term fundamentals of the economy and companies remain intact. However, unlike in mid-June, market valuations are now at fairly stiff levels, and stock prices are already taking for granted a robust growth rate in corporate earnings over the next few years. Any signals to the contrary, either from the macro-indicators or from the earnings announcements of companies in the third quarter, will thus be taken pretty seriously. Therefore, investors have to brace for the fact that corrective phases will be sharp and difficult to predict.
Bearing this in mind, irrespective of the prognosis for the market, it may be prudent to make the following changes in your investment strategy in order to de-risk your portfolio.
If equity investments make up, say, 70-80 per cent) of your overall assets after the recent rally, it may be prudent to book profits on part of your portfolio and re-balance toward debt.
If your equity investments remain within comfortable limits, hold on.
If you are looking to make fresh investments in equities, taking the mutual fund route may be less fraught with risk than direct investments. Though conventional wisdom suggests that sticking to large-cap stocks offers less volatile returns, the substantial gap in valuations between mid-cap and large-cap stocks at this juncture make the former a reasonable investment. Opting for equity funds that invest across the market-cap range, thus appears a sound strategy.
:SugarwareZ-064:
Corrective phases, when they occur, will be sharp and difficult to predict. It may be prudent to make strategy changes to de-risk your portfolio.
Investors who were poised to hit the `sell' button may have been tempted to hold on just a little bit longer by this week's events. The 977-point reversal in the Sensex was compressed over just two trading sessions; but the recovery was just as swift, with the index back at 13,600 by end of the week. Parallels are likely to be drawn between this correction and the one in May, raising the question: With the market bouncing back from every decline, is it wise to book profits? But understanding that market conditions are now very different could be the key to your decisions.
What's different this time?
The triggers: Global factors were at the heart of the May meltdown, with the Indian market tumbling in sympathy to reversals across the world. Factors such as high crude oil prices, fears about rising interest rates and meltdown in metal prices, all interrupted the flow of liquidity into emerging markets, India included. Foreign Institutional Investors made net withdrawals from Indian equities from mid-May until mid-June, even as the indices hit new lows. The recovery began after interest rate concerns began to abate on signs of a US slowdown and a moderation in crude oil prices.
But the recent decline was purely an Indian phenomenon, with the Sensex tumbling even as it was business-as-usual in the other Asian markets. A surprise hike in the Cash Reserve Ratio by the RBI (resurrecting domestic interest rate concerns) and unexpectedly weak numbers in the Index of Industrial Production for October were key triggers for the meltdown.
Net purchases by FIIs, both on December 11 and December 12, suggest that domestic investors led the profit-taking, with margin calls also kicking in as the decline snowballed.
Mid-caps versus large-caps: Mid-caps bore the brunt of the May reversal. Since the recent rally has been narrower, with the buying focused on the bellwethers, valuations of mid-cap stocks are now at a substantial discount to the large-caps.
The magnitude: May's corrective phase lasted more than a month. When the market bottomed out in mid-June, the Sensex was at 8,900 levels, with 29 per cent shaved off its peak value. This significantly tempered stock valuations, with the price earnings multiple of the Sensex basket at barely 18 times earnings by mid-June. In contrast, the recent market decline barely made a dent in valuations and the Sensex PE now hovers at about 21 times its earnings. Is this corrective phase over? Or is there more pain round the corner? Difficult to say. But here are a few pointers investors need to bear in mind while deciding on their course of action.
The fundamental picture
The steady appreciation in stock prices over the past few years has been supported by strong growth in such macro-indicators as GDP growth, industrial production and infrastructure growth. On this count, the unexpected blip in the October IIP numbers is a cause for concern, provided it was not triggered by seasonal/one-off factors, such as the "Diwali" effect. Quarterly earnings numbers from Corporate India for June and September re-affirmed that companies have so far weathered higher commodity prices and rising borrowing costs well. But will these trends continue if domestic interest rates, and thus borrowing costs, keep rising? With companies on a fund-raising spree, what impact will an expanding equity base have on earnings? Therefore, while both the macro and earnings picture does look positive, uncertainties remain.
As investors, we are often assured that nothing can go wrong with stock market investments so long as long-term fundamentals of the economy and companies remain intact. However, unlike in mid-June, market valuations are now at fairly stiff levels, and stock prices are already taking for granted a robust growth rate in corporate earnings over the next few years. Any signals to the contrary, either from the macro-indicators or from the earnings announcements of companies in the third quarter, will thus be taken pretty seriously. Therefore, investors have to brace for the fact that corrective phases will be sharp and difficult to predict.
Bearing this in mind, irrespective of the prognosis for the market, it may be prudent to make the following changes in your investment strategy in order to de-risk your portfolio.
If equity investments make up, say, 70-80 per cent) of your overall assets after the recent rally, it may be prudent to book profits on part of your portfolio and re-balance toward debt.
If your equity investments remain within comfortable limits, hold on.
If you are looking to make fresh investments in equities, taking the mutual fund route may be less fraught with risk than direct investments. Though conventional wisdom suggests that sticking to large-cap stocks offers less volatile returns, the substantial gap in valuations between mid-cap and large-cap stocks at this juncture make the former a reasonable investment. Opting for equity funds that invest across the market-cap range, thus appears a sound strategy.
:SugarwareZ-064: