Understand risks, and stay invested

Retail investors must stay the course as there is no structural change in India’s domestic growth expectation

Lisa Pallavi Barbora, Mint Money

source: http://www.livemint.com/Money/HQ1kj5xx0iFsbaKsR1NY3K/Understand-risks-and-stay-invested.html

In January 2015, there was euphoria all around; domestic equity markets were touching all time highs, rate cuts were expected to come through and boost the sagging economy, and, of course, it was anticipated that the momentum in reforms would pick up pace as the Narendra Modi-led government settled into its new role.

A year later, a disheartening gloom underlines everything. Domestic equity markets (large- cap indices) have corrected around 17.6% from their peak in January 2015. The 125-basis-point (bps) interest rate cut delivered by the Reserve Bank of India (RBI) in 2015 hasn’t yet translated to significantly lowering lending rates. One basis point is one-hundredth of a percentage point. Globally, the US Federal Reserve has increased rates, however, economic recovery is expected to be slow. Commodity prices worldwide have collapsed due to Chinese demand falling. And now the sharp correction in Chinese equity markets has everyone wondering what next.

The risks are well known and the current crisis in China is being compared with 2008. Time and again, price movement has shown that markets find reasons to rationalise levels if valuations run ahead of earnings. The current correction in the domestic equity markets might just be that reversion to rational levels. At such a juncture, it always helps to evaluate risks and understand what more can go wrong.

What if China worsens?

The fear is that history will repeat itself and once again it is high debt levels that will trigger a crisis. China has produced too much concrete—buildings, airports, roads, and so on. In the process, its debt as a proportion of gross domestic product (GDP) has sky rocketed. The problem is that now every incremental unit of lending is producing lesser.

At the moment, it seems things could go either way. The Chinese government’s efforts with monetary easing and other measures could effectively reduce the interest burden. But, at the same time, to stimulate demand, more leverage itself could be needed.

According to a report by Citi Research in September 2015, Global Economics View, helicopter money drops (fiscal stimulus by making more money available) and debt restructuring can prevent a recession. But these are easier said than done. While the former can have an unwarranted impact on inflation, the latter might just end up pushing the problem further down the road rather than resolving it.

If the conditions in China worsen, the worry is that its currency may get further devalued. According to a report from BMI Research in August 2015, the devaluation (of yuan) has worsened the outlook for global trade and will clearly have a negative effect on China’s competitors and those with high exposure to the country’s market. Importantly, it has increased the risks of another round of competitive devaluations in emerging markets, and will contribute to global deflationary pressures. If this happens, the Indian rupee, too, will be affected.

“The worry with the situation in China is that global manufacturing growth could slow down further. For India, the impact could be felt in the form of capital outflows if stock markets in the region correct,” said Gopal Agrawal, chief investment officer, Mirae Asset Global Investments (India) Pvt. Ltd.

So, the domestic market could feel the pinch if the crisis in China continues. However, this is not a structural issue for India, hence, the impact may not be lasting.

Fall in commodity prices

A global manufacturing slowdown has fuelled a fall in commodity prices, which prima facie works well for many segments of a growing economy as margins expand and some of that cost advantage might even get passed on to the buyer. However, a sharp fall in prices reflects a lack of demand, which, in turn, shows the absence of growth and that by itself is worrisome.

Moreover, there are many large industries that are dependent on commodity sales, and if revenues decline in these, jobs and earnings come under threat. This takes away from overall economic growth

“While commodity companies will keep producing as long as they are able to earn up to the marginal cost of production, any slowdown in manufacturing impacts job creation negatively. This can only be countered by higher government spending on infrastructure development,” said Agrawal.

The silver lining for India is the fall in crude oil prices as we are net importers. But again, a depreciating currency may somewhat dampen this benefit.

Domestic reforms

When the National Democratic Alliance government took over around a year-and-a-half ago, many changes were expected, including ushering in foreign direct investment (this has actually happened to some extent), move to goods and services tax and boost to Indian manufacturing.

However, saddled by politics and a banking sector that is struggling with high levels of non-performing assets, the government hasn’t been able to push through as many reforms as it had hoped to. While macro-economic indicators have improved, impact of any real change is yet to be reflected in corporate earnings.

“What we are looking out for is a turnaround in corporate earnings. Government capital expenditure needs to be more aggressive for this to happen. There is some pent up consumption demand in the economy, which we hope will hold out,” said Anup Maheshwari, executive vice-president and head, equities and corporate strategy, DSP BlackRock Investment Managers Pvt. Ltd.

Government spending on building infrastructure can have a multiplier effect on consumption and corporate earnings. However, the translation can take time. India needs changes that will have a lasting impact, hence, it will pay to wait rather than hurry into superficial facelifts.

Maheshwari said earnings seem to be bottoming out as there have been continuous quarters of lower profits, and the banking sector has seen some cleaning up of bad assets. As we learnt in 2015, while the direction of change can be predicted, the timing is harder to ascertain. While earnings disappointments can continue to come through, directionally, a cyclical turn is what experts are talking about.

Mint Money take

Leaving aside the global tremors that are expected to have a short lived impact on our markets, experts are talking about lower levels in benchmark indices based of rationalisation of valuations. Although not expensive at 14-15 times, earnings need to catch up.

“If we consider earnings and work with the worst case at the lower end of the earnings cycle, another 7-8% downside in markets can’t be ruled out. And that’s the level at which odds turn positive to make a decent absolute return over a 3-5-year period,” said Maheshwari.

Clearly, there is more downside in the markets but when that will come through can’t be predicted with conviction. If the news flow turns sharply negative, global or local, the downside will come through faster. If the opposite happens and for some reason there is a positive news flow, markets could even rise or stay at current levels.

Given the economic changes that are expected to come through, a situation that supports a long drawn out bear market seems unlikely. Moreover, unlike the correction in 2008, when many asset markets were in the bubble territory before correcting, in 2016, there are fewer asset bubbles (except the Chinese stock market, which is witnessing sharp daily moves).

For retail investors who are already invested, staying the course and sticking with asset allocation might cause anxiety— especially on days of sharp falls—but it is the appropriate response.

Short-term investors should be worried about further downside. Traders and short-term investors will adjust their daily, weekly and monthly positions according to the market trend, but long-term investors needn’t be perturbed by noise.

No one asset outperforms all the time, hence, one must diversify. Let the allocation be dictated by your financial objectives rather than market events.

***

 

Fee Based Top Best List Certified Financial Planners Chennai Bengaluru India Certified International Wealth Management Advisors Companies in Chennai Bengaluru India Stock Market Mutual Funds Tax Saving ELSS Consultants Advisors Brokers Agents Managers in Chennai India Vridhi Vivek Karwa Investment Advisors Consultants Chennai Executive Financial Planner Jobs Stock Market Finance and Mutual Fund Distribution Tax Planning Certified SEBI Registered Personal Investment Advisers Planners in Chennai India Rakesh Jhunjhunwala Portfolio, Financial Planning Presentations, Stock Market Tips, MarketFastFood Market Fast Food Money Advisors In Chennai India Financial Planners in Chennai India Financial Planning Companies in Chennai India Money Advisers in Chennai India Mutual Funds Advisors in Chennai India Investment Advisory Chennai Bengaluru India Systematic Investment Plan Mutual Fund SIP Mutual Fund ELSS Tax Saving Scheme, Good Speakers and Trainers in Chennai

Advertisements

Post your Valuable Comments below:

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.