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How investors can gain from the stock market correction

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The market’s dream run has been halted. With benchmark indices such as the Sensex and the Nifty falling more than 10% from their respective peaks, the market is now in a correction phase. But fears of a bear market are unwarranted. For the Indian stock market to be termed bearish, the broader indices must fall by another 10%—a 20% cut from the peak signals a bear market. Experts don’t believe that markets will enter the bear phase.

“The Indian stock market is just in a correction phase and it’s not a bear market. The ingredients that signals a bear market are not there,” says Shankar Sharma, Vice-Chairman and Joint MD, First Global. The warning signals—hyper speculation, companies without strong fundamentals leading the market, etc. are missing. Big macro-economic crisis can also trigger a bear market, but as the global economy is picking up now, we can discount that possibility in the near future.

Expect volatility in 2018-19
“The market will remain on tenterhooks due to political headwinds and high valuations. Unexpected moves from the US President, Donald Trump, can also hurt the market,” says Raamdeo Agrawal, Joint MD and Co-Founder, Motilal Oswal Securities.

The upcoming Karnataka elections are being seen as a semi-final match for the Lok Sabha elections in 2019. If the incumbent Congress retains power in Karnataka, it will raise doubts about the NDA retaining power at the Centre in 2019. “There might be some political sentiment-driven correction if the BJP doesn’t win Karnataka,” says Amar Ambani, Head, Research, IIFL.

The assembly elections in two major states ruled by the BJP—Rajasthan and Madhya Pradesh—will also test the market. Experts say that investors should not get jittery because of short-term volatility. “Election induced volatility is normal and there is nothing to worry about it. The fear of a coalition government after 2019 is also unwarranted. In the past 25 years, coalition governments have delivered better GDP growth. Coalition will also bring control on government policies,” says Sharma.

Staying put during periods of short-term volatility, such as the one induced by elections, has proved beneficial for investors, historical data shows. “In five out of the past six parliamentary elections, the market has delivered handsome return for holding shares during the turbulent times,” says Prateek Agrawal, CIO, ASK Investment Managers.

Investors can gain from political uncertainity
The market has mostly delivered handsome returns over a two-year period starting the year before the general elections.

CAGR is for a two year period starting the year before the general election.

Another factor that will keep the market in check are higher valuations. Though Sensex PE has fallen from 26 in January, when it was in the grossly overvalued zone of 24-28, to 22. It is still in the slightly overvalued zone of 20-24. The Sensex EPS, which has remained flat for the past three years, slightly improved to Rs 1,466 compared to Rs 1,416 during March 2015 and things are beginning to improve now.

“With the bad effects of demonetisation and teething troubles of GST behind us, earnings growth is expected to pick up,” says G. Pradeep Kumar, CEO, Union Mutual Fund. “The December quarter was good and the March quarter is likely to be good as well. We expect 17-18% EPS growth in 2018-19,” says Agrawal of ASK Investment.

However, experts warn that the high earnings growth may not get fully reflected in stock prices. “The expected economic and earnings growth may not result in higher returns because valuations need to correct from higher levels. So, investors may end up getting only mediocre returns in 2018,” says Motilal Oswal’s Agrawal.

Muted earnings growth
Due to sluggish earnings growth, valuations continue to be high.

Muted-earnings-growth

EPS stands for Earnings Per Sahre. Source: Bloomberg, Complied by ETIG Database

On the global front, the continued rate hike by the US Federal Reserve poses a challenge to the Indian market. “The US Federal Reserve has made its intention clear, and it will keep on increasing rates in the coming year,” says Kumar. According to Bloomberg estimates, the US Fed is expected to raise rates thrice in 2018. But rate hikes may not be as big a threat as some commentators have suggested.

The Indian stock market has done relatively well during periods of earlier rate hikes by the US Fed. For instance, the stock market delivered fabulous returns between 2004 and 2006, when the US Fed rate moved from 1% to 5.25%. “The US rate increase is not a big worry now because it will be slow and calibrated. The global economy is picking up and the US corporate profits are also good,” says Ambani. Though the trade war-related fears have subsided a bit, rash moves by the US President on trade could impact the markets.

Don’t worry about rate hikes by the US Fed
Rate hikes by the US central bank, triggered by economic growth, have proved good for the Indian markets.

US-fed-rate-hikes

Soruce: Bloomber, Complied by ETIG Database

Don’t panic, continue with SIPs
As explained earlier, we are in a correction and not a bear market. So what should investors do? Should they move out or stop new investments? “There is no need for investors to exit the market. If you want to win, you need to be in the game,” says Motilal Oswal’s Agrawal. Chandresh Nigam, MD and CEO, Axis Mutual Fund concurs: “Investors shouldn’t allow market sentiment to affect their return expectations. We are comfortable allocating to equities when the market is doing well and hesitate or hold back investments during corrections. Such actions harm investors’ portfolios.”

Continuing with systematic investment plans (SIPs) is the best strategy for long-term investors. Since an SIP works on the principle of rupee cost averaging—you buy more mutual fund units when the prices are down and less when prices are high—volatility will work in favour of regular SIP investors.

Not only should you continue with your existing SIPs, you should increase your investment—for instance, buy when the broader market index is down by more than 1%. The best timing strategy for long-term investors is to go by market valuations: Increase equity stake when the market is in the fair or under-valuation zone

Do not go overboard with equity investments
Equities deliver poor returns if you invest in them when the market is overvalued—as it is now.

Equity-investments-and-PE

Source: BSE, Compiled by ETIG Databse * Averge 1 year returns

Review asset allocation
Asset allocation review should be done on a regular basis and the start of the financial year is the best time to do it. Volatile times also require that investors review their portfolio. As a first step, you need to find out what how different is your portfolio’s existing asset allocation compared to your preferred, original asset allocation. If you have not reviewed your portfolio for years, your equity allocation might have gone up due to their massive outperformance over the past few years.

If the gap between your existing and original equity allocation is wide, you need to set it right by paring down your equity exposure. If you had re-aligned your investments at the end of last quarter, your equity exposure might have come down due to the ongoing correction, and you can consider increasing it back to its original levels. “By reviewing your portfolio systematically, at regular intervals, you can convert sell-offs into an opportunity rather than a crisis,” says Nigam.

If you are among the investors who opt for tactical asset allocation based on the market situation, you need to hold your horses. Since valuations are still in the slightly overvalued zone, do not increase your equity allocation. Wait for the Sensex PE to fall below 20, before you start buying.

Retain large-cap bias
The mid-caps have seen higher price cuts in the recent correction, but this doesn’t mean that you should focus on them now. Their valuations are still high. “The large-cap segment is looking attractive compared to small- and mid-caps owing to their favourable valuations and the capacity to withstand minor hiccups in the economy,” says Sundeep Sikka, ED and CEO, Reliance Mutual Fund. ASK Investment’s Agrawal concurs.

“Despite the recent correction, valuations of the mid-cap segment are still high. A greater correction is needed to make the mid-caps attractive. Our preference now is for large-caps.” Traditionally, mid-caps used to quote at a discount to large-cap because of their higher risk, but the situation has reversed and mid-caps’ PE is now several times higher than that of large-caps. This doesn’t mean that you should avoid mid- and small-cap altogether as some of them are reporting good earnings growth. “Investors can continue to bet on small-cap stocks reporting good earnings growth,” says Sharma.

Time to stick with large-caps
Despite the correction, mid-cap valuations remain sky high.

large-caps

Source: NSE, Compiled by ETIG Database

Increase allocation to gold
Traditionally, gold underperforms in periods of rate increases by the US Federal Reserve. However, it may be different this time. While the US Fed is increasing rates in a calibrated manner, the actions of the US President—like the recent trade wartype situation—can lead to a lot chaos. Gold will be a beneficiary of any global uncertainty. “The financial market uncertainty and trade war fears are lending support to gold and it makes sense to allocate a small portion to gold. While it increases returns only marginally, gold allocation reduces risks drastically,” says Chirag Mehta, Senior Fund Manager, Alternative Investments, Quantum Mutual Fund.

Investing in gold can reduce portfolio risk
Gold is close to its four-year high and could rise further due to domestic and global factors.

Investing-in-gold

Source: Bloomber, Compiled by ETIG Database

Due to fears of sanction, Russia has emerged as a big buyer of gold, lending support to the yellow metal which is trading at close to 4-year highs. Indian investors have another reason to invest in gold. Any US action against India as part of a trade war will result in an immediate fall in the rupee and will push up the price of gold in the domestic market.

There is no hard and fast rule about gold allocation, but experts suggest between 5% and 15%, depending on your risk profile. So, if you are at the lower band of 5%, you can increase allocation to 10%. Just like other asset classes, you should also see if your allocation to gold has changed from what it originally was. As a first step, you need to set your asset allocation right.

For instance, equity had been doing quite well over the past few years, while gold had suffered, so allocation to equity might have gone up and gold might have come down. It makes sense to shift back to the original allocation to gold, if not raise it a little.

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