What should an active investor do, faced with a sharp market correction like the one occurred last Monday? The optimists would say, "Buy on the decline". The more cautious would say, "Wait for momentum to turn positive." It is easy to find historical examples to support one or the other type of advice. Prices could recover quickly favouring optimists. Or, fall further or the bearish cycle could carry on for longer, even if prices find the bottom. There have been many short, sharp bear markets. There have also been many long bear markets, which favoured those who waited.
Every bull and bear market has some similarity with previous bear/bull phases and each also has its own unique characteristics. This crash has been triggered by external factors. It can be compared to the 2008 bear market, driven by the bursting of the US sub-prime bubble. This time of course, it's all about China.
The Indian economy was in reasonable shape in 2008. It is in reasonable shape now. In 2008, global trade collapsed for a while, foreign institutional investors (FIIs) pulled out of emerging markets and foreign direct investment (FDI) commitments reduced. The stock market saw a very steep correction in 2008.
In 2015, there could be a similar pattern of a sharp correction followed by gradual recovery. In terms of fundamentals, the global economy will take a while to recover. The recovery of the Indian markets after 2008 was also tied to events abroad and this one could see a similar pattern too.
Global trade has been badly hit. India's exports have dropped for the past eight months. FDI and FII inflows might slow down, or reverse for some time. The gross domestic product (GDP) growth projections will almost certainly be pared down. India is dependent on its connections to the global economy. It needs external financing; it needs markets for its goods and services exports. However, India's domestic economy is large enough to sustain some basic growth.
On the plus side of the ledger, low commodity prices are good for inflation and for the current account. India survived 2008 and it survived another global dip (caused by the so-called PIGS of the Euro zone) in 2011-12. So there is some institutional understanding of the required counter-cyclical measures.
One key difference: Unlike 2008, the China slowdown is not only about over-valued assets. It is caused by lower global demand for manufactured goods. It is unclear how long it would take for global demand recovery. It is hard to see the Indian stock market logging big gains, while the global economy drifts.
The Nifty is down about 14 per cent from its all-time highs of March 2015 (when it hit 9,119). So, this correction has already lasted five months, although the bulk of the losses happened only in August. In terms of time, the correction is very likely to continue because of the fundamentals of the global situation. Of course, there will be recoveries, when prices rebound temporarily.
Investors need to accept that there will be a time correction, as well as a price correction. Even if prices don't correct much more, (they are likely to), they will not zoom up immediately. Hence, an investor should plan to invest steadily over a long time while being prepared for further falls in price.
It is useful to look at valuations. Corporate earnings have stagnated, or fallen, for several quarters. The Nifty was trading at a PE of 24 when it hit the 9,000-mark. It is now valued at a PE of about 22. Even PE22 is high, given a market where earning per share has fallen for the last couple of quarters.
Historically, the three-year return for an index investor who buys at valuations of PE 22 and above is near-zero or negative. The long-term (10-year) average for the Nifty is PE19.3 (mean) and PE19.25 (median) with a standard deviation of 3.04.
Historically, investors who have done their buying at below PE19.5 have picked up three-year compound annual growth rate of 12 per cent or more. Investors who are committed for the long haul and prepared to buy more if the market falls further, will reap good returns with a buy on declines strategy, where they average down and hold for the long haul.
Every bull and bear market has some similarity with previous bear/bull phases and each also has its own unique characteristics. This crash has been triggered by external factors. It can be compared to the 2008 bear market, driven by the bursting of the US sub-prime bubble. This time of course, it's all about China.
The Indian economy was in reasonable shape in 2008. It is in reasonable shape now. In 2008, global trade collapsed for a while, foreign institutional investors (FIIs) pulled out of emerging markets and foreign direct investment (FDI) commitments reduced. The stock market saw a very steep correction in 2008.
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The Nifty fell from a high of 6,357 in January 2008 to a low of 2,252 in October 2008. That was a correction of 64.5 per cent in nine months. Although prices bottomed in October 2008, recovery took a long time. The Nifty rose to a new high above 6,400, only in December 2013. Those who bought through the 2008 declines received excellent returns, compounded over 2008-2013.
In 2015, there could be a similar pattern of a sharp correction followed by gradual recovery. In terms of fundamentals, the global economy will take a while to recover. The recovery of the Indian markets after 2008 was also tied to events abroad and this one could see a similar pattern too.
Global trade has been badly hit. India's exports have dropped for the past eight months. FDI and FII inflows might slow down, or reverse for some time. The gross domestic product (GDP) growth projections will almost certainly be pared down. India is dependent on its connections to the global economy. It needs external financing; it needs markets for its goods and services exports. However, India's domestic economy is large enough to sustain some basic growth.
On the plus side of the ledger, low commodity prices are good for inflation and for the current account. India survived 2008 and it survived another global dip (caused by the so-called PIGS of the Euro zone) in 2011-12. So there is some institutional understanding of the required counter-cyclical measures.
One key difference: Unlike 2008, the China slowdown is not only about over-valued assets. It is caused by lower global demand for manufactured goods. It is unclear how long it would take for global demand recovery. It is hard to see the Indian stock market logging big gains, while the global economy drifts.
The Nifty is down about 14 per cent from its all-time highs of March 2015 (when it hit 9,119). So, this correction has already lasted five months, although the bulk of the losses happened only in August. In terms of time, the correction is very likely to continue because of the fundamentals of the global situation. Of course, there will be recoveries, when prices rebound temporarily.
Investors need to accept that there will be a time correction, as well as a price correction. Even if prices don't correct much more, (they are likely to), they will not zoom up immediately. Hence, an investor should plan to invest steadily over a long time while being prepared for further falls in price.
It is useful to look at valuations. Corporate earnings have stagnated, or fallen, for several quarters. The Nifty was trading at a PE of 24 when it hit the 9,000-mark. It is now valued at a PE of about 22. Even PE22 is high, given a market where earning per share has fallen for the last couple of quarters.
Historically, the three-year return for an index investor who buys at valuations of PE 22 and above is near-zero or negative. The long-term (10-year) average for the Nifty is PE19.3 (mean) and PE19.25 (median) with a standard deviation of 3.04.
Historically, investors who have done their buying at below PE19.5 have picked up three-year compound annual growth rate of 12 per cent or more. Investors who are committed for the long haul and prepared to buy more if the market falls further, will reap good returns with a buy on declines strategy, where they average down and hold for the long haul.