Keep investing to average out costs, as low valuations won’t last.
Last week, the rupee dropped to a new 30-month low, below the Rs 50 to USD mark. The 2021 G-Sec traded at a yield of 8.82 per cent on Friday. Earlier, on Wednesday, the 91-day T-Bill was auctioned at 8.65 per cent and the 364-Day T-Bill at 8.68 per cent.
Next week, the RBI unveils its next credit policy. The consensus expectation is that the central bank will hike policy rates again, by around 25 basis points. Quite a few pessimists expect a stiffer 50 bps hike. Nobody expects a pause, let alone a cut.
Those negative expectations are obviously reflected in the yield curve. The flat yield curve suggests that monetary policy has run out of steam. Yields flatten or invert when the market is expecting further rate hikes. Rates have been hiked continuously since February 2010.
A rate hike is usually undertaken in the hopes that it will have a braking effect on inflation. But if everyone is expecting the hike, and it's been factored into their plans, the impact is more muted. Inflation has not halted since the RBI began tightening. GDP Growth has fallen and consensus says it will continue to fall.
Hikes tend to work best if they're sudden and unexpected and if they target inflation caused by an booming economy on the verge of overheating. In the current circumstances, rate hikes won't make a difference to inflation; they will merely further decelerate growth rates.
As a host of people have pointed out, this bout of inflation has been driven by a combination of rising fuel prices and rising food prices. These are necessary goods, where demand isn't very price sensitive. The only way to reduce prices in such circumstances is to increase the supply of such necessary goods. That requires political will and imagination and unfortunately, those attributes are also in short supply!
The falling rupee is likely to trigger further inflation as well, since it drives up the prices of fuel. This is inevitable, given India's dependency on crude, gas and increasingly, coal imports. While a weak rupee may help exports to some extent, the key markets for Indian goods and services are all in recession or slowdown. So the trade deficit and the current account deficit could both balloon.
Net-net, it's a difficult environment. My sense is that valuations need to fall further to reflect a clearly worsening situation and rising rates. If we assume that meaningful action to tackle the situation is unlikely to occur inside a meaningful time frame, investors and India inc. will just have to wait until the economic cycle turns around. It will eventually.
I suspect the macro-economic bottom in terms of GDP growth rates will be hit sometime in the next fiscal. The stockmarket and bond market will probably lead the real economy and bottom out late in the second half of this fiscal.
In the previous bear market (2008) and the one before that (2000-2004), the major market indices bottomed out at average PEs of below 12. That implies roughly 30-35 per cent downside from here if the historical pattern holds and the bottom comes within the next six months. At bond yields of nearly 9 per cent, a PE of 11-12 looks perfectly reasonable. If the bond yield curve hits 10 per cent, ideally the equity PE should drop to single-digits.
The historic pattern may not hold. The bottom could come at higher valuations. Or, given a further succession of global shocks, the bottom could come even lower. We could also see a drift for an indefinite period with the market range trading with a more gentle downside bias.
Broadly speaking, the Indian market becomes attractive below the 15PE mark. It is a no-brainer investment below PE13. Looking at the last 20 years, 15PE has always been a safe investment level. Every time the market has hit the 15PE zone, the three year return has been well above 15 per cent CAGR I think of this mentally as the 15-15 equation.
The level of 13PE is more rarely achieved. The 3-year return from 13PE has always been close to 20 per cent CAGR or higher. Usually 13PE is as close to a market bottom as a normal investor can hope to get. Valuations below that are very rare and occur only for brief periods.
If you are a systematic investor, you should be prepared for drastic action, as and when the market drops to 15PE. By investing heavily at that stage, you lower your average acquisition cost. If the market drops to 13 PE or below, consider liquidating other assets and going overweight on equity.
