 "Question mark for long-term investors")
Britons voting to leave the European Union has diminished Dalal Street’s chances of maintaining its decade-long streak of double-digit annual returns for long-term equity investors.
The benchmark S&P BSE Sensex needs a further 20 per cent rally in the remaining nine months of the current financial year to deliver at least a 10 per cent compounded annual return (CAGR) to an investor who entered the markets at the start of 2007 and has stayed put. The bulls will need even greater buying power this year to maintain the past 10-year record of a 15 per cent CAGR return for long-term investors.
This looks challenging thanks to the Brexit tremors to the global financial markets and economies. The Sensex closed the day down a little over 600 points or 2.2 per cent, compared to its Thursday close. If the market stays at the current level during the rest of the financial year, the 10-year return for a long-term investor works out to around eight per cent, down from a 10-year rolling return of 11.8 per cent at the end of FY16.
The analysis is based on the rolling 10-year return for an equity investor who invested in a portfolio mirroring the Sensex at the end of March every year and remained invested for 10 years. The return is calculated on a CAGR basis for 10 years.
Earlier, most of the market optimists expected the benchmark index to close the 2016 calendar year at around 30,000 points, up nearly 15 per cent from its closing level in the 2015 calendar year. This translates into an index level of 29,500 at the end of March next year, some distance away from the 32,500 needed by long-term investors to remain in double-digit territory.
Experts now see a downside risk for the market in at least the near to mid-term, with the Brexit vote leading to a risk-off trade and a move away from risky assets such as equity.
“The follow-up sentiment has triggered a rush to safe havens like the US, Japan and German government bonds. While there appears to be a general outflow from Europe, particularly the UK (across most asset classes) in emerging market Asia, the outflow is largely in equities,” says Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services.
Money also moved to gold, another safe haven for investors looking for a hedge against inflation and financial volatility. Gold prices were up five per cent in the international market on Friday.
As the dust settles, Sinha expects the markets to recover a part of the loss and continue to trade sideways as economic uncertainty lingers post the UK vote.
Victor Shvets of Macquarie Capital foresees a rise in risk premium in the financial markets, which will have significant secondary impact on global growth, inflation and liquidity. “There is a considerable degree of volatility embedded in the financial system and, hence, volatility spikes are not just unwelcome but dangerous,” he writes in a report on Brexit.
This could dampen foreign institutional investment inflow, as investment in India is perceived to be a riskier trade than developed markets and other safe havens.
Dalal Street could also come under pressure from a likely depreciation in the rupee. “Sentimental impact will be larger through the currency and flows, rather than through the economic pass-through. In the near term, this could put further pressure on the forex reserves and liquidity conditions in the domestic market,” adds Sinha of Emkay.
While a weaker rupee could aid exporters such as information technology and pharmaceutical companies in the near term, it would be negative for companies in non-tradable sectors such as banks & financial services and infrastructure. At nearly 30 per cent of the market capitalisation, financials are the largest component on the Indian equity market.
The markets also face a downside risk from companies such as Tata Motors, Tata Steel, Tata Chemicals, Tata Global Beverages, Bharat Forge, Tech Mahindra and Motherson Sumi and Apollo Tyres, which have large exposure to the UK market/European Union. In all, Indian companies are the third largest investor in the UK and a Brexit vote could negatively impact returns on these investment, at least in the near to mid-term.
