 "A man holds his notebook as he checks a terminal showing stock information at a brokerage house in Beijing")
Certain stocks are considered 'buys on declines', in stock market jargon, generally good sound businesses, which tend to be highly valued. A price decline allows long-term investors to go bargain hunting.
Market conditions suggest these will be the most popular category of stocks in 2016. There has been a bear market for nine months and it looks likely the decline will continue.
I hope I am wrong but there are a lot of negative signals. First, some disillusionment with the government/ruling party and not much confidence in their ability to accelerate the pace of growth. The government has not been able to pass key bills to enable reform. The disappointment is even more because it came to power by making extravagant promises.
The economy is suffering from serious cyclical and structural issues. There is an enormous amount of surplus manufacturing capacity, close to 30 per cent by the Reserve Bank India's estimate. Investment has tailed off, as a result. Employment has also grown very slowly.
Many infrastructure projects remain stalled. Corporate earnings have stagnated for two years and investors are getting tired of waiting for faster growth in earnings per share. Exports have also shrunk, month by month. Public sector banks are in collective trouble, with a vast amount of sticky debt on their balance sheets. Quite a few could see their net worth being wiped out. Food inflation also continues to plague consumers, although weak crude oil prices helped to push wholesale inflation down. The monsoon was not kind in either 2014 or 2015.
Foreign institutional investors have been net sellers in equity since April 2015. They have, however, been buying government debt and state debt. There has also been a fair amount of money coming for start-ups. In addition, mutual funds (MFs) have seen a renaissance in terms of rising subscriptions. Hence, domestic institutions have been able to prop up the market.
There are signs that those positives might now be tapering. Foreign institutional investors were net sellers in debt assets as well in November and December. Anecdotally, there might have been something of a slowing in start-up action in the recent past. Retail subscription to MFs always slows down in the face of a sustained period of bearishness and if it does so, domestic institutions will also cut back on buying.
A decent Budget, a good monsoon, an improvement in consumption demand and an uptick in global growth could all help to turn things around. However, sentiment is now a great deal worse than a year before and sentiment is unlikely to fully recover in a hurry.
Valuations are still above historically comfortable levels. The major market indices could take a 15-20 per cent hit before valuations normalise down to historically reasonable discounts. Sentiment is a peculiar thing, however, and market valuations rarely stay exactly within the range of fair value. Valuations either overshoot or undershoot. If there are setbacks for the ruling party next year - poor results in state elections or Vyapam or controversies involving ministers, sentiment could see a big dip.
This is a great situation for the long-term investor with patience and judgment. It could also be a good time for the systematic investor who ignores market conditions. The latter has a simple task: Keep buying index funds systematically or even buy well-diversified active funds systematically. Increase monthly equity exposure gradually if the market falls significantly. The active investor should instead look for safe stocks in the 'buy on declines' category. Such businesses are generally not strongly cyclical in nature. It is dangerous, for instance, to buy a shipping company on the basis of a price decline, since this sector has a long cycle. A stock in a highly cyclical segment could take years to bottom out.
Apart from generic market sentiment, stocks which are not very cyclical can also see price weakness on the basis of poor results in a given quarter. Or, there could be some temporary management crisis or, perhaps, a hike in tax rates. Or, regulatory action by the authorities, such as tax demands or transfer pricing cases foisted on multinational corporations. Or, a pharma major might face regulatory action from the US drug regulator. All these situations could throw up bargains.
In sum, 2016 could indeed be a very happy new year for those investors who are prepared to wait until 2017 or even till 2019 for returns.
