“The stock market is a device to transfer money from the impatient to the patient.”

– Warren Buffett

There was a drop in equity markets across indexes

After a scorching year so far, the market demonstrated that it could go in a reverse direction as well and for no good or bad reason for that matter. Foreign institutional investors have reduced exposure to India in the past few weeks and it appears that this is a continuing feature for now. India equity markets are sensitive to these flows no matter how substantial domestic inflows have been in the past few years and as a result we have seen softness in the markets has persisted on this count as well.

On the fundamental side there has been a concern that markets are expensive given the momentum of earnings seen so far. Markets have been in the expensive zone for quite some time now so there is no reason to believe that this reason now suddenly is the cause for concern and that the markets are reacting to it. Earnings season has been mixed so far and we have seen softness in stock prices in the face of robust profits delivery as well as seen sharp downtrends in companies reporting surprise negative numbers as well. This indicates a general sentiment that appears negative for now

This is important to point out since various global markets are exhibiting diverse outcomes as of date and expensiveness has not essentially corrected in some markets while some markets continue to remain cheap. Take for example the S&P500 in the US has appreciated 39% YTD and the Nasdaq at 45% YTD. The S&P500 trades at 26 times while the Nasdaq trades at an all-time high and a P/E ratio of 26.87 on most recent reported earnings. Compared to these the Sensex trades at a P/E of 23.3 times earnings . The Nikkei, that has been the other market which has shown strength this year is up 26% for the year. Comparatively the Sensex is up 24% for the year and London Stock Exchange, the FTSE is up 13%.

There is divergence across markets in terms of degree of appreciation and valuations and if one were to see risk from a valuation perspective the US markets appear more at risk than others, given the prospects of a presidential election that promises to be controversial and divisive, next month, and an expectation of a softening economy in the coming quarters. While in India the election is behind us and the economy is not showing signs of slowing down and is expected to grow in a range between the optimistic estimate of 7% and a conservative estimate of 6.5%. Corporate profits generally are always in line with this overall growth expectation with an inflation component added to the real growth rate.

So where should investors place their bets for the coming year?

Investors must decide on their time frame

A continuing bull market with higher levels each month is unlikely

Investors have gotten used to a certain market environment in the past few months in the Indian equity markets. No matter how much a market corrected briefly over this time, it bounced back to higher levels in a matter of days, setting record highs consistently. With this happening at regular intervals the mindset of the investor appears to have changed, and it will take time to adjust to the new volatile era ahead. By volatile we do not mean sharply correcting markets or a deep drop in valuations, only a normal up and down variety as opposed to what we have been used for a while. Possibly at a broader index level there may not be significant absolute gains to speak of for a while as well. This is due to a lot of earnings expectations already baked into the current valuations allowing for very little room for P/E re-rating and expansion in the valuations from here. Stock prices for a while are likely to follow earnings growth assuming slightly lower P/E’s. This would mean that in the face of robust earnings growth we may yet see tepid stock price increases. This may continue till valuation appear attractive from a longer-term perspective again

What should investors do?

Revisit asset allocation and determine how much volatility they can withstand and how much tolerance they give to interim drops in price levels given this scenario. If investors are unable to undertake this period with equanimity this is not any indication of market returns but that of investor tolerance for risk. Equity markets are inherently volatile and are best suited for longer term investment returns, significantly better than other asset classes.

However each investor has to decide how they play the coming periods and decide on asset allocation based on tolerance for risk, investment horizon and ability to hold the course in the face of uncertain times.

“Thousands of experts study overbought indicators, head-and-shoulder patterns, put-call ratios, the Fed’s policy on money supply…and they can’t predict markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.”

Peter Lynch

Mr. Tushar Pradhan
Chief Mentor – Investment Strategy, Multi Ark Wealth & Director – HXGON Partners LLP

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