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Wednesday, November 16, 2016

Understanding Up & Downturn of Indian Equities in 2016

Dear Reader,

Stock prices were on rise till March last year and we have seen significant increase in retail investors participation compared to previous years. However i
n beginning of this year, with lot of pessimism building around equity market globally, we have seen a severe correction in Indian equities in the month of Jan and Feb this year with major indices - Sensex and Nifty falling by more than 24% from all times high made in March last year. If we look into broader markets, stock prices of many mid and small cap companies have seen a steep fall in the range of 30% to 50% or even more in first 2 months of 2016. In such situation every investor looking to create wealth is confused whether to exit, hold or enter the stocks and at what levels to enter or exit.

Later from March to mid October this year, we have witnessed strong rally on positive global as well as local cues. Major indices, Sensex and Nifty have risen by more than 25% from their lows made in last week of Feb this year. However in Nov'16, we have witnessed sharp correction in Indian equities mainly on account of two developments, one from the domestic and another from the global front.

Being an equity investor, its important to understand what exactly has caused severe fall in Indian equity market in Jan and Feb 2016 and sharp rally during March to October this year followed by ongoing correction in November. Its important to note that the volatility in stock market during this year is mainly because of changing sentiments of investors towards global as well as Indian equities.

Below are the major factors which initially hurt and later boosted sentiments of equity market in 2016 followed by ongoing correction mainly on account of FIIs buying and selling Indian equities.

Major reasons for severe fall in Indian Equities in Jan & Feb 2016

i) Continuous Selling by FIIs - During Jan and Feb this year, foreign investors have sold shares to the tune of Rs. 26,800 crore. With continuous redemption pressure from sovereign wealth funds of the middle east, China woes in terms of sustaining growth, dampening global sentiments led to sell off in emerging markets. Investors who were sitting with hefty profits and invested in Indian stocks during last 18 months also started selling to book profits against falling rupee. Moreover, signs of recovery in the US economy has also resulted in funds travelling from Asian markets back to the US markets.

ii) Slowdown in China Economy - China, world's one of the fastest growing and 2nd biggest economy has shown signs of slowdown. There was a panic because of China's continuous poor manufacturing growth. Moreover, fall in crude prices due to oversupply of oil, fall in base metals prices due to sluggish demand not only hurting China but all the stock markets of the world resulting in major sell-off in markets in US, Europe and Asia.

iii) Weak Corporate Earnings - For any stock market to deliver good returns, it is very important for the earnings of the companies to match its valuations. But in last 18 months, the valuations of India Inc has sky rocketed but the earnings were not seen at par. This was the major concern of the investors and thus we have seen profit-booking in last year and now facing the heat due to redemption pressure in emerging markets from the global funds.

iv) Delay in Reforms took off the Premium - There was lot of expectation from Modi led NDA government with major announcement made to bring reforms by passing two major reform bills - the goods and service tax (GST) and the Land Acquisition Bill. Given the build-up of political opposition to his government, there was more than a fair chance that two major reform bills will not get passed which further impacted Investors sentiments in terms of future growth outlook of Indian economy, this took off the premium valuations which India had last year compared to other emerging markets.  

v) Cognizant forecast slowest Revenue Growth in 14 Years - IT services provider Cognizant forecast its slowest quarterly revenue growth in 14 years, adding to mounting worries about clients keeping a tight lid on technology spending. Cognizant, whose rivals include Indian IT services firms such as TCS and Infosys recently took a beating due to fear of overall slowdown expected in the IT sector. 

vi) Surge in Bad Loans of PSU Banks - A significant surge in bad loans and provisions hurt PSU Bank stocks. Its important to mention here that the Reserve Bank of India recently directed banks to reclassify loans and set aside more money against stressed assets. The central bank has set banks a deadline of March 2017 by which time it expects banks to recognize stressed assets and make adequate provisions to cover them.

Major reasons for sharp rally in Indian Equities from March to Sept 2016

i) Positive Union Budget with Focus on Fiscal Discipline - Overall market sentiments turned positive as government decided to stick to its fiscal consolidation road map despite the pay commission, targeting 3.5% of GDP in FY17, the third lowest fiscal deficit in 40 years. Moreover, another major positives for equity market were no increase in the service tax, which was speculated to rise by 2 percent and also no change in capital gains tax.

ii) Change in Fed view regarding US Rate hike - In the last Federal Open Market Committee (FOMC) meet on March 16-17, the Fed maintained its status quo on interest rate. FOMC signaled that the future rate hikes will be on the low gear, indicating only two rate hikes in calendar year 2016 due to tepid global growth compared to consensus in December of four rate hikes in 2016. This apart, central banks across the world were increasing their liquidity to support economic and financial activities. The latest data from China were also showing signs of stabilisation, diminishing fears about the extent of the slowdown. This is positive for emerging markets to attract foreign funds.

iii) Continuous Buying by FIIs post Union Budget - India remains one of the most favourable investment opportunity for long term investors considering the fact that India is now the fastest growing major economy in the world, expanding by 7.3% and cementing its position as one of the sole bright spots in a flailing global economy. Foreign institutional investors (FIIs) poured in over Rs 5,000 crore into the Indian equity market in a matter of three sessions after the Union Budget of 2016, which pushed the benchmark indices above their key resistance levels.With favourable Union budget and positive stance taken by FED, FIIs turned to by net buyers pouring more than Rs. 24,000 crores in Indian Equities in March month, maximum in any single month since March 2014.  

iv) Expectation of a Rate Cut by RBI - Expectation of a rate cut by the Reserve Bank of India after a six-month pause has also heightened the buying frenzy on the Street. India's central bank cut its repo rate by 25 basis points to 6.50 per cent on 5th April, making a widely expected first reduction since September to bring the rate to its lowest in more than five years.  But in a surprise move, the Reserve Bank of India also raised the reverse repo - or the rates lenders charge to the central bank - by 25 basis points to 6.0 per cent, taking measures to ensure more availability of cash in the banking system.  A cut in the repo rate means lower cost of funds for the banks. Assuming banks pass on this rate cut to the borrowers of home, car and other loans, it will help in growing demand and hence the overall economy. 

v) Positive Monsoon Forecast - After two consecutive deficient rainfall years, the country is expected to receive good rainfall this year. The India Meteorological Department (IMD) has predicted above normal South-West monsoon in 2016. As per IMD, the monsoon rainfall is likely to be 106% of the Long Period Average. This year the rainfall is expected to be 6% more than normal, which was 14% deficient last year. Forecast of above normal monsoon and inflation falling below 5% boosted the overall market sentiments, uplifting Sensex and Nifty to higher levels. 

vi) Stability in Commodity Prices - Stable commodity prices, aided by weakness in the dollar, also pushed risk assets such as emerging market equities higher, adding to the cheer in the Indian markets. Moreover, highly volatile crude prices also stabilized by trading between USD 45 - 50 per barrel.

vii) Passage of GST Bill - The Constitution amendment bill for roll-out of GST was pending in Rajya Sabha for a long time and the government was keen to see its passage. The Goods and Services Tax seeks to bring a uniform tax structure subsuming a number of imposts and the government claims that it will help add 1 to 2 per cent to the country's GDP.  Stock market gathered pace considering reports of discussion between the Congress and the government which fueled hopes that the crucial Goods and Services Tax (GST) Bill is likely to be passed soon. Further, the progress of the monsoon in the country with good rainfall so far also aided market sentiments.

Major reasons for downside correction in Indian Equities during Oct & Nov 2016

i) Selling by FIIs on Global Uncertainties - Although May, June and August months this year saw FIIs pulling out their money from India's debt markets, October was the first month in the current fiscal where they took out money from equity markets. The FII outflows in Oct and Nov can be attributed to the growing global uncertainties and increasing market caution ahead of key global events like the US Presidential elections and the anticipated US Fed Rate hike before year end. FIIs have sold off equities worth Rs. 14,000 crores since Oct'16. However, the removal of overhang of US election outcome with Donald Trump being elected as President of the United States of America with recent correction in market improves the outlook for Indian equity going forward.

ii) Demonetising Rs. 500 and Rs. 1000 Currency Notes - The government’s historical reform of Demonetization on cracking down on black money will be structurally long term positive for the economy, however will a short term negative impact on economic growth due to liquidity crunch across country. The measures may have a short-term impact on industries which are majorly dependent on cash transactions. Industries such as construction, real estate, micro finance, hotel businesses, self-owned businesses, jewellery etc will have a major impact. Hence, we have seen major fall in stock prices of companies linked to these sectors during last one week.

Its important to note that Demonetization to curb black money, fake currency and terrorism is likely to have a long term positive impact on economy. It will have several long term benefits like rise in tax collections, lower inflation, shifting of the cash economy to the banking system, improved banking system liquidity etc.

Historical data indicates that most of the new investors get fascinated towards stock market to make quick bucks and finally end up loosing their capital as they cant hold on their stocks in case market corrects and sell out their stocks in a panic. Stock market is not a money making machine, you need not to be greedy on rising market or fearful when stock market falls, simply buy right and sit tight having sufficient patience with you to see your investment growing over a period of time. 

The investors who got worried with severe fall in stocks prices during Jan and Feb this year  and sold off their holdings thinking to buy the same again at lower levels might be repenting later by looking sharp rally of more than 25% in all broader indices in the period of next 6 months.

We always suggest our members not to time the market and follow a disciplinary approach while investing in equities with medium to long term perspective. Its important to know, whether you would be able to hold on your positions in case stock market tanks? We believe market has already bottomed out in February this year and any significant downside going forward must be considered as buying opportunity. We may not see Feb lows again, indices are expected to move much higher from current levels during next one year if there is no negative surprise on global front.

The Bottom Line - Stay for Long Term & Be Greedy when Others are Fearful

Smart investors do not listen to the herd and take a rational approach with their wise & intelligent thinking. As rightly quoted by Warren Buffett - Be Fearful when Others are Greedy and Greedy when Others are Fearful. At the point of time when Nifty closed below 7,000. We started listening majority of TV analysts and media person giving target of 6,300 with another 10% downside. It was the time to invest rather than waiting for another 10% downside. We do not believe in timing the market and always advice our readers to take a systematic approach while investing in equities with a long term horizon. Moreover, severe corrections must be considered as buying opportunity to add on good quality stocks at discounted prices.

We firmly believe that Indian stock market is going through a correction phase similar to Jan and Feb this year and ongoing market correction must be considered as buying opportunity by long term investors. We believe that its time to start accumulating good quality stocks in staggered way which are becoming available at much discounted prices.

We would like to update our members that we published article titled Know your Risk Tolerance While Investing in Equities dated 11th Feb'16 informing our readers to start accumulating good quality stocks and do not try to time the market. 

Below are the few paragraphs worth reading from the same article:

If Sensex hits 22,000, in that case its price to earnings (P/E) multiple will be similar to what it was during the time of Lehman crisis in 2008. That was a stressed situation with lot of fear among global as well as domestic investors like today, The average six-month P/E on a one-year forward basis for the Sensex was 14 times after the Lehman crisis and if we keep the same earnings multiple on FY17 earnings estimates, it gives a target of 22,000 on the Sensex which means correction of another 4-5% from current levels. But we do not want to set any target here, it is just an estimate, Sensex may bottom out around 22,000 levels or it may go down to 21,000 i.e. 30% correction from all time highs made in March 2015 or it may rebound from current level of 23,000.

With every fall, Indian equities valuations are getting attractive day by day. Moreover, once the markets bottom out and form a base, we can see renewed buying interest from global investors. Moreover, upcoming budget can boost the sentiments of investors, hence its time to start accumulating good quality stocks which are now becoming available at discounted price.

We always suggest our members not to time the market and follow a disciplinary approach while investing in equities with medium to long term perspective. Its important to know, whether you would be able to hold on your positions in case stock market tanks?

To read full article: Know your Risk Tolerance While Investing in Equities - Click here

Time has shown that smart investors have made their fortune by investing in equities in long term. None other asset class can match giving you such extra ordinary returns. Yes, its important for you to invest in right set of companies at right price with medium to long term perspective. If you think to invest in stocks for period of 3 months or 6 months, we suggest you to stay out of stock market because you are not investing, you are betting on volatility of stock market which could be risky.

If you have patience and want to add extra power in your portfolio, start investing some portion of your savings in fundamentally strong small and mid cap companies - Hidden Gems & Value Picks.   

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Do contact us in case of any queries, we will be delighted to assist you.  

Wish you happy & safe investing!

Team - Saral Gyan.