Inevitable correction: Retail investors must show patience

Indian investors have had to cope with the double whammy of poor global sentiment and a populist Budget in the last fortnight. Over this period, every major stock market has seen a sell-off and the bond markets have also gone bearish with rising yields. This global bearishness was provoked by the apprehension that the US Federal Reserve might accelerate its schedule for hiking policy rates. The US economy is expanding fast and, more specifically, employment is growing at a clip that may cause higher inflation. In addition, global crude oil and metal prices have risen significantly. The European Central Bank and the Bank of Japan could both be contemplating monetary tightening, given the economic expansion and rising inflation. In India, higher customs duties, and signs of fiscal slippage have made things worse. The fiscal deficit will be higher than hoped for in 2018-19. Moreover, equity investors have also been hit by a tax on long-term capital gains, and the RBI is braced for higher inflation, going by its latest monetary policy review. As a result, India’s stock market indices are down by around 6-7 per cent from their all-time highs while bond yields have risen. The rupee, too, is surrendering some of the gains it made against the dollar in 2017.

This is the sort of situation when retail investors, who drove the market in the past two years, tend to become nervous. Individuals have pumped money into the market, both directly into stocks and primary issues, and indirectly, via mutual funds. Along with foreign portfolio investors, retail investors have been heavy sellers since the Budget. If retail investors continue to reduce their equity exposure, it could lead to redemption pressures that trigger enforced sales from mutual funds. This sort of correction is inevitable after a long bull run and indeed, India has seen a bull run since early 2016, with a brief correction caused by demonetisation. The major indices such as Nifty and Sensex rose by over 50 per cent between February 2016 and January 2018. The pullback that has occurred so far is just a minor blip in that context. Valuations were stretched with the Nifty’s price-earnings ratio running at over 27 by January while the PE for the Nifty Smallcap Index was an eye-watering 55. A correction is healthy. Even now, the market looks overvalued with a Nifty PE of 25.

However, there is no reason to panic. Indeed, third-quarter results indicate that corporate revenues and earnings are starting to pull out of a trough and earnings acceleration is expected to last through the whole of 2018-19. While there are certainly signs of higher inflation, those are largely driven by a rise in global demand for commodities, as the First World economies pick up steam. That cannot be bad for India, since it should energise exports. The long-term returns from broadly diversified equity holdings exceed returns from every other asset class. However, the full benefit of an equity portfolio is only available if it is held through periods of volatility, since such phases cancel out in the long run. During the past two years, retail investors exhibited maturity by systematically investing via mutual funds. They must now keep their nerve to ensure that they receive the returns they deserve.

Business Standard is now on Telegram.
For insightful reports and views on business, markets, politics and other issues, subscribe to our official Telegram channel