Be ready for volatility

Patience will be the key in Samvat 2075

Stock markets flattered to deceive investors in Samvat 2074. After hitting all-time highs a few months ago, indices lost steam because of a combination of external and domestic factors. The benchmark BSE Sensex clocked gains of only 7.4 per cent, less than the 7.8 per cent yield on the risk-free 10-year government bonds. Mid-caps and small-caps did worse than their larger peers. The BSE mid-cap and small-cap indices were down 8.5 per cent and 15.5 per cent, respectively. Consequently, many investors have been suffering from “negative wealth effects” as their portfolios have seen capital erosion.
 
The proximate causes of bearishness are obvious. A deteriorating macro environment and an escalating trade war have led to crude oil prices rising while the rupee has fallen. This, in turn, has impacted sentiment, and markets have slid as foreign portfolio investors have sold rupee assets through the last few months. A continuing banking and bond market crisis, triggered by the collapse of Infrastructure Leasing & Financial Services, have not helped matters. Though collections have of late shown signs of stabilising, feedback from the ground suggests that the goods and services tax continues to suffer from teething troubles, with many businesses, specially small and medium enterprises, still struggling to cope with its complexities.
 
However, corporate revenues and earnings have seen some improvement in the first half of 2018-19, albeit because of a weak base effect. But margin pressures are visible and, more worryingly, consumption momentum is showing signs of slowing down, as households became more nervous. Since most stocks are still trading at high valuations, it is entirely possible that the current correction will continue, with downside risks.
 
All of this suggests that Samvat 2075 may not deliver great returns. But that should not surprise anybody. In the past five years — except Diwali 2014, when it shot up 26.4 per cent year-on-year, and 16.6 per cent last year — Sensex returns have been disappointing. The past two years saw households making large commitments to the equity market, both directly and via mutual funds. As the correction has deepened, some of that money has pulled out and it is entirely possible that there will be more redemptions. At this instant, investors are more focused on protecting their capital than looking to increase equity exposure.
 
It is a harsh truth that investments are subject to market risks and those risks are now very visible. The next six months could resemble a roller-coaster ride as investors will be firmly focused on every political twist and turn, and this uncertainty will tell on markets for much of Samvat 2075. But things might settle down once a new government takes over next year. Experienced investors can use such periods of uncertainty to build their portfolio at reasonable valuations as they know that substantial equity returns only accrue to those who invest with a long-term perspective. Those who can hold their nerves through the coming period of political strife can hope to be eventually rewarded for their patience.