Markets: What is behind the fall and what should you do

It isn't new, it isn't over

1. The panic is global
 
India is merely a bystander getting dragged in. And, in all likelihood, the fall isn’t over. In all probability, it might have just begun – at least optically. On a year-on-year basis, yesterday the Nifty was down 16%, the highest one-year fall for quite some time. As the chart below shows, the Nifty’s one-year returns peaked in August 2014 and have kept falling since. To put things into perspective, one-year returns on the Nifty have declined every month since September 2015, making February 2016 the sixth consecutive month. This fall will look worse in coming months, simply because last year this time the Nifty was on a tear. This is what they call ‘base effect’. Just because last year’s returns were high, the ongoing fall will look worse on a one-year return basis.

FALLING RETURNS



2. This isn’t new
 
In fact, it happened in 2011, when the Nifty fell 27% from January high to December low. Yet again, the fall then was driven by global concerns. The world was in turmoil following the European debt crisis and concerns on economic growth in the US. This time around, the list of concerns is longer: slowdown in China, crash in oil prices putting pressures on the economies of oil-exporting countries, and stress in European banks. Recall that emerging-market equities have been weak after the global financial crisis. India, by comparison, has done spectacularly well. The chart below shows the dismal performance of the MSCI Emerging Markets Index. After 2011, the Nifty has trumped the MSCI Emerging Markets Index in every subsequent year.

Returns given by Nifty and emerging-market index (%)


 
3. Liquidity fuels the fall
 
The fall in the markets is purely driven by liquidity. Foreign institutional investors have pulled out $2 billion from Indian equities so far in 2016, the worst since the global financial crisis in 2008. Domestic investors are too small to make a meaningful difference. In fact, domestic flows appear to have stalled with equity inflows in January 2016, to Rs 2900 crore, the lowest in 20 months. Liquidity drives markets to rise, and liquidity drives markets to fall. Simply, the age-old relationship of demand and supply, greed and fear, is playing out. No one can predict the bottom. Investors are simply taking bets — that’s what they do.
 
4. Beware of bad news
 
In times of panic, fundamentals take a back seat. Investors are fully aware of India’s superior economic growth. On the flip side, they are also aware that India’s public sector banks are in deep trouble — no wonder then that private banks like HDFC Bank and Kotak Mahindra are now more valuable than all PSU bank stocks. Incremental good news will be forgotten quickly. For example, the coming Budget is a non-event. The government will stick to its fiscal deficit of 3.5% for next year. No one really expects miracles. Unfortunately, no one is expecting bad news, either. So you should hope and pray that, for example, no PSU bank announces a major, unexpected write-off.
 
5. Accept uncertainty
 
Falling markets are excellent opportunities to invest, provided you have the guts to accept uncertainty, face deep losses and be realistic about long-term returns, as I had mentioned in an earlier post.
 

 
Right now, the base-case scenario is similar to 2011 and 2012 — that is, global panic continues but eventually sorts itself out. The best-case scenario is that this sorting out happens sooner than later. The worst-case scenario is full-blown contagion, led by sell-offs across asset classes. No one really knows which of these scenarios will play out in 2016. The best that you can do is accepting this uncertainty and adjusting your priorities accordingly.

Anupam Gupta is a Chartered Accountant and has worked in equity research since 2000, first as an analyst and now as a consultant. He contributes to the Business Standard platform, Punditry, through his blog, Beyond Markets on markets & the economic horizons. 

He tweets as @b50