The Hindu Business Line : Correction or reversal?

It is not often that a market barometer drops 13 per cent over just seven trading sessions. But when it does, it naturally sets alarm bells clanging, as it happened with the Sensex last week. The much-followed index, which touched its life-time closing high of 12,612 points on May 10, plunged to 10,938 points on May 19.

Is this the much-awaited and feared but necessary and healthy correction, or is it more than that? Is there a further downside or has the Sensex touched the bottom? What should you, as an investor, do in this market?

Not a trend reversal

A fall of 1,674 points, or 13 per cent, may appear too big to be termed a correction, especially because it happened in such a short time-frame. But there are a few points to note here.

First, the Sensex rose spectacularly the last year, almost doubling in value; the last three months were particularly heady, with investors forgetting there could be a flip side to the rise. Given this, the fall now is inevitable and seems to be only an adjustment in the market, which has run way ahead of fundamentals. The fall had to be steep, and sharp enough to compensate for the massive run-up in recent times.

Second, the jitters were getting worse among marketmen and fund managers, some of whom may have intelligently cashed out a part of their investments in the last few weeks.

The meltdown in the global metals market and the confusion over the FII taxation issue (see accompanying story) were just the catalysts needed to push a nervous market over the edge. They were not the basic causes.

India story still strong

Third, if you look at the large picture, there is really no change in the fundamentals that would warrant a dip in market sentiment. The overall India story is still good, the macro numbers are as strong as they were, and there has been no deterioration in that.

Corporate results flowing in point to robust growth in most industrial sectors. And, importantly, there is no significant change in the two pivots on which the economy now seems to be turning — infrastructure investment and consumption growth.

There is no slowdown whatsoever in infrastructure investment; if anything, more projects are being announced to set up power plants, refineries and steel mills, apart from the public investment going into highways and airport modernisation. These should logically set in motion a virtuous growth cycle across the economy. Similarly, the demand for consumer durables, passenger cars, branded textiles and other consumer goods is showing healthy growth. You only have to look at the high streets in all cities and towns to judge the increasing purchasing power of the average Indian, who is out shopping like never before.

More downside?

There has been no change in these in the last few weeks to justify a free fall. Therefore, the extent of the drop notwithstanding, this appears to be no more than a correction, with a possible further downside from current levels.

Is this the bottom, then, or is there a further dip in store? There are those who believe that there could still be a downside to the Sensex of up to 500 points.

The logic is that price-earnings multiples would come down to more comfortable levels only then. The fall in the last week has already reduced the Sensex PEM to 19.4, from a high of 22.1, and a PEM of 17-18 would be more in the comfort zone.

However, this has to be weighed against the fact that mutual funds could be sitting on some cash that could find its way into the market very soon. That will bring in some support to the market and keep it from dropping further.

A lot would also depend on the behaviour of FIIs, which have been unenthusiastic investors in the last few weeks (see infographic). Their apprehensions seem to be that the market is already stretched and overvalued. However, this again could change, as the present levels are almost near the `comfort zone'.

What should you do as an investor? As an investor, it may be safe to assume a minor downside from these levels. But if you are investing for the long term, this may be the time for you to re-enter the market.

A number of stocks — frontline, mid- and small-cap — have now been beaten down to levels where they are already attractive, or close to that, for accumulation with a long-term perspective.

Even assuming there is a further dip from the current levels, you should not panic if you are a long-term investor. Savvy investors would rather look at average costs and returns than absolute ones, given the current market levels.

Medium-term outlook

What is the outlook for the market in the medium term? There are those who believe that the current valuations reflect expected earnings for the next couple of years!

This could mean that the appreciation from these levels may not be at the same pace as the market witnessed in the recent past till earnings catch up with valuations again.

Two other factors could impact the course of the market simultaneously. First, the IPO pipeline, which has been full in recent times, could gradually dry up if sentiment stays depressed for the next couple of months. This will mean that the expansion in the universe of investible stocks, which was good for the market, will stop.

In the near term, the mega IPO of DLF, which is hitting the market soon, could suck up Rs 15,000-20,000 crore from the system; a lot of this could come from sell-off of holdings in the secondary market.

Second, the interest rate scenario in the US may cast its shadow on the Indian market. Any further hardening of rates could mean an interruption of fund flows into India and, in the worst-case scenario, even a reverse flow of funds out of the country.

Another near-term factor to watch out for will be the approaching monsoon's behaviour. This could well be the next inflexion point for the market. A good monsoon could reverse sentiment and take the Sensex back on its upward journey.

Apart from this, the other worries are the direction of global oil prices; an adjustment in domestic fuel prices is due anytime now and this could trigger a cost-spiral across the economy. That should logically lead to inflation, which may rise if energy costs increase.

Finally, all these could lead to a further hardening of interest rates, which is bad news not just for the market but also for companies with capital investment programmes.

This will have an impact on the earnings card of the corporate sector in the coming quarters — interest costs have already shown an increase in the last quarter earnings statements.

Irrespective of whether the carnage last week was a mere correction or a trend-reversal, the fact is that the momentum that had built up in the last few months has been interrupted now and it may be a while before it is regained.

The market could be range-bound in the near to medium term, possibly with even a negative bias, as all the uncertain factors play themselves out.

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