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Don’t panic when markets go down - Your portfolio might be fineOverall RATE RATE (0.00)

On Feb 2 2018, the Sensex and Nifty started going down. Sensex went down 800 points and then continued going down on Feb 5th on Monday and continued falling. After weeks and months of just going one way, i.e. up, investors are wondering what is causing this sudden downfall. Is there something wrong? It all seemed to have started after presentation of Budget 2018. Was there something in the Budget which caused this?

Since the Budget introduced the long-term capital gains tax after nearly 14 years, that might seem like a possible trigger. But, the LTCG tax is not that high at 10%. Also there is a grand fathering available until Jan 31st 2018. Any selling until March 31st 2018 is exempt. For the next financial year, only the gains from Jan 31st 2018 onwards are to be treated as gains. So again the impact will be next year. Despite the taxes, equities still remain the most rewarding asset class in the long run. So that is not the reason for the fall.

Next suspect in the Budget is the fiscal deficit. This is pointing to a slightly higher borrowing by the Government during the year. But again it is not very large. But, yes, the bond yields had already started moving up. Further, the crude oil is increasing and the Rupee was relatively overvalued vis-à-vis the US Dollar. But all of that was true before Feb 1st. So that cannot be the primary cause.

All of the above factors are important. But none of them are so bad to cause a drastic fall of nearly 2000 points in Sensex over 3-4 sessions. However, even 2000 points is not that big a fall either; it is just about 5.5%. But the number looks large and daily drops of 800 and 1000 points are relatively rare. So it does cause concern to a new investor.

But the important thing to keep in mind is that the overall economy is actually doing quite well. Recently IMF has projected India to grow at 7.4% in 2018 and 7.8% in 2019. In fact, India is projected as the fastest growing economy in the World over next two years. So that is not a cause for concern.

Further, the earnings for Q3 FY18 are better than expected and clearly point to a turnaround in the earnings cycle. So that is not a cause for concern either. If the domestic fundamentals are fine then what is the issue? Why did the markets fall?

We will have to look globally for that. The reason is the Employment Report in the US which came out on Feb 2nd. That clearly showed that the job market is doing quite well and jobs increased by 200,000. Further, the unemployment rate is at the lowest at 4.1% and the average hourly wages have gone up by 2.9%. The last point of wage inflation is the most important to pay attention to.

But remember, all of this is point to a very good US economy. Typically, a good US economy is also good for the rest of the World. So a good US economy with initial signs of wage inflation.

This caused the Bond investors to think about what will happen to their long-term bond returns. The Fed will start factoring in the good economy and have a rethink on the interest rates. Wage inflation and a tight labour market will force them to think about increasing the interest rates faster. This will cause the Bond yields for new issues rise and hence for the existing issues to rise as well. This will cause the 10 year and 30 year bonds to fall in price thus giving negative returns.

The bond investors exited their positions and this made the bond yields quite high. This caused the equity investors to rethink their discount rates. If the discount rates going forward would have to go higher to compete with the higher bond yields. So the PE multiple would have to drop. So the margin traders in equities had an incentive to quickly exit the trades which would not remain attractive going forward. A lot of them doing it at the same time caused a sudden drop.

The same logic applied to their positions in Non-US markets, such as, India. The negative trend forced Indian traders as well to rethink their positions. And they too had to liquidate it given the fall. This caused a further fall and then the trend followers always magnify a trend by selling when everyone is selling.

In short, the fall was triggered by the US economy doing better than expected and hence increasing concerns of a faster rate hike by the Fed. In fact, fundamentally, the US earnings are expected to be in double digits for the next 3 years. Same is the case with Europe.

So the global economy is turning around for the better and doing well. The Indian economy is also turning around and doing well. The potential increase in interest rates are the immediate reason why the markets fell. This is an adjustment phase and post that the markets should again focus more on fundamentals and based on the future earnings expectations the markets look reasonably valued.

No need to panic. But a good opportunity to take a look again at your portfolio and possibly rejig it to enter even better companies at even better prices.

Vikas Gupta 

by Dr. Vikas Gupta 
CEO & Chief Investment Strategist
OmniScience Capital

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