A very happy, healthy and prosperous Diwali to all of you!
The year 2018 has turned out to be a tumultuous year so far for the stock market. And it promises more uncertainty ahead. The perception in India is that the stock markets started falling post the introduction of the long-term capital gains in the budget on 1st Feb 2018. However, the seeds of the tumult in the stock markets are not be found in India.
The seeds of uncertainty were sowed in December 2017 and in the US bond markets. And it was not triggered by an increase in tax but by a decrease in taxes; and that too, not in India, but in the US. On 22nd December, 2017, Donald Trump signed the US Tax Cuts and Jobs Act into law.
The bond markets started falling immediately in anticipation of a boost to the economy which would result in the Fed increasing rates making the 30-year US treasuries overvalued at the bond yields prevalent in December. One month later, starting January 27th, 2018, the US Stock markets started falling due to strong economic data being anticipated in the US employment report expected on Feb 2nd, 2018. The eventual impact was that the FPIs started pulling out money and that caused the Indian stock markets to fall. We have covered all of this in this article earlier: Funny Capital Markets: they are down because…the US Economy is up.
However, post that the global and Indian stock markets got further shocks. The US-China trade war and the rise in crude oil prices were global factors impacting the global stock markets. Higher crude oil prices were unfavourable for India since they trigger a current account deficit, leading to a depreciating rupee, higher domestic inflation and higher bond yields. Higher bond yields eventually have an impact on the stock prices in a negative manner. This has accelerated the already strong FPI outflows causing the Indian stock markets to lower levels.
As most investors know from looking at their portfolios, the average stock is down much more than the headline indexes indicate. Further, there are other domestic factors, such as, the ILFS default and its spill-over effects on the rest of the NBFC space and some banks. On top of all this, this year the election year with a number of prominent states going to election and the national elections.
It is likely that the rest of the year will be tumultuous. What actions can an investor take under these conditions to benefit from the uncertainty?
We propose, on the lines of Buffett, that an investor should buy their stocks the same way they buy groceries rather than the way they buy perfumes. In groceries, the cheaper the prices the better and the buyer buys more when prices are lower. While in perfumes, the higher the prices the more the buyers prefer it.
Since most participants in the markets are in the phase of investing and will not need the money for several years, it makes sense to be happier in times of uncertainty since uncertainty causes lower stock prices and hence like groceries they are a better deal.
We suggest that investors should go for diversification under uncertainty. Divide your investment corpus into around 25 stocks. Similarly, in light of the uncertain year ahead, we suggest that investors go for time diversification. Divide your investment corpus into 10 instalments. Invest one instalment each month for the next 10 months. The benefit of this is that one is able to take advantage of the ups and downs of the markets without having to predict the next move of the markets.
Typical investor questions are:
- Is the market going to fall further?
- Is the market now going into an upswing?
- Is the bear market over?
- Has the bull market started?
An easy way to handle these uncertainties is to start investing in instalments. The next 10 months with 10 instalments will help one build a portfolio which would have been invested at the average price of the next 10 months.
Is it a good time to start?
Given the large drops in stock prices ranging from 10% to more than 50%, it is likely that a lot of investable stocks are available at a discount to their intrinsic values. If in a future month the markets fall further, there will be even more discounted stocks available.
For example, currently Nifty 50 is at a PBV (Price to Book Value) ratio of 3.26 vs 3.8 in the last week of August. Nifty midcap 100 is at a PBV of 2.46 vs 3.26 in the last week of August. And Nifty small cap 100 is at a PBV of 1.59 vs 1.95 in the last week of August. Further falls will only make the stocks available cheaper.
However, the solution is not to try to predict the bottom of the markets, but rather, get started with 10 equal instalments spread over the next 10 months.
This will help one ride the uncertainties and generate a potentially large return on the uncertainty. Important thing is to get started on this plan rather than wait for certainties. Carpe Diem! Seize the day!
Happy investing and a prosperous Diwali!
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Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.