6 Good Reasons to Buy into the Correction
- Low global and domestic interest rates, high global and domestic liquidity to drive flows into equities. Bond yields are too low for significant returns and commodity demand led by oil demand is in doubt given various economic and disruptive factors.
- For the Indian economy the macroeconomic parameters are extremely comfortable with current account deficit (CAD) at 2.4% of GDP as of 1st quarter of fiscal 2017-18 followed by fiscal deficit targeted at 3.2% of GDP for 2017-18, inflation below 4% levels and forex reserves at all time highs of USD 402 billion.
- Earnings growth for domestic companies have been mixed for the 1st quarter of 2017-18 but sectors where earnings growth have been strong such as transportation, retail, agri products, downstream oil & gas will continue to lead the markets forward
- Political stability with the BJP led government seeing strong traction in recent assembly and municipal elections looking at a selection in 2019
- US and global companies are showing strong earnings growth with S&P 500 companies earnings growing at close to 15% levels in the 2nd quarter of 2017, which indicates strong global demand on the back of improvement in economic fundamentals in both the US and Eurozone
- Global central banks led by Fed and ECB are still seeing uncertainty on inflation and are reluctant to tighten policy too soon. Global rates and liquidity will continue to stay high. Fed is guiding for gradual rate hikes and drawdown of its balance sheet, which is positive for markets.
The Sensex and the Nifty have been on a rally year to date and have reached record high levels in the month of September 2017. The Sensex and Nifty have declined by over 4% after reaching record high levels in the recent correction. The market was expecting a correction as liquidity other than fundamentals had driven the benchmark indices to return 18% year to date. The Sensex and Nifty continue to trade at a trailing price to earnings ratio of 24 and 26 respectively. The benchmark indices are trading at expensive valuations in the current scenario but expectations of earnings growth continue to keep the momentum more or less intact.
There are various factors that are cited for the recent correction in the market but it has to be understood that markets were anyways looking for an excuse to correct for quite sometime now. Geopolitical factors such as tensions between North Korea and the US. The Fed has once again induced volatility in the equity markets by guiding for rate hikes and reduction of its balance sheet. The extent of correction may or may not be always possible to predict. The obvious question is what should investors do in such a kind of scenario.
The reason for the correction in the market has to be carefully analysed and considered in such a kind of situation. Most investors tend to think from a short term point of view and refuse to take any action as uncertainty clouds the decision to invest or wait. Any scenario which directly impacts the earnings and revenue growth for the broader market is a sign of worry and investors should wait to invest if revenues and profits are continuously declining or refusing to recover from any downturn. Any other scenario where revenues or profits are temporarily impacted but are expected to recover in the long run provides an opportunity to invest in the market as the indices tend to correct for a short term. This means that the long term trend of the market has to be known to decide whether to invest or wait.
In an emerging economy like India growth in most of the industries and sectors is but obvious as there is tremendous scope to grow. This can be understood from the fact that the Gross Domestic Product which is the value of all goods and services produced in the economy is at USD 2.264 trillion for India as compared to the figure of 18.57 trillion for the USA. So when we know that the economy is growing at a certain pace and growth is bound to happen it becomes very easy to understand the fact that the long term trend is positive.
For the Indian economy the macroeconomic parameters are extremely comfortable with current account deficit (CAD) at 2.4% of GDP as of 1st quarter of fiscal 2017-18 followed by fiscal deficit targeted at 3.2% of GDP for 2017-18, inflation below 4% levels and forex reserves at all time highs of USD 402 billion. So with the economic parameters improving on a year on year basis earnings growth would tend to follow the same pattern with a lag effect in the near future.
Liquidity as a factor is also an important aspect to consider during times of correction because a lot of money is waiting on the side-lines to enter the market at some point of time and any slight positivity or favorable news would tend to take stocks back to record high levels in a short span of time. The Banking system is flushed with liquidity from demonetization, government spending and RBI forex purchases. Hence any volatility in the benchmark indices will be temporary and will provide buying opportunity on falls.
Waiting for markets to meaningfully correct because valuations have overtaken the fundamental growth in earnings is also true but when the factor of ample liquidity is taken into consideration then it becomes very difficult for stocks to fall to levels that would be justified. This could be because of the fact that if long term trend is intact most of the market participants would not wait to buy fundamentally strong companies at below par valuations as there would be an opportunity cost for waiting too long.
So instead of waiting for the markets to correct further stock specific buying would be advisable for investors. If lump sum buying is what fears investors during times of correction then one can buy in a staggered fashion depending upon the percentage of correction in the market.