Worry but do not bail out of equities. Do not rush in to put fresh money into equities till markets stabilize. Stay focused on your investments, understand what you are investing in and follow global risk aversion trends closely. You will not go wrong on your investments.
The BSE Sensex had its steepest fall since September 2013 on the 6th of January 2015. The Sensex fell 854 points, down 3.07% on the back of rising global risk aversion. The Sensex is down over 5% from record high levels of 28560 seen in the beginning of December 2014. The NSE Nifty fell 251 points, down 3% to close at levels of 8127 and the index is down over 5% from peaks seen in beginning of December 2014.
The sharp fall in the Sensex and Nifty would worry you as the indices have been on a singularly upward trajectory since January 2013. The indices have gained by over 30% on the back of a strong political mandate given to PM Modi and on the back of extraordinary low interest rates globally and high liquidity pumped in by Central Banks from the Fed to the ECB.
Why the sharp fall in the Sensex and Nifty and will it continue for longer periods of time? The fall in the Sensex and Nifty is due to rising risk aversion globally on the back of three factors a) Worries of Eurozone crisis re-emerging as Greece goes in for elections b) Expectations of Fed rate hikes and c) Collapse of oil prices leading to economic collapse in large countries like Russia. We have analysed all the three factors mentioned here. Read our analysis on Greek Election and the Euro, The Return of the King (USD) and Global Crude Oil Dynamics.
Our analysis suggests that Greece going out of the Euro (unlikely but markets are worrying over it) is not a catastrophe for the Euro. Fed rate hikes will not suck out global liquidity as ECB and BOJ will keep pumping in liquidity into the system and oil price fall is more positive than negative for India.
However you should always worry about global risk aversion, as it will help keep your investments in perspective. Sharp sell off days such as today will cause a long of angst for speculators who had bet one way on rising markets. Investors who have invested in speculative and fundamentally weak stocks will have to digest their losses. Investments made with short term gains in mind will suffer.
What are the classical signs of global risk aversion? One is the strength in the USD, the second is the fall in yields in US treasuries and German Bunds and rise in global credit spreads and the third is volatility in equity markets. The USD index is trading at its highest levels since 2005. US ten year treasury yields have fallen 100bps from highs seen in 2014 while German Bund yields are at record lows. US junk bond yields have rise 300bps from record lows while CDS (Credit Default Swap) spreads of emerging market credits are rising from lows. Global equities are down from record highs seen in 2014.
Will this risk aversion continue and will the Sensex and Nifty continue to fall further? Risk aversion can continue as markets reposition risk in the face of the factors stated earlier but given that global liquidity is comfortable, US economy is looking strong and interest rates are at record lows globally, markets will stabilize at lower levels and regain their strength in calmer times. Sensex and Nifty can fall further but the fall will not be a free fall and will be capped at levels where investors believe risk reward is in their favour.