The recent meltdown in the Indian equity market has washed off a substantial wealth of the investors that was created in the past few years. A sudden financial crisis in the US (but anticipated a while back), forced many portfolio investors to press for a sell-off in most of the emerging markets, including India, to cover-up the losses and liquidity crunch in the US. It would be important to mention here that FIIs sold Indian equities worth around $3.25 billion in just six sessions (reported between January 17 and January 24).
A sudden sell-off of such a magnitude resulted in massive erosion of investors wealth and created huge volatility. In our view, Indian investors have to gear themselves up for such unavoidable factors and learn to live with unprecedented volatility thrown open by a sudden plight of foreign portfolio money. In such a scenario, the investors need to be extra cautious and look out for indicators that could potentially change the equity market scenario in India.
The US sub-prime development would be one such factor that should be closely watched for and would play the leading role in shaping the investment decision. As per the estimates, around $100 billion of losses have been cumulatively written-off so far by lenders and investors in the US, which, according to some other estimates, is just 20-30% of the total potential losses. Therefore, furthermore write-offs are quite inevitable and would again remind investors of the volatile markets, which we have just witnessed and havent really recovered by the shocks it provided. The FIIs and hedge fund investors in emerging markets would be coerced to withdraw a part of their investments to cover-up the losses owing to sub-prime woes.
Another factor that would play a major role regarding the growth of the equity market in emerging economies, which India is a part of, is the US economic growth. A large section of economists worldwide believe that even the aggressive rate cut measures undertaken by the Fed (75 basis point rate cut on January 22), would not really ease the pressure of looming economic growth scenario in the US. Further, this liberal monetary stance of the Fed would not be able to hold up the scenario beyond more than three-four quarters, where after, the US slowdown would become inevitable. Now, if the US falls into a recession, it is needless to say that it would change the growth outlook of the world economy as a whole and emerging economies in particular, since the fortune of many emerging economies is closely linked to the US economy. In such a scenario, self-consuming economies, which India is very much a part of, would be least affected. The domestic consumption in India, which is around 85% of the GDP, provides a lot of cushion and relief to the much-talked of theory of decoupling or self-sustaining.
To access the performance or behaviour of the Indian equity market in the future, long-term investors should generally watch out for important macro-economic factors, which amongst others include interest rate, inflation rate, IIP growth, and the overall GDP growth. Till the time these broad factors are much on track, which they are at present, one must continue to believe in the India growth story. Although short-term hiccups (like volatility and sell-offs) would continue to test the confidence level of investors, as evident historically, one has to ignore the distracters.
The recent correction that has resulted in the valuation of the Indian market at more acceptable and comfortable levels, coupled with the fact that the corporate earnings growth in India is expected to score better than most of its Asian peers, Indian equity markets now present a more compelling case for sustaining high growth. Going forward, the returns from the Indian equity market are expected to be more reasonable and rational, unlike the 40-50% CAGR levels that we have seen during the last few years.
The author is senior analyst with Atherstone Capital, a boutique investment firm