Global Markets’ Marginal Returns: Is It Time To Panic? by Ankur Shah, Value Investing India Report
Rather than create an air of suspense, I’ll get straight to the point. Whether it’s time to panic depends upon your time-frame as an investor. We can see from the chart below, which is updated weekly at the Advisor Perspectives website, that global markets have produced marginal returns so far in 2015. In fact, the Sensex has substantially underperformed even the ignominious Shanghai index. Although the Shanghai index has had a dramatic swoon, there was a massive run-up during the summer (see blue line below). Thus, the year-to-date performance doesn’t look so bad. However, the question remains whether the Shanghai market will find support at current levels. I think it’s important to emphasize that the stock market is not the economy. It’s clear to me that China is going through a transition from an economy based on infrastructure spending and exports to one based on consumer demand and services. Unfortunately, the neither the Chinese government nor the PBOC is handling the transition effectively. The continuous plans to prop up the stock market are ultimately going to fail as you can’t centrally plan equity prices. The process of price discovery will continue to occur despite the best intentions and plans of China’s leaders. Ultimately, weakness in the manufacturing sector is offsetting growth in the services sector. However, I do think the commodity exporting countries will be affected materially as the pace of investment declines in China. India, on the other hand, should benefit from the recent decline in commodity prices.
The point that I want to bring up is that you need to take a longer time-frame into consideration before you start panicking. The chart below shows that the Sensex is actually up 26.6% over a two-year period, even factoring in the recent sell-off.
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If we go back even further and look at the performance of the Sensex since the current global market rally began back in March 2009 we can see that Indian investors have enjoyed serious gains. Since March 2009, the Sensex is up 189%, excluding dividends. In fact, the Sensex has been one of the top performing markets in the current global bull market cycle.
There is no need to start panicking about the recent bout of volatility unless you were buying on margin. In my view, the long-term outlook for the Indian equity market is still positive. Inflation is coming down, the RBI is cutting interest rates and economic growth is still strong. In fact, the recent market rout has removed some of the valuation excesses that occurred during the Modi rally. While screening for new investments, I’m consistently coming across a number of high-quality businesses trading at reasonable valuation levels that will produce excellent returns over a three to a five-year period if you remain patient.
There is also going to be a lot of noise and hype surrounding the potential rate hike at today’s Federal Reserve meeting. If Yellen does pursue a rate hike, it would be the first step toward monetary tightening in over a decade. Even if they end up hiking the Fed funds rate by a measly 25 bps, do you think that will be enough to derail the Indian economy? Obviously there will be a short-term impact on both the Rupee and the stock market, as the “hot money” looks for the exits. However, the long-term outlook will still remain positive.
Furthermore, my personal view is that the Fed will not pursue an aggressive tightening policy. I agree with Anthony Boeckh, who stated the following in his book The Great Reflation:
“The Fed does have the distant precedent of 1937 to keep in mind, as well. Fearing a return of inflation then, the Federal Reserve embarked on a premature tightening of monetary policy when the economy looked like it was recovering. However, the reality was that the recovery was fragile, and the tightening policy sent the economy and stock market into a tailspin and ratcheted up the fiscal deficit even further.”
Given the severity of the crisis in China and the nascent recovery in the US economy, the Fed will not repeat previous policy mistakes. Yellen will err on the side of caution. In short, it’s not the time to panic if you’re an Indian equity, investor. It’s actually time to do some bargain hunting with the caveat that you take a long-term perspective.