The S&P BSE Sensex fell 3% in the last one month and as if that weren’t enough, bond yields have been moving up since May 22, causing a fall in the bond prices and a consequent dip in the NAVs of many of your medium to long-term debt funds.
Quite a few of you have been calling in to ask us the reason for the fall and whether you should move out of equity /move out of debt, at least temporarily, given the fall in both asset classes.
Yes, you are right in being confused. So are we. Let’s take solace from Warren Buffet’s words ” “if you’re not confused, you don’t understand things very well”.
But we still hope we will answer some of your questions in this article or at least put them in perspective for you.
1. Why did the markets fall?
Okay, the obvious answer, as mentioned enough in the media is the rupee’s fall against the dollar and how it spooked the FIIs in to exiting the market.
Partly true, but let’s admit, this is not the first fall in 2013. We have already had 2 rallies in the space of less than 6 months and both have petered out. Post September 2012, when a stream of measures were announced, there were enough indications of things getting better. Improvements by way of mellowing inflation and fiscal deficit, lower commodity prices and optimism over recovery in GDP as well as earnings growth, later in the year, sent the market rallying.
But then, actual GDP data for the just ended fiscal year sent the market’s optimism for a toss. The current account deficit and earnings numbers too did enough to pull the markets down every time they rallied.
Ok, we’re listing this simply to remind that the recent rupee fall perhaps accentuated fears but there were enough factors in play in the last few months to keep the markets at bay.
Now moving to the rupee’s weakness against the dollar, it is noteworthy that the Indian markets are not alone in their fall. A number of emerging market currencies and their markets in general have had a bad May themselves, what with a possible ‘Quantitative easing’ tapering in large markets like the US and Japan sending fear signals.
When the monetary shots are withdrawn by such large markets, there is a fear of liquidity withdrawal in emerging markets with institutions showing interest in markets such as US and Japan. Simply put, there could be a flight to safety.
But before you conclude, just keep in mind a few key factors about the Indian markets:
One, there has not been any terrible news/data internally to cause panic.
Two, the government is actually looking at more reforms especially in areas such as FDI to boost foreign inflows.
Three, a gaining US dollar means flat-to-low commodity prices. That means some relief to the raw material costs and therefore operating earnings of companies. That also means oil, which is a key dent on our current account, may actually not play spoil sport. Yes, while, weak rupee would makes imports costlier, to some extent, exports too would gain from a higher dollar.
Four, in normal conditions, a depreciating rupee could spell a hike in interest rates. But given the poor economic growth internally, this will be spared. Yes, rate cuts may not happen as fast as we all anticipated; yet, the 50-75 basis point cut will remain impending over the course of the year.
Five, a fall in markets due to external factors, would mean fall in valuations, what with limited impact on the already tepid earnings growth. That means Indian markets are becoming more attractive.
Now, if you ask me if I expect a recovery now, honestly I have no answer. But if you are asking with a long-term view then my answer would be: to be in equities now would amount to being on the right side – perhaps a bit early. But then, it is the early bird that catches the worm!
2. If the US markets are looking up and FIIs are moving there, should I invest there?
Investment in international markets could be a good diversification strategy (at about 10-15% of one’s portfolio) but if you wish to move your existing domestic allocation to international markets now, you’re probably not doing the best thing for your portfolio.
By moving now, you are shifting from a cheaper market to a rather expensive market that has rallied quite a bit.
The BSE S&P 500 is at 16.6 times its trailing earnings now; and guess where the S&P 500 (US) is at? It is 18.4 times its trailing earnings and at forward 12-month estimates of 15 times, would remain expensive than Indian markets.
And remember, earnings growth in emerging markets like India can far outpace developed markets in the long run.
Also, by moving to an international market like US now, you are exposing yourself to a very expensive currency. Any fall in the dollar will pose you enough currency risks.
3. Why are bond funds falling?
It is the same currency effect that has spooked the market. A falling currency would mean that the RBI may not cut rates in its upcoming monetary policy early next week. That has caused a rally in the yield of long-term gilts and bonds, resulting in a fall in their price. This led to a slip in most of your NAVs since May 22. The currency fall has also triggered FII selling in debt.
But according to a Credit Suisse report, the fears of FII selling in Indian debt may be rather exaggerated. While the selling led to about 17 basis point increase in Indian 10-year government securities, the rise in yields in similar instruments elsewhere in emerging markets (Indonesia, Turkey, Brazil, Russia, South Africa) was to the tune of 60-115 basis points suggesting that the damage in India was minimal.
Also, India has a relatively closed debt market as there are caps on FII holding limits (less than 5% of the bonds in India are foreign-owned according to Credit Suisse), the impact of FII selling on the yields is not high.
The fall in your fund NAVs between May 22 till date would be anywhere between 0.01% to 1.25%, for most income funds and long-term gilt funds.
4. Should I move out of my bond funds?
The same principle that applies for equities applies here as well. By moving out of your debt funds now, you will be moving out at a cheaper price and probably come in again when yields have fallen (and when NAVs have rallied). Its not easy to time your entry into debt based on macro factors. If you have a 2-3 year view, its best to stay invested.
But if your goal is a couple of months away, then you should probably be moving to liquid funds as any disappointment in the RBI policy stance would only irritate the markets more.
5. Should I invest now?
If you are starting to invest now for a long-term goal, its probably a good time, both in equities and debt. But this, only if you are game to invest more systematically through SIPs. With election year coming up, you can expect more volatility in the coming months and such skittish markets are best managed through the SIP tool.
In debt too, if you are investing in income funds with a 2-3 year view, use an SIP for the course of 6 months to 1 year at least.
If you are already running SIPs, make sure you are not tempted to stop them. If you are serious about your long-term investment, the only way you are going to lower your cost is by buying in a down market; which is what we are going through. Stopping SIPs and starting later would simply mean a lost opportunity to average.
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