Significant portfolio returns possible if investors remain unnerved by 5-10% corrections

Indian corporate sector is doing even better than the overall economy.

By Pradeep Gupta

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India’s economic recovery has been stronger than initially anticipated. The IMF has retained its GDP projections of India in the current fiscal year at 9.5% and 8.5% growth for the next year, retaining the tag of one of the fastest-growing economies. Globally, the economic recovery continued, but at a slower pace. The global economy is projected to grow at 5.9% in the current year and 4.9 in the next year, a downgrade from the earlier projection. This downgrade is partly due to the supply chain disruption for the advanced economies in hand with the pandemic disruptions for other nations. 

Globally, the US economy is set to grow by 5% in Q4 2021 and 3.5% on a y-o-y basis in 2022 and 2.9% on a y-o-y basis in 2023, the downgrade is mainly due to expectations of policy rate hike by the Fed, the persistently rising inflation rate and also due to the resurgence of covid-19 cases which may slow consumer spending growth. Looking at the Euro area, the GDP rose to 2.2% from the previous quarter displaying signs of recovery from last year’s recession. Despite positive consumption and private investment numbers, the economic sentiment continues to be on a declining trend. The Euro area also faces inflation risk, supply chain shortages alongside rising commodity prices, shipping costs, and baseline effects due to low economic activity and negative inflation rates last year, are partly responsible for rising inflation risks. 

Domestic markets outperform

Coming back to the Indian equities, in the last one year, the Indian equity market has been the best performing amongst all major markets of the world. Nifty 50 rallied 50% and mid-and small-cap indices have done much better, since April 2020, Nifty has gone up nearly 150% and the small-cap indices by nearly 250%. Certainly, equity market returns are way above the past averages and given the strong rally, there are apprehensions among many investors whether the market is likely to see a large correction in the near-term.

5-10% correction norm rather than exception

Equity markets are by nature volatile and 5-10% market corrections are norms rather than exceptions. In this sense, a level of market correction at the current juncture cannot be ruled out. That said, the bigger questions are whether the equity market is out of sync with the current and expected underlying macro and corporate fundamentals, whether the equity valuations are too expensive or whether past experiences suggest that whenever the equity market rallies the way it has done in the recent past, it results in significant correction in the next one-year. 

If the answer to any of these questions is a clear yes, then investors should be more worried and think about reducing their equity allocation.

Fortunately, our analysis suggests that the answers to all these questions are NO. Most parts of the Indian economy including agriculture, manufacturing, and infrastructure, most parts of services, banking, foreign trade and government finances are currently doing much better than the pre-pandemic period. 

Reforms attracting global investors

We witnessed healthy FII inflows which resulted in strong growth in the Indian capital market. India was among the very few nations that witnessed strong foreign direct investment (FDI) in 2020 and the momentum continued in 2021. Recent reforms and policies to further liberalize FDI in a few sectors such as insurance, agriculture, telecommunications services and defense have attracted global investors. Schemes such as the production-linked incentive (PLI) and labor reforms have increased foreign interest in several investable. Besides, the national monetization pipeline of brownfield assets is likely to generate investment interests and attract foreign capital. That being said, our current account position would not be challenged even if there was an adverse situation where there is an outflow of capital. 

As suggested earlier, the Indian corporate sector is doing even better than the overall economy. Consequently, the up move of the equity market is in line with the improvements in macro and corporate fundamentals. The perception of the economy and the markets are moving in different directions is therefore not right.

Equities as an asset class is volatile in the short term, therefore, the possibility of a 5-10% market correction in the short term cannot be ruled out. At the same time, a continued rally in the equity market is also a distinct possibility, timing the market accurately is not possible. The consistent and less risky way to make significant portfolio returns is, therefore, to remain invested in the market and not to get unnerved by the possible or actual corrections in the equity market.

(Pradeep Gupta is the Co-Founder & Vice Chairman of Anand Rathi Group. Views expressed are the author’s own. Please consult your financial advisor before investing)