Are you predicting a stock market correction?

Jan 27, 2015

In this issue:
» What do the December quarter earnings say?
» FIIs pump in big money in Jan 2015
» India's forex reserves at all-time high
» and more....

We just witnessed the solid seven-day rally in the Indian stock markets. The benchmark indices went up about 7%. The BSE-Sensex closed at an all-time high of 29,279. From here the 30k mark is just another 2.5% rise. How do you feel at this point? You think the market still has enough steam left to scale new highs? Or do you think a correction is imminent? What is the story in your mind right now? What is your strategy to outsmart the market and to be on the winning side all the time?

Many investors seem to be obsessed with the near-term direction of the markets. Their thought process often lingers around the questions mentioned above. What they are really trying to do is time the market. Exit before the market corrects. Buy again when stock prices drop. They are trying to predict every market wave... all the time focusing simply on stock price movements. While in their minds they believe that they are being contrarians, they are often doing what almost everyone else is doing - trying to judge where the markets are headed.

When it comes to market timing, most people get it wrong. If you look back into the history of the US stock market, the 1950s was a great time to invest. It was in 1954 that the Dow Jones Industrial Average surpassed the 1929 peak for the first time. But most investors kept away from the market during this period. They kept watching, waiting for the right time. They started investing by the droves in the early and mid-60s, after seeing how good the markets had been in the 1950s. They were hoping that the 1960s would be just as good. But well, here is what happened. The markets hit their peak in 1966. Many investors ended up entering the market close to peak levels. Had they started investing regularly in the 50s for the long term, they would have enjoyed handsome returns on their investments.

Here is another piece of insightful information that we would like to share with you. As you already know, the markets do not move in a linear pattern. There are certain days when there are big gains. Some days tend to be lackluster. On some other days, there can be big losses. It is nearly impossible to consistently predict which will be the days of big gains. So if you keep jumping in and out of stocks, you might miss out some of those big gains. And over longer time periods, this loss can be significant. Consider this example. From 1982 to 2005, the US stock markets delivered average annual return of 10.6%. Now, if you eliminate the 50 best trading days during this period, you would end up with a meagre annual return rate of just 1.8%. The trick to making those big gains was simple - stay invested for the long term. Don't worry too much about when the markets will correct.

A quote by legendary fund manager Peter Lynch sums up the message quite aptly: "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves."

If long term investing is really rewarding, then why do investors focus so much on the short term? The reason is that the human brain is wired to focus on the immediate stimuli. It is not instinctive for us to think long term. Long term investing is a discipline that has to be developed and trained. The truly genius and successful investors tend to recognize this human limitation. Instead of giving in to the tendency of trying to outguess the market, they keep their sights trained on the long term big picture. And this is what makes all the difference.

Have you been trying to guess when the Indian stock markets are going to correct? Let us know your comments or share your views in the Equitymaster Club.

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  Chart of the day
As we all know, the December quarter results have started pouring in. As per an article in Business Standard, about 290 companies have announced their quarterly numbers. And the numbers certainly don't seem encouraging. If you consider the aggregate topline growth of all these companies, there has been a 4.4% year-on-year decline. Let us tell you that this is the first decline in sales in the last eight quarters. The growth in net profits was positive but lackluster at merely 2.2% year-on-year. Again, this is the slowest growth rate in net profit in the last eight quarters. Now, if you exclude companies from information technology, banking and finance space, the numbers get even worse. The decline in net sales deteriorates further to 11% year-on-year, while net profit declines by 4.8% year-on-year.

The only silver lining has been the improvement in core operating margins. This was mainly on account of lower commodity prices. As you can see in the chart of the day, the December 2014 quarter reported the highest operating profit margins in the last eight quarters.

Indian economy not out of the woods yet

It is clear that the Indian economy is not out of the woods yet. The stock markets don't seem too concerned as they are betting high on an economic revival driven by strong political leadership, lower commodity prices and reversal of the interest rate cycle. If the future earnings do not match up with the expectations that are being priced into stocks, then we may be up for a rough ride ahead.

The year 2014 ended on a high note for the Indian markets. 2015 seems to have kept the optimism alive and growing. It has been quite a roaring start so far. Right now, India is clearly among the favorite markets for foreign investors. As per the latest data, foreign institutional investors (FIIs) have pumped in nearly Rs 213.3 bn into the Indian capital markets till January 23, 2015. The investments in equities stood around Rs 59.9 bn, while the debt market witnessed inflows of about Rs 153.7 bn. With the European Central Bank Chief Mario Draghi announcing a trillion euro scheme to buy government bonds (read money printing), there will be further flood of cheap liquidity in the global economy. And quite likely, some of this money will find its way into the Indian markets. But if you are thinking of investing on the premise of global liquidity pouring in, let us tell you this is not a safe investing zone. FII money can change direction at the fall of a hat. So keep your eyes glued on earnings, and not where the money is going to come from to boost stock prices.

Given the heavy dependence on imports, India has, more or less, been a current account deficit economy. And this has been the main reason why the Indian rupee has been largely in a downward trend. But there is some good news on this front. As per a leading financial daily, India's foreign exchange reserves have hit an all-time high of US$ 322.14 bn during the week ended January 16, 2015. It is worth noting that India's foreign exchange reserves have witnessed the fastest rise in the last 12 months among BRIC nations. In fact, Brazil and Russia have seen their foreign exchange reserves decline.

As a monetary strategy, the Reserve Bank of India has been building dollar reserves to guard the Indian currency in the event of sudden large outflows of capital. The US Federal Reserve's likely move to raise interest rates later this year has been a prominent concern from the liquidity point of view. But it seems right now India is in a better position to guard its currency against outflows of foreign exchange reserves. A big positive has been the sharp decline in commodity prices, particularly crude oil. As such, India's current account deficit is expected to be much lower this year. And this may even prop up the value of the Indian rupee. Overall, it seems like a good time for India to fix and strengthen its finances.

The Indian stock markets continued to trade above the dotted line after opening the day on a positive note. At the time of writing, the BSE-Sensex was trading higher by about 64points or 0.2%. Barring IT, metal and healthcare, all sectoral indices were trading in the green led by the stocks in the capital goods and realty sector. Mid and small cap stocks were trading strong as well with their representative indices trading higher by about 0.6% and 0.4% respectively. Asian markets were trading mixed with China and Hong Kong leading the pack of losers, while markets in Japan and Singapore were trading firm. European indices were trading in the green at the time of writing.

 Today's investing mantra
"Our stay-put behavior reflects our view that the stock markets serve as a relocation center at which money is moved from the active to the patient." - Warren Buffett

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1 Responses to "Are you predicting a stock market correction?"

kamal jain

May 14, 2015

say,if your predictions about the market goes right here and there ,then you are destined for a DISASTER,for sure.

Equitymaster requests your view! Post a comment on "Are you predicting a stock market correction?". Click here!

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