The Secret to Investing Riches Is Understanding the Cyclical Nature of the Markets

Nov 5, 2018

Ankit Shah, Research analyst

October was a sizzling hot month in Mumbai, with mercury levels soaring to multi-year highs. But over the last few days, there's a change of wind. The air is drier. And while winter is still away, there is a sense of relief that the hottest months are behind us. At least, for the time being.

October was also a month of intense heat in the Indian stock markets. After hitting an all-time high around the end of August, the BSE Sensex entered correction mode in September, which intensified further in October. At one point, the Sensex was down as much as 14% from its August peak.

However, since the last week of October, there are signs of weather change in the Indian stock markets as well. There's been a recovery across the board. The Sensex has regained over 1,600 points from its October low.

What is behind this recovery?

If you recall, in a piece I'd penned in September, I'd highlighted half a dozen macro factors weighing on the Indian stock markets - rising, crude oil prices, depreciating rupee, rising interest rates, trade war tensions, election year uncertainty, Indian banking and NBFC mess.

Some of these macro factors that had triggered a heightened sense of panic and uncertainty in the markets have mellowed down recently.

Last month, Brent crude oil price had risen above US$ 86 a barrel for the first in nearly four years. Amid looming US sanctions against Iran supply concerns, there were predictions of crude hitting US$ 100 per barrel mark. For import-dependent India, this was certainly a big concern.

Recently, the Brent crude oil price has corrected and is currently near its six-month low of US$ 72.57 per barrel. This has come as a pleasant surprise when the markets had been overwhelmed by several macro concerns.

Moreover, the US government has agreed to let eight countries, including India, to keep buying Iranian oil after it reimposes sanctions on Tehran.

Since crude oil imports have a major impact on India's trade deficit, lower crude oil prices and the easing of US sanctions have provided a relief to the Indian rupee. It has also eased concerns of inflation and fiscal slippage. As a result, the 10-year Indian government bond yield also dropped to a near three-month low.

And then, on 2 November, PM Modi unleashed a "Diwali gift" on the micro, small and medium enterprises (MSME) sector.

He announced sanction of loans of up to Rs 1 crore in 59 minutes, 2% interest subsidy for GST-registered enterprises, higher interest subvention for pre-and-post-shipment export credit, increased procurement by PSU companies, relaxation in labour laws, easier compliance with environmental rules, and changes in company laws for the MSME sector.

On the face of it, it indeed looks like an economic bonanza for the MSME sector.

But the mainstream media fails to point out that the "Diwali gift" is a belated, half-measure remedy for this ailing sector.

The MSME sector has been under severe duress owing to Modi's demonetisation drive in November 2016, followed by the hasty implementation of the GST in July 2017. Both these policies resulted in a sharp drop in employment and revenue in this largely informal, cash-dependent sector, which is also the country's second biggest employer with an estimated 6.5 crore units.

With three upcoming state assembly elections in two months and the 2019 general elections just six months away, expect more shocks, surprises, and gifts in the coming months.

So, while some macro factors have turned somewhat benign right now, it's impossible to predict how long the effect will last.

Coming back to the stock markets...

After the heavy correction in September and October, what's in store for the markets now?

To answer this question, I'll offer you an analogy...

I believe the market cycles are quite analogous to the cycles in nature. They're constantly changing, from one season to another. Winter gives way to summer. Summer gives way to rains. And so on. The farmer knows when to plough the fields, when to sow the seeds, and when to harvest the produce.

Many investors fail at the game of investing because they don't understand the cyclicality of the markets. When markets are brimming with optimism, they start believing that the bull party will run indefinitely. Similarly, when the markets are in a bear grip, all they see is gloom and doom.

The intelligent investor knows that the markets have their own seasons. He doesn't try to predict the rain, but rather keeps an umbrella handy.

He understands that the best buying opportunities often surface when there's heightened fear and uncertainty. Eventually, when the cycle turns and the bulls come back, he will be rewarded for sowing his investments at the right time.

Chart of the Day

There are some interesting trends about how the global markets performed last year and this year.

Countries heavily dependent on crude oil exports performed poorly in 2017. However, with crude oil prices in a rising trend this year, they're among the best-performing markets.

India, a country that relies heavily on crude oil imports was among the best-performing markets when oil prices were weak. However, the tide turned this year as our oil import bill has witnessed a significant jump.

The BSE Sensex closed at 34,057 at the end of 2017. It gained 14% to hit a life-time high of 38,897 on 28 August 2018. Thereafter, the Sensex has been in correction mode through September and October. However, after hitting a year-to-date low of 33,349 in the last week of October, the Sensex has reclaimed the 35k level.

While the Sensex has shed most of its gains in 2018, it still doesn't appear so bad in Indian rupee terms. But for foreign investors, the fall in the Sensex has been worse, because they're also exposed the currency risk.

The below chart shows the difference between the performance of the Sensex and the Dollex 30 index (Sensex in US dollar terms).

Dollex-30 Is Down 10% in 2018

You can see how the trend between the Sensex and Dollex-30 diverged since February 2018.

The Dollex-30 index has declined 10% in 2018 so far.

No wonder that foreign investors have been dumping Indian stocks. Since April 2018, foreign investors have sold equities worth Rs 56,550 crores. What is worth noting is that Rs 27,623 crores worth of equities were sold in the month of October alone.

Happy Investing,

Ankit Shah
Ankit Shah (Research Analyst)
Editor, Equitymaster Insider

PS: ****

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