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Is a correction due?
Mon, 23 Aug Pre-Open

The performance of the Indian markets has been good off late. After a 3.5% drop in May over April 2010, the markets have clocked three consecutive months of gains (till August so far). These gains have taken the BSE-Sensex to its 30 month high. In fact, the last time the Sensex was at the current levels was just before the crisis started in January 2008

Source: Yahoo Finance

The biggest help that the Indian markets have received since this rally started in March 2009 has been the heavy dose of cheap liquidity flowing from the international markets. FII inflows into Indian stocks have been around US$ 11 bn since the start of this year alone. In terms of magnitude, this is the highest ever FII inflow into Indian stocks during the January-August period. So FIIs have been bullish on India all these months.

But then, when it comes to domestic institutional investors, like mutual funds and insurance companies, they have rather been cautious on stock prices. This is seen from a meagre US$ 1 bn of investments from these big investors since January 2010. And a large part of this investment has come from insurance companies and not mutual funds.

Anyways, with markets now trading at near expensive levels, the biggest questions are – will the FIIs continue to flock into Indian stocks, and if yes, for how long?

Well, we do not have a clear answer to these. After all, FIIs are known to be fickle investors. They come in hordes, and leave in hordes.

But one signal we are getting with respect to the possible FII behaviour can be found in the vibes coming out of the US central bank – Federal Reserve.

The Fed has maintained a range of 0-0.25% for its benchmark rate for short term loans since December 2008. It has done this to encourage the recovery in the world's biggest economy. Now with several experts (including the bond guru Bill Gross) expecting the Fed to maintain the dollars cheap, we see this as laying the foundation of a financial bubble in emerging market stocks like India.

A continued and heavy dose of cheap dollars printed by the Fed has led to excessive risk taking by speculators to speculate in stocks. While the situation has still not reached a stage that could be termed a ‘bubble’, it won’t take much time for things to get out of hand.

The risks especially lie in emerging markets (like India) that have seen a huge inflow of low cost global liquidity over the past 18 months. This has led to sharp surge in stock prices in these countries. In India, for instance, stock prices have risen by anywhere between 1 and 10 times since March of last year.

With more cheap dollars available, and for a longer time, stock prices in emerging markets like India can rise even further. But the house could well come crashing down the day the supply stops!

So, what should investors do?

Is it the right time for you to enter the markets? Well, the answer lies in valuations. As we stand now, the overall valuations of the Indian markets are at high levels. And this makes the markets vulnerable to a correction.

Anyways, the answer to this uncertainty does not lie in selling all stocks and sitting on cash. The answer lies in the strictness with which you select stocks. Investing is a continuous process and like you need to be prepared for a bull run, you also need to be prepared for a correction (and not fear it). Having safe and sound companies in your portfolio, which you believe will do well in the long term, is the way to go. As far as new investments are concerned, if you are able to identify good companies trading at reasonable valuations, you can still invest in them from a long term perspective. Any compromise on quality (of companies) or investment horizon can lead you to despair.

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1 Responses to "Is a correction due?"

venkatesh prabhu

Aug 23, 2010

The prices of certain stocks only getting to higher levels and that too not sustained it is getting unpredictable whether the is imminent or rather it will take some more time.

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