With the wild swings of the stock markets, the direction of the market and what happens next are some questions that are baffling investors.
The election results have not taken only the National Democratic Alliance by surprise. Every investor in stocks and mutual funds was almost as certain that the market would only go up, just the same way as the NDA thought it would form the government. The result: big declines last week, specifically on Friday and Monday.
The market took another direction altogether on Tuesday and Wednesday. Between the close of May 7 and the low on May 17, the Sensex had shed 1442 points or 25 per cent. Of course, besides the political uncertainty, there was an across the board sell-off in other emerging markets that added fuel to the fire in India as some FIIs took the safe way out. But as investors sobered to the reality of cheap valuations and the not-so-bad political situation, the market came back 779 points to close at 5006 points on Wednesday.
An absolute see-saw! The political uncertainty has not gone away. The Common Minimum Programme for the new government will be announced within the next few days. But we will only know the government's political will over the course of time. In such a scenario what should investors do? Let us look at the best and the worst scenarios for investors.
Best case scenario
In this scenario, the new government would manage to carry out reforms with vigour and complete its term. After all, even the outgoing government followed Dr Manmohan Singh's broad path for reforms. But with the political compulsions facing the government at centre, this scenario is difficult to visualise. If you believe in this, then you should look for dips and crashes in the market as buying opportunities.
Worst case scenario
In the worst case, you can believe that there will be chronic instability at the centre and the infighting between different sections of the government will paralyse the decision-making process. FIIs will pull out and the markets will sink. In such a case, you are better off getting out now, with whatever you can salvage.
The middle path
In this scenario, the government will continue to go along with small scale reforms and some populist measures. There could be some positive surprises along the way. But in general, the proportion of reforms and the populist measures will create many different possibilities, which will keep changing over time. The economy continues to grow and this year's monsoons are also bountiful. Commodity and cyclical companies continue to do well as PSUs recede from the limelight. Returns from the market will depend on individual stock-picking rather than a broad-based rally in equities.
Undoubtedly all these scenarios call for investment action, specific to the situation. But the problem is that one cannot know which set of circumstances will play out. But that is the same uncertainty that our daily life is made of.
Equities: The best investment avenue
In the midst of all this volatility, it is important to remember that over the long-term growth in equity prices follow earnings growth. So, as long as the fundamentals of the economy remain unchanged, the economic growth story should continue to translate into inflation beating returns from equities. Value Research analysed the Sensex returns from 1979 till date and found that for a one-year period, the best returns from stocks (the Sensex) are an astounding 266.68 per cent. In the worst-case scenario, returns have fallen by 46.78 per cent. If, however, for the long-term, the best five-year annualised returns are 53.04 per cent while the worst 5-year annualised loss is restricted to 6.78 per cent. Over 15 years, the worst one could have done was to achieve annualised returns of 10.99 per cent.
The Way Ahead
The probability of the best case scenario with reforms galore is low. So, is the worst case scenario of there being no decision making as the new government will try to strengthen its position for the future. What we are left with is the middle path, where there will be many shades of grey.
The most important question is where will the markets go? It is likely that because the government will follow a mixed approach of some reforms and some populist measures, there could be some adverse effect on the corporate sector.
But remember that the Indian economy is doing well, the corporate sector has restructured and there is increased demand for goods and products. If the consumption of goods and services continues, investors in equities will do well over a period of time. Investing is about having discipline and being at it over long periods of time. It is about not panicking in bear markets and not going overboard in bull markets. There is a possibility that the market will not go anywhere for the next two-three years. But in the long run, only equities deliver.
You need to have clarity on your investment horizon and asset allocation. In your equity allocation, the best strategy is to stay invested in the four-star and five-star funds that have long-term track record and have the experience of all kinds of markets. Investing regularly in a disciplined manner is the only way out for most investors.
This article was originally published on May 20, 2004.
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