Stocks sank in a global sell-off. Markets stabilized towards the end of last week, but the damage has been done as investors lost crores of market wealth. The Sensex, having lost 1630 points, now stands below the critical psychological levels of 23,000.
So, is the pain over? Where is the bottom? How will mid-caps fare?
Stimulus measures and negative interest rates might drive the market higher in the coming few weeks, but chances are that a relief rally could be short-lived. Lower oil prices are the culprit. Global demand could shrink, particularly as oil producing countries curb buying. As a result, production and economic growth of the world and Indian economy could taper off.
PE levels, historically, hovered around the 12-13 mark between 2009 and 14. If one extrapolates the downside on current earnings at a discount rate of 12 times earnings, the Sensex could shrink to 18150 levels, a fall of 22 per cent.
The worst case scenario being built into valuation models is that Indian markets could see 15,000 on the Sensex, a 33 per cent drop. At 15,000, the PE ratio dips to below 10, a level that was hit during the worst phases of the Lehman crisis – October 2008-March 2009.
Past corrections during a global sell-off have seen markets tumble by 40 percent on average. By this yardstick, the Indian markets are not yet done with the correction and we are somewhere in the middle (correction from March 5 2015, high is 23 per cent), if this corrective phase lasts.
The big question, how to deal with this crisis? Avoid going overboard for now. Let the tide settle. Existing investors will have to see that they clean up their portfolios of dud stocks, in the mid-caps space.
One has to wait for signs sovereign wealth funds to stop selling. Most of these funds are backed by oil producing countries that are likely to see their government revenues slammed due to lower oil price, hence their selling might not tapper-off soon.
But there are bright spots in the world economy. The US economy is at low levels of unemployment. India has a low current account deficit with GDP clocking 7.3 per cent.
On the wrong side, steel companies lost considerable wealth the last quarter on lower profit. They could take 24 months to post a recovery following the rout in commodity prices. Banks are reporting lower profit and in some cases heavy losses due to stringent recognition of bad loans. Bank stocks have corrected nearly 50 percent, particularly some PSU banks.
In this environment, it will take while for stock prices to rise above the average PE levels of 15 times earnings. There could be a relief rally as speculators cover their positions. But this may be short-lived. Stock prices are expected to remain range bound with a downward bias.
So unless you are a very long-term investor, take an exit on low-quality stocks in your portfolio, particularly where stock prices have risen for no rhyme or reason. Mid- and small-caps are in for further trouble. Most of these stocks don’t have a revenue model, so jump out of these stocks. Dump them at the first signs of liquidity.
Large-cap valuations have dipped from above-average levels to normal levels, but have yet to go to inexpensive levels – i.e. about 12 times PE. In a downtrend, bellwether companies tend to get hammered, but in an uptrend they are the first to recover, so one can buy on the dips here, but be prepared to average your holdings at lower levels. But the classic mantra for now is to sell on rises till the clouds clear.
BW Reporters
Having addressed business, stock markets and personal finance for the last 18 years, Clifford Alvares has ridden the roller-coaster markets - up close and personal -successfully, traversing the downs and relishing the rises. The greater part of his journalistic ventures has gone into shaping articles about how to shape portfolios