What Are Time Corrections, And Why Do They Occur?
All asset classes go through ups and downs. Sometimes, prices run ahead of fundamentals in a collective euphoric rush; and at other times, waves of pessimism bear down heavily on asset prices, pushing them below even their intrinsic fair value.
The classical definition of a “correction” is - a sustained and heavy drop in price, usually between 10% and 20% of its previous high. Any fall in price exceeding 20% is called a “crash”. And any fall of less than 10% - well, that’s just part and parcel of how all risky asset classes fluctuate. While corrections are frustrating for long-only investors, they generally do not lead to irreparable damage. Crashes, on the other hand, can leave investors reeling for extended periods of time.
What is “Time Correction”?
More recently, economists and market pundits have coined the term “time correction”. Contrary to a price correction, which is expressed in terms of percentage points, a “time correction” is the name given to an extended period of quietude for an asset class, without a meaningful drop in its price. Take, for instance, the one-and-a-half-year period between March ’12 and August ’13, when the NIFTY essentially traded in a 200-point band between 5,200 and 5,400. Similarly, many pockets of real estate in the Delhi/ NCR region have undergone time corrections over the past two years, with prices moving neither higher nor lower.
Though not as damaging as price corrections, time corrections can prove to be quite damaging to investor wealth. More so, they can be frustrating for investors who are fence-sitting in anticipation of a deep cut in prices.
Why do they occur?
Time Corrections typically occur during periods when there are mixed signals coming in for a particular asset class. Take real estate, for instance. Falling interest rates and the RERA have buoyed investor sentiment to a degree, but the still massive build-up of unsold inventory still acts as a dampener in most urban areas.
Similarly, equity markets have been buoyed by the government’s recent efforts to pass the GST bill and improve ease of business. However, the short-term impact of the GST implementation still remains unclear. The paucity of earnings growth is raising concerns amongst investors as well.
With bulls and bears equally balanced in their numbers, and neither party willing to give up their stronghold, asset prices enter a stalemate situation and stagnate for extended time frames – leading to a time correction.
As time corrections lock prices into a narrow band, fundamentals sometimes catch up. This can lead to the sparking of a fresh rally in the said asset class. For instance, if the NIFTY were to continue trading in the 10,000 to 11,000 range, while earnings growth picked up, we may witness a breakout from this range.
The impact of leverage on time corrections
Leverage – the act of “borrowing to invest”, can prove particularly destructive during time corrections. Say, for instance, you take out an 8.75%, 20-year loan to purchase a flat worth 60 lakhs – with the intent of selling it off 5 years later. Assuming a down payment of Rs. 10 Lakhs and a loan amount of Rs. 50 Lakhs, you’ll have built up an equity of 15.79 Lakhs in the property, having paid approximately 35 Lakhs from your pocket (down payment plus loan EMI’s). If property prices in your region undergo a 5-year time correction during this period, you’ll end up making a loss of Rs. 20 Lakhs if you’re constrained to sell it to raise liquidity for the fulfillment of an important planned goal!
Advice to investors
One, don’t leverage to invest unless an asset class is in a deeply undervalued territory. Two, don’t fixate on price corrections and sit on the sidelines indefinitely waiting for an opportune time to ‘jump in’. Focus on fundamental valuation indicators, which may signal a ‘buy’ even in the absence of heavy dips in price.
