When it looks impossible, it happens. For any investor it is very difficult to accurately predict where the markets are headed. Although markets might give you a hint that they are distressed or walking on the air; they are moody indeed.

At the beginning of the year 2015; nobody would have even imagined that markets may fall substantially in the second half of the year. S&P BSE Sensex has slipped below 25,000-mark; an important psychological level, if you ignore the bounce back that happened over last two days. While Sensex is down more than 13% from the life time high, as many as 100 stocks listed on BSE have fallen more than 50% from their 52-week highs. It has been observed that, when markets give up gains and keep falling, investors start losing faith and exit.

Heavy selling by Foreign Institutional Investors

(Data as on September 08, 2015)
(Source: ACE MF, PersonalFN Research)

Are markets on the verge of entering a bear phase?

The current bull phase has lasted for about 37 months and is still in progress, although now there is a possibility of it coming to an end, if markets fall further. We must try to analyse why markets are falling, what investors are so worried about and finally trying to understand what possibly may happen, going forward.

Global factors that are driving markets down

China Crisis: Impact of China slowdown on global markets is also dragging Indian markets. Devaluation of Yuan and subsequent appreciation of U.S. Dollar has sent Indian Rupee to new 2-year low. China crisis accentuated the sell-off in global markets.

Possibility of a rate hike by Federal Reserve: This has been the elephant in the room. The August non-farm payroll data suggests that, unemployment rate in the U.S. has fallen to 5.1%. This makes many investors believe that, Fed is likely to hike policy rates in 2-day long meeting scheduled mid-September. Rate hike by Fed may make dollar stronger and a basket of major currencies weaker. This may signal the end of dollar carry trade that started soon after U.S. Fed announced its first stimulus about 7 years ago. On the other hand, monetary policies in other regions are expected to be loose. European Central Bank (ECB) is pledged to announcing further stimulus, if needed. Situation in Japan is unlikely to change much. This might result in further strengthening of USD. Strong USD will unwind dollar-carry trade draining the liquidity from other asset classes such as emerging market equities.

Double-blow to mining oriented economies: Countries such as Australia, Russia, Brazil and Middle-East Asian Countries exporting crude oil remain vulnerable to a slowdown considering gravity of problems in China and possibility of U.S. Fed hiking rates mid-September. Let's not forget, ultra-loose monetary policies in the U.S. and relatively strong China combined together had supported commodity prices for long. If mining oriented exporting nations fail to cope with changing economic situation, the slowdown may become a global phenomenon and deepening of recession can't also be ruled out.

Now we must also see where India stands in this context

Slower than anticipated recovery: GDP numbers for Q1, FY 2015-16 show that, growth in Private Final Consumption Expenditure (PFCE) has been 7.4% while that in Government Final Consumption Expenditure (GFCE) has been only 1.1%. Gross Fixed Capital Formation (GFCF) has witnessed lacklustre growth of 4.8%. Exports have come about 6.4% lower on Y-o-Y basis. Deposit growth and credit growth aggregated at 11.4% and 9.3% for the quarter ended on June 30, 2015. This suggests that, demand for credit at prevailing interest rates is low. During the first quarter of last fiscal credit growth had aggregated at 13.3%. This shows that Indian economy is recovering at snail's pace.

Economic activities may remain soft going forward: Survey done by FICCI reveals that, just about 25% of the manufacturers have planned to expand their capacities in next 6 months. This suggests that, most of the manufacturers expect demand to remain soft and thus are worried about investing in capacity additions at this point of time.

Mixed Economic Indicators: Although retail inflation stayed lower than targeted for the most part of last 1 year, upside risks persist. So far, monsoon has been 14% lower than long period averages. Moreover, distribution of monsoon has been unequal and rainfall has been erratic which makes it tough to keep food inflation low. Growth in corporate profits in Q1, FY 2015-16 was largely driven by the falling commodity prices, but in the wake of poor rural demand and weaker monsoon, only soft commodity prices may not help record profit growth here onwards. Demand recovery looks unlikely in near future.

India's response to global slowdown

India will be affected by what happens in China. Monetary policy stance of Fed in the U.S. will also affect India. To discuss issues at hand, Prime Minister recently met industry leaders and heard them out. He appealed industry chiefs to take more risks and rev up investments in new projects and capacity additions. Confederation of Indian Industry (CII), Associated Chambers of Commerce & Industry of India (Assocham) and Federation of Indian Chambers of Commerce and Industry (FICCI) made various recommendations to the Government which include; shielding Indian industry from dumping of Chinese goods by making adjustments in anti-dumping duties, speeding up project clearances, incentivising equity investments in India and monetary easing among others.

PersonalFN believes, as we stand at crossroads where we are not sure whether the bull-run will continue or markets will slip into a bear phase. PersonalFN is of the view that this is the time when you should keep calm and keep investing. S&P BSE Sensex has bounced back sharply from its 15-month low.

Where are markets headed?

A rate hike by Fed has already been factored in therefore it is uncertain guidance of the Fed that is keeping markets edgy at the moment. If Fed gives softer guidance on interest rates, markets may not fall much even after considering that it announces a smaller rate hike in its September meeting. Apart from economic recovery in the U.S., devaluation of Chinese currency would also affect the decision of the Fed with regard to interest rates.

Strategy to tackle volatile market conditions

Get rid of weaker stocks and mutual funds: when markets are going down, you should exit weaker stocks and mutual funds during pull back rallies. As PersonalFN always believes, you should never try to time the market but when market conditions look tough, you should be ultra-careful about quality of your holdings. Weaker stocks and mutual funds perform poorly in bear phases. You may avoid them and replace with fundamentally strong stocks and mutual funds. If you are not sure, which stocks to invest in, you should rely on professionally managed equity diversified mutual funds.

Re-balance asset allocation: Suppose, you invest 60% of your savings in stocks, 30% in fixed income instruments and 10% gold; it is likely that, proportion of equity holdings may fall with falling markets. Nonetheless, you shouldn't get worried about the fall and instead try to rebalance the portfolio. In other words, it means, if bears pull the worth of your portfolio down, try to restore it by putting more money or by readjusting the asset mix.

As Baron Rothschild says, "the time to buy is when there's blood in the streets." PersonalFN feels you shouldn't be afraid of buying quality stocks and mutual funds when markets fall but bear in mind, speculation in any form is hazardous. Following market momentum may affect the quality of your portfolio negatively. Chalk out an asset allocation plan considering your goals and risk appetite, and follow it meticulously, irrespective of where markets go.

PersonalFN offers unbiased mutual fund portfolio review services which may help you get rid of weaker funds and invest in fundamentally strong funds.

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