What is happening to the markets - and what can we expect?

Well, interestingly, the equity markets just refuse to go up. Just about an year back, there could be nothing wrong with the markets. Now, there seems to be just nothing right. So what is the deal here? And what has changed on the macro front, that has caused this kind of a correction?

The answer to this question lies in the history of world markets as we have seen them, if we choose to look at them again. Time and again, there have been great stories about markets, such as this is the place to be in and this is the time to invest, only to realize that such euphoria lasts only about 2-4 years, and then we witness history all over again. Be it the scams of 1992, the dotcom bubble in 2000 and the credit boom now, we keep seeing these cycles, only to say that this time it is different than the last one. Alas, it isn't so...

The key issues right now are two - one the credit crisis slowing the US economy appreciably and hence affecting the world economy, and the second is a definite slowdown in India as borrowing costs surge and demand slows down. Both are impacting India's growth story, and hence the valuations of the markets. Is the story over - by no means. We are still one of the few countries in the world growing at more than 7%, and structurally we are in a phase of the economy growth that will last more than just a few years. The momentum of this growth is not going to slow appreciably, and the story is definitely going to last through 2015. But that does not mean there will be no hinderances in the way - or that the growth cannot slow down for a couple of years before resuming. This could happen due to various factors, some domestic such as elections and populists measure, and some international such as the credit crisis in the US. Also remember that long term returns from equity markets are typically in the region of 12-20%, depending on various stages the economy is in. The last 4 years witnessed an unprecedented bull run in India, and the returns were much higher than these long term averages. Markets are just mean reverting, and what is happening now is that the returns are moving towards the mean. If we stay around 15000 levels on the Sensex for a couple of years, we would have largely reverted to the mean return of 15-20% per annum. And most likely, it is going to happen.

So in the near term, expect more downside, and volatility. Most markets bottom when the underlying story regarding the markets starts getting questioned. From the look of things, i still do not think many people question the underlying story of India. The next 2 quarters will reveal that corporate growth is slowing down, and earnings are under stress. That is when the India story will get questioned - and that is when markets will bottom in my opinion. Such savage corrections where stocks are hammered 80% from their peak prices are not succeeded by V shaped recoveries, but by slow sideway movements of markets which are long enough to make investors question their beliefs. Otherwise - it was becoming all too easy a game, which I am afraid, it is not.

And to cap the story - an interesting observation. Most analysts around us say that to make money in the market, we need to stay invested for the longer term (please note that none of them define the term 'longer term', and the definition varies from 1 year to 10 years depending on what is the case the analyst is presenting ). While on average if you are diversified, this would hold in economies like India (stress on 'India', since developed economies could faceother pressures, which may impact these returns), there is an important pre-requisite for the above statement to hold for individual stocks and even sectors. You should not have invested at the peak. An example is Unitech. The following charts show its move from 2005 to 2008 beginning, and then from 2008 January till date. And yes, you are right - it moved from Rs 2 to make a high of Rs 550 in 2008, and is now at Rs 110!! If someone bought it in January 2008, he can be rest assured that he needs to be invested for the long term to get positive returns on this. And this 'long term' my friends - will be really long. The real estate story is now being questioned in India, and probably these stocks will bottom out valuewise in the next 3-6 months. The same needs to happen with the markets. Does that sound bearish - it surely does, but this is good for the markets. The earlier it happens, the better it is. These next few months will throw up immense opprtunities for the 5 year investor in India, but he needs to sit through the near term pain that the markets may witness.