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Investors should be ready for high volatility in short term

Compared to the first three weeks of February, when the Sensex crashed by 2,261 points, the stock market was relatively stable in the last week. Some technical factors played an important role in providing short-term stability to the market. For instance, the Sensex bounced back from its 100- day moving average.

Does it mean that the period of high volatility is over and the market will continue its upward journey? Investors should not jump to such conclusions, say experts. While the Sensex crossed the 100-day moving average, it is still struggling to cross the immediate resistance-50-day moving average. There is more."Since all the factors that induced the recent volatility are still present, volatility will continue in the short term (3-6 months). However, there is nothing to worry over the long-term (3-5 years). Investors should use these dips as a good buying opportunity,"says G. Pradeep Kumar, CEO, Union KBC Mutual Fund.

So what are the factors that led to market volatility? First, the imposition of long-term capital gains tax on equities dampened the stock market sentiment. While the existing investors will not be impacted much by this due to the grandfathering of gains up to 31 January 2018, new inflows into equities will get impacted.

Continued spike in the US interest rates was among the key factors behind the sudden bout of market volatility across the globe. Markets began stabilising only after the US 10-year bond yield started moving away from the dreaded 3 % mark-but the yield is still close to a 5-year high. Several hedge funds also initiated carry trades-borrowing in the US dollar and investing in other markets-at close to 3 % levels, and some of these carry trades will get reversed iftheUS 10-year yield goes above this crucial3% mark. Since the trend show rise in yields, experts say that the 3% breach will happen in the near future.

"US Federal Reserve has made its intention clear (it will keep on increasing rates in 2018), so the US 10- year yield can go to3.5% in six months' time,"says Kumar. The only positive here is that since the market is already expecting this, part of it might have already been priced in. High domestic stock market valuation was another reason for the increased volatility. For instance, the broader market valuations were in the highly overvalued zone during the recent peak.

Despite the correction, Sensex PE is still at 23.95, close to the higher end of the slightly overvalued zone of20-24."In the past year, everyone was justifying high stock market valuation due to low interest rates. With the change in the interest rate outlook, that support is shaky now,"says Vetri Subramaniam, Group President and Head. Equity, UTI Mutual Fund.

"Since the market is still quite expensive, it will remain volatile with a downward bias in 2018 and one should wait before buying," says Suhas Harinarayanan, Head of Research, JM Financial.

Increased earnings growth is the only saving grace for the market among the host of negative factors. "Private companies and domestic-oriented companies have done well in last quarter and a similar trend is expected in the coming quarters as well," says Amar Ambani, Head, Research, IIFL. Though the overall earnings growth has been muted because of specific sectoral woes-pharma due to issues related to US regulations and PSU banks due to NPA worries.

"The temporary setback due to demonetisation and GST implementation is over and the situation is back to normal now. Earnings will continue to improve in the next few quarters due to the positive aspect of GST," says Kumar. While sectors like pharma and PSU banks will continue to be a drag, sectors related to infra-roads, ports, airports, railways, etc.-should continue to do well. Due to the recent surge in global commodity prices, commodity companies are also expected to report good numbers in the future." 

Though earnings growth may pick up in the coming quarters, it may not translate into rise in stock prices, mainly because of muted sentiments due to the weakening domestic macro situation."While the micro (corporate results) is improving, the macro (fiscal deficit, trade deficit, interest rate outlook, etc.) has started deteriorating. The NPA situation is also expected to remain under the cloud for the next two quarters," says Harinarayanan. Also, the market has been running ahead of earnings for the past few years limiting the scope of a further upside."Most of the market returns in the past five year gave been on account of PE expansion (due to the expected revival in earnings). So, while earnings growth will continue, it may not get fully reflected in share prices and the valuation may continue to compress from current levels," says Subramaniam. 


Read the original article:

The Economic Times