Use Market Dips to Purchase Quality Stocks

Info_graph_005

The stock market has been excessively volatile in 2018, and it appears that this volatility is likely to continue. The global economy is in fine shape. In India, there are clear signs of cyclical recovery in both GDP and earnings growth. These augur well for markets in the medium to long-term. However, there are short-term headwinds, both globally and domestically, that can cause excessive volatility in the market. Investors should use these market dips to buy quality stocks and remain patient.

The Indian stock market has corrected by around 9 per cent from the 2018 peak. In spite of this correction, the market valuations are higher than historical averages. But this scenario is likely to change, going forward. Sharp recovery in GDP growth is pushing up the aggregate demand in the economy which, in turn, is improving capacity utilisation in the industry. The consequence of this turn-around is the improving operational leverage, which can lead to disproportionate increase in corporate profitability. FY 2019 earnings are likely to be in high teens, perhaps even better. Corporate profit to GDP ratio is presently at a trough of 4 per cent. This is set to rise steadily to reach the historical average of 6 per cent soon. Seven to 8 per cent GDP growth (nominal growth of above 12 per cent) and corporate profit to GDP steadily climbing to the historical average of 6 per cent can ensure sustained rise in earnings in the coming years. This will bring valuations down and leave room for market appreciation.

There are volatile days ahead for the market. Market corrections can be caused by the following headwinds:

CONCERNS OF A GLOBAL TRADE WAR

A trade war is destructive for everyone (trade war was a major contributing factor to the Great Depression of 1930s) and therefore, the general consensus is that it is unlikely. The recent decision of the Trump administration to impose import duty of 25 per cent on steel and 10 per cent on aluminum is widely regarded as posturing for better negotiation. However, this should not be dismissed lightly. Earlier, Trump scrapped the Trans-Pacific Partnership and forced renegotiation of NAFTA. Therefore, we cannot rule out more triggers by Trump targeting other countries, particularly China; and if others retaliate by increasing tariffs on imports from the US, an ugly trade war may erupt damaging global economic recovery and trade. This can have bad consequences for markets. As the IMF chief Christine Lagarde remarked, “trade war is not only destructive for everyone, but unwinnable also.” Let’s hope sanity will prevail.

POLITICAL HEADWINDS

The Indian political landscape has been changing rapidly and looks all set to spring surprises, which can have major impact on markets. The market has not discounted a non-NDA Government in 2019. The market sets high score for the PM. Till recently, a non-NDA Government in 2019 did not appear even as a remote possibility. Even now it is advantage NDA in the general elections scheduled for 2019, but it is no longer a certainty as it was a few months back. The recent UP election results indicate that a combined opposition would be a force to reckon with. This has serious implications for markets. Investors need to watch out for the political developments.

The market is presently caught in the cross currents of these headwinds and tailwinds. Investors should remain calm and use corrections as opportunities to buy quality stocks, preferably large caps and high quality midcaps, in installments. Continue with the SIPs. Patience will be rewarded.