Not LTCG, not US effect – it was simple market correction

The Indian stock markets were thoroughly roiled last week - dropping 2,000 points out of the blue. No one saw it coming. Though everyone was talking 'correction' and 'froth', no one could quite call the exact time. Or knew how much, and how long it would last.

Many say it was triggered by the Long-Term Capital Gains (LTCG) Tax and other new capital / tax related budgetary provisions, and worries on the fiscal deficit (and inflation prospects).

Others blamed it on the good "bad" news out of the USA, even as it reaches full employment, wage growth, firming inflation, positive interest rates and above average economic growth after a long time.

The world is not in any way in a tailspin nor headed for deflation like 2008 or the last correction in early 2016. Nor is it the end of the world in spite of the sharp blood-letting.  The world (the USA, the EU, China and India) in fact is very much in a sweet spot.

Stocks were being run up to soak up excess liquidity as a consequence of extensive QE and low interest rates over the last decade. As any high school student knows, cash needs a return, and will chase down any asset to stay ahead of a zero or negative return.  Scrips, especially in emerging markets, were always a good channel to soak up such sloshing liquidity (though the share of emerging market stocks rising is just 13 per cent, still well below decade high of 21 per cent in 2010).

Sure, the record run up of last year into mutual funds in India led to some froth, as prices went beyond earnings capacity by a fair margin. Correction was due and had to come back to the standard of 19-25 times earnings, rather than double that.

But in spite of the end of easy money, debt is becoming viable once again. The overall market sentiment is good and should see the ground being recovered. Economic growth and corporate earnings are keeping pace and showing good uptick in Q3 of FY18. Whilst household and institutional savings constantly look for steady non-zero return. Or minimise opportunity loss.

Just as a reference — the UK markets normally correct from peak to trough by 12 per cent every year over the last ten years. They have not had such a correction the whole of last year! Which means there was substantial pressure building up in that market too. which needed a release. So too other western markets like the USA — where the intra-year peak to trough is 14 per cent per annum.

Generally as a rule of thumb I find markets correct up to 20 per cent every two - three years, and a big correction of up to 33 per cent comes every 5 to 7 years.

In short the higher the market valuation, the larger the points drop, Indian markets being no exception.

Therefore corrections though not predictable are but inevitable, and are a normal part of the capital market cycle — each trough becoming the base for another new peak.

One can’t buck it.  So the sooner one gets one head around that the better becomes one’s investment strategy — patience, not fear being the guiding motive.

^{(The writer is a technology entrepreneur and commentator on public policy and financial technology.)}