Markets have their own way of surprising investors, They fall when least expected to. They rise when we think the justification is limited. The idiosyncratic rhythm of the stock market is the only thing that is constant about it and investors need to understand how to use it to their advantage. Investors waited for the whole of 2010 for the elusive correction in the domestic stock markets. The correction that eluded investors in 2010 is coming to town suddenly in January 2011. Expectations of a recovery in the US economy, return of investor confidence in US markets and higher valuations in emerging markets are the reasons bandied around for the changed Indian market outlook. Inflation delivered the final blow and markets got the jitters leading to a sharp drop in valuations. FII’s turned persistent sellers in January 2011.
Investors who waited for all of 2010 to buy the dip are clamming up now with the sudden change in sentiment. Investors believe that rising inflation will erode corporate profits, raise finance costs as interest rates rise, lower consumption, and drag stock valuations down. The valuations do not always move exactly in sync with the actual changes in the business fundamentals. Mostly, the drop in valuations is overdone and investors shunning stocks leads to several good bargains getting thrown up. I believe that bargains will only increase in the days ahead.
Firstly, let us evaluate the concerns on inflation and rising interest rates. Inflation and interest rates follow cycles and do not reverse very quickly. Inflation results in rising interest rates. This impacts consumption and prices gradually retrace over a period of time. Interest rate movements follow the inflation data over an extended period of time. The markets tend to discount events ahead of time. While inflation is not showing signs of easing anytime soon, the markets may well change direction after discounting the negative impact quickly. The movements of the first week of January indicate that FII’s are selling and DII’s are buying. The indices and stock prices have been in free fall despite the selling and buying of FII’s and DII’s being evenly matched.
Investors must use the correction to buy selectively in businesses that are able to pass on the inflation effect or are impacted marginally by inflation. Sectors like telecoms, domestic services, FMCG and IT should throw up interesting opportunities and investors must selectively buy the dip. Intelligent buying into the correction will ensure that investors return significantly outperform in 2011 when inflation and interest rates recede in the latter part of the year.
written by Shyam Sekhar, ideator and founder, ithought.