Prepare for volatility

The market has turned very choppy recently. As I write this, the Nifty is up only by 1.44 percent for the year till date and the Nifty Mid-cap and Nifty Small-cap indexes are down sharply with cuts of 17.16 percent and 31.30 percent respectively for the year till date. This correction in the market has been caused by a whole host of factors like rising bond yield in the US, which in turn, had triggered big FII selling, sharp spike in crude, worsening CAD, rupee depreciation, liquidity issues and fears of systemic risk stemming from the ILFS crisis. Going forward, the political environment is likely to keep the market very volatile.

In a volatile market, headwinds and tailwinds blow alternately. Favorable and unfavorable factors emerge and disappear quickly and surprisingly. We saw that in the behaviour of crude price in October and November. Brent crude above $80 a barrel was a strong headwind for the economy and the market in October; but the crash in crude in November has turned out to be a strong tailwind now. Crude is no longer a commodity alone; it is a financial asset in which investment and trade happens on a huge scale. That’s why crude surges and crashes (crude crashed by 7 percent in a single day on 13^th May) with surprising speed.

Apart from crude, another tailwind supporting the market is the robust inflows into mutual funds. In October mutual fund inflows were robust at around Rs 35529 crores. The sustained inflow into equity funds, even during times of negative sentiments, is a very healthy trend that reflects the maturity of the Indian investor. The dip in US 10-year yield to 3.11 percent currently from the recent high of 3.26 percent is another tailwind for the market since this, along with INR appreciation from 74.30 levels to around 72 levels (as I write), has stopped FII selling which was unnerving the markets. FIIs have again turned buyers recently.

We expect the market to remain choppy for the next several months. Political uncertainty is likely to be the most important factor influencing the markets. The outcome of the ongoing state elections and the run up to the union elections will weigh heavily on investor sentiments till clarity emerges on the outcome of the general elections.

Headwinds from political uncertainty and tailwinds from crude and improving micros are likely to set the market on a roller coaster ride. The dips in this ride would be great opportunities to invest. A bottom-up approach to accumulate good quality stocks would be the ideal investment strategy in these volatile times. Risk-averse investors should stick to large-caps. Investors with higher risk appetite can pick good quality mid-caps beaten down in the recent carnage in this segment. Retail investors, particularly first-time investors who started investing say, 12 to 18 months back, are a bit unnerved by the negative returns on their investments.  They should keep their cool. Negative returns would turn to very good positive returns when the tide inevitably turns. Continue with SIPs and, if possible, scale up SIPs.