The last few weeks have been very volatile for the equity market globally. Indian equity market which has performed better than most global markets has suffered as well. There are multiple reasons for this. Expensive valuation, inflation and hence rising interest rates are the main reason behind this latest bout of decline. Since March 2020, NIFTY has gone up from sub 8000 levels to 18000+ level. After such a strong performance, it is natural for the market to correct and consolidate.
One good thing in all this has been that Indian equity market has shown remarkable resilience in this global equity market correction. This is clear when we see how much the Indian market has fallen from its all-time peak. After UK equity market, India has fallen the least. NIFTY has fallen 12.5% from its all-time high. This is despite massive outflows from foreign investors.
Despite, the double-digit correction, challenges remain
While the stock market has corrected and market definitely offers better value at 16000, one should not expect a very quick recovery. I feel that rising interest rates amid high inflation will weigh on the market for some time. Hence, we could see a period when market will struggle to go up in a hurry. Further, we could potentially see market falling a bit more in the near-term.
It is a good time to invest more in equity market
When is a good time to invest has always be an interesting question? The behavioral pattern of investing suggests that most people are willing to invest more when markets are rising and the general consensus is very positive on the market. However, things change when market starts falling. People stop their SIPs, redeem their investments. In essence, they do the opposite of what they should be actually doing.
Returns from stock markets are mean-reverting. This means that if the market has delivered more return recently, it will deliver less return in future. When we look at the trailing return of NIFTY, the long-term trailing return (5 year to 10 year) is in line with long-term average return. The short-term trailing return is below long-term average returns. Very simplistically, it means that we should expect average return over the long-term from current levels and this average return has been in the range of 12% to 14%.
The decision to invest more in equity also depends on return potential of alternative assets available. It will be reasonable to expect double-digit annual return from equities over the medium to long-term. On the other hand, annualized returns from fixed deposit or debt mutual fund will most likely be in 5% to 7% range over the next 3-5 years. After tax, returns from fixed deposit or debt mutual funds are almost certain to be well below the inflation. Hence, it is almost a no-brainer to deploy more long-term money into equities. However, one should keep in mind that we should invest only that portion of savings in equity which they can remain invested for at least 5 years or more.
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