This year has been volatile for investors so far. Nifty 50 is up four per cent in 2018 while mid-cap and small-cap indices are still down by 12.3 per cent and 14.6 per cent, respectively, in 2018. However, in the last one year, Nifty 50 is up by 12 per cent while mid-cap and small-cap indices are five per cent and four per cent, respectively.

The market was under pressure due to rising crude oil prices, weakening Indian rupee against the US dollar, rising inflation, fear of subsequent interest rate hikes by the Reserve Bank of India (RBI), US Fed rate hikes, and especially the fear of a trade war, which has dampened market sentiments more than anything else.

One of the main reasons for the massive carnage in mid-cap and small-cap stocks can be attributed to a slew reforms announced by SEBI.

Two SEBI rules that have affected trading are:

Guidelines on Mutual Funds Re-categorisation and Rationalisation

Additional Surveillance Measures (which restricted share price movements and imposed higher margins on purchases)

Due to these restrictive rules, we have witnessed a massive sell-off in mid-cap stocks.  Negative returns were reported by 1,179 stocks in past six months. Mutual funds have sold `10,000 crore in mid-cap and small-cap stocks to meet the new requirements in equity mutual funds from December 2017.

In addition, India’s current account deficit (CAD) widened to $13 billion in Q4FY18, up from $2.6 billion in Q4FY17 due to a higher trade deficit of $41.6 billion. The trade deficit widened due to an increase in imports of electronics, especially mobile phones, and crude oil. Normally, a $10/barrel rise in crude oil price can increase WPI inflation by 1.7 per cent, widen CAD by $9-10 billion, and reduce economic growth by 0.2-0.3 per cent. We expect rising crude prices will further widen the CAD and weaken the Indian rupee. However, such currency depreciation may provide tailwinds for export growth, which have been a big drag on economic growth in the past few years. 

The CPI inflation spiked to 5 per cent in June 2018 with the RBI raising repo rate and reverse repo rate by 25 bps to 6.25 per cent and 6.00 per cent, respectively. The central bank also increased the CPI inflation (including HRA) forecast to 4.8-4.9 per cent in H1FY19 and 4.7 per cent in H2FY19. In a meeting this month, RBI will take cognizance of the rising inflation and may further increase policy rates by 25 bps.

We believe that investors are cautious of  three state and general elections results but, historically, the Indian equity market goes up, irrespective of the party in power.

Currently, the market is trading at an 8 per cent premium to its 10-year average P/E ratio. However, recovery in consumer demand and increasing capacity utilisation rates are favourable tailwinds for corporate earnings growth. We are expecting Nifty’s FY19 earnings to grow at 20 per cent after many years of single-digit growth. This is due to decline in provisioning in banks, improvement in profitability of metal stocks due to global commodity price rise, a third consecutive good monsoon, and a weaker Indian rupee to support the export sector and IT sector.

We advise investors to stay invested for the long term in stocks whose growth story is still intact. Investors can increase their allocation in equities in a systematic manner by investing every month to take benefit from this correction.

The author is Head of Research, IIFL Securities Ltd.