Indian Equity Market Has Corrected! How to Approach Mutual Funds Now

Let's begin by understanding the reasons behind the correction before exploring the likely headwinds and actionable strategies for investing in equity mutual funds during such times.

4 Factors That Led to Market Correction

The downturn, which marked the sharpest decline since March 2023, can be attributed to several interlinked factors, including:

1. Global Uncertainty

   Concerns over the depreciating Indian Rupee (INR) and a rising U.S. Dollar (USD) index, coupled with foreign investors pulling out of the domestic market and shifting to other emerging markets, such as China due to more attractive valuations, dampened investor sentiment.

   The other factor was the looming geopolitical tension, such as the ongoing Russia-Ukraine conflict, tensions in the Middle East, and the uncertainty surrounding the re-election of Donald Trump as the 47th President of the United States.

2. Subdued Corporate Earnings

   Nearly half of the Nifty 50 companies reported net profits below the analysts' expectations in the September quarter, particularly in key sectors.

   A Business Standard report cites that earnings growth has been uneven with several sectors such as metals, oil & gas, power, auto, and FMCG facing a slowdown. Only the Banking & Financial Services (BFSI) sector and certain companies in the construction and infrastructure space are driving earnings.

   The subdued corporate earnings owing to the slowdown in consumption due to elevated inflation, is weighing on market sentiments and investors are turning cautious and more selective in their investment choices.

3. Decline in GDP Growth

   India's GDP growth slowed to 5.4% in the July-September quarter of FY25, marking the lowest pace in seven quarters. This slowdown was influenced by several factors such as the subdued performance of manufacturing and the contraction reported by mining & quarrying - which are the secondary sectors.

   Private Final Consumption (which accounts for nearly 60% of GDP) also slowed perhaps due to higher borrowing costs and stagnation of real wages. In other words, inflationary pressures also weighed on the GDP growth.

   This underperformance raised concerns about the sustainability of the economic recovery, which likely contributed to the weakening of market sentiment. This is because weakness in GDP growth is also expected to show up in corporate earnings.

4. Lofty Valuations

   Prior to the correction, Indian equities looked frothy in terms of valuations. After the correction since the peak, some froth has settled down, showing the Price-to-Equity (P/E) and Price-to-Book Value (P/B) of the Nifty 50 and the BSE Sensex.

   However, valuations for certain segments, particularly mid and small-cap stocks, still look stretched, leading to concerns about sustainability and prompting profit-booking among investors.

   Table: Valuation Snapshot of Nifty 50 & BSE Sensex

   Index	Current P/E Ratio	Historical Average P/E Ratio (5 Years)	Current P/B Ratio	Historical Average P/B Ratio (5 Years)
   Nifty 50	22.4	25.1	3.6	3.94
   BSE Sensex	22.9	25.97	4.1	3.28

   Data as of December 2, 2024
   Note: Valuation metrics are subject to change based on market dynamics.
   (Source: www.trendlyne.com)

   While the correction has resulted in uncertainty for investors, it has helped temper the inflated market valuations to some extent. Currently, valuations of the bellwether indices are closer to their historical averages, potentially offering more reasonable entry points for investors.

What Are the Likely Headwinds for the Indian Equity Market Moving Forward?

While both the Nifty and Sensex are showing signs of rebound after the correction of over 10%, the following headwinds could still pose obstacles for the bulls:

1. FPI Selling

   FPI selling in the Indian equities may continue as Indian equity continues to command a premium compared to their global peers. In such times, FPIs may continue to reallocate to equity markets that seem attractively placed on valuations and offer more attractive wealth creation opportunities.

   Following Beijing's recent economic stimulus measures, FPIs could get attracted to China. The depreciating INR further may nudge FPIs in this direction, making Indian investments less appealing due to potential currency losses.

2. Rising Crude Oil Prices

   India is a major importer of crude oil, with over 85% of its oil needs met through imports. Elevated oil prices and depreciating INR are adding pressure to India's oil import bill.

   The government, as you may know, recently hiked jet fuel and LPG prices amid a hike in global oil prices. This may keep inflation elevated and delay the anticipated rate cuts from the Reserve Bank of India (RBI), further impacting rate-sensitive sectors.

3. Uncertainty Rising from Trump's Victory

   The return of Donald Trump as the 47th President of the United States inflicts uncertainties with respect to global trade and foreign policies. Trump's America-centric policies and trade tensions with China or other countries could disrupt supply chains.

   Further, changes in US tax policies or immigration laws may impact Indian technology and export-oriented sectors.

4. Geopolitical Tensions

   The effects of the ongoing military conflict between Russia and Ukraine, as well as between Israel and Iran-backed terror groups in the Middle East, is a cause of worry for the global market. It could disrupt supply chains and lead to volatility in oil and gas prices, keeping global markets cautious.

Should You Go for a Lump Sum Investment or SIP?

As you may know, wealth creation through equities is never linear; it consists of up and downswings. In other words, volatility is the very nature of the equity market.

But if you follow an astute and disciplined approach, it is possible to compound your hard-earned money with equity investments and yield respectable returns over the long term.

Given that, at the current juncture not ruling out the challenges ahead and intermittent volatility, to make fresh investments, staggered lump sum investments are better instead of going gung-ho and investing all your investible surplus at once.

A staggered lump sum can be considered by those with surplus cash, especially when the equity market dips, offering attractive entry points.

For most investors, Systematic Investment Plans (SIPs) remain the best way to approach volatile markets, particularly when you are addressing long-term financial goals. Regular systematic investments ensure disciplined buying, averaging out costs, reducing the impact of short-term market fluctuations, and facilitate compound money over the long term.

Alternatively, you could use the Systematic Transfer Plan (STP) facility, wherein you deploy the investible surplus first in a lump sum in a liquid fund and then systematically transfer systematically to one of the best equity funds, which can help mitigate the risk of timing the market.

Ultimately, the choice between lump sum and SIP depends on the market outlook, the financial goals you are addressing, and the time in hand to achieve those goals.

Strategies to Follow Now When Investing in Equity Mutual Funds

Here's what is recommended to optimise returns while managing risks:

1. Asset Allocation

   Asset allocation is the cornerstone of investing. It is parking money across different asset classes -- mainly equity, debt, and gold -- whereby you diversify your portfolio and minimise the impact of significant market downturns.

   Your asset allocation should be as per your age bracket, personal risk appetite, the broader investment objective, financial goals, and investment time horizon to achieve those goals. There is no one-size-fits-all approach to asset allocation and building a portfolio.

   When investing in equities, it would be wise to follow a 'Core & Satellite' approach -- a strategy followed by some of the most successful equity investors around the world.

   The term 'Core' refers to the portfolio's more stable, long-term equity holdings. Given that, your core portfolio of the equity mutual fund portfolio should mainly comprise some of the best Large Cap Funds, Flexi-cap Funds/Multi-cap Funds, and Value/Contra Funds that can add stability to the investment portfolio and potentially steadily multiply your wealth by keeping an investment horizon of around 5 years.

   The 'Satellite' portion of the portfolio, on the other hand, may include a couple of best Mid-cap Funds (max 2) and an Aggressive Hybrid Fund. When considering these funds, keep an investment time horizon of around 7 to 8 years. These funds would support boosting the portfolio's overall returns given their risk-return characteristics.

   At this juncture, avoid adding Small Cap Funds and Sector/Thematic Funds to the satellite portfolio, unless you are a very, very aggressive investor with a stomach for very high risk, a time horizon of over 8 years, and have a good understanding of these funds.

   Such a 'Core & Satellite' investment strategy with prudent allocation shall prove sensible when deploying money into equity funds.

2. Rebalance Your Portfolio

   After having built your portfolio following the core & satellite approach, ensure that you are paying attention to timely rebalancing it to maintain the desired mix of equity, debt, and gold to achieve long-term goals because market ups and downs could shift the portfolio allocation.

   With thoughtful rebalancing and an annual portfolio review (to ensure that the mutual fund schemes in your portfolio are performing well), potentially you will be able to create wealth and accomplish the envisioned financial goals.

To Sum-up

Market corrections and headwinds are an inherent part of equity investing. That said, they also provide an opportunity to reevaluate and refine your financial strategy.

By staying committed to your long-term goals, focusing on diversification, devising a sensible investment strategy, and following financial discipline, you can handle periods of volatility with a greater sense of clarity and direction.

It is important not to let short-term market volatility faze your long-term goals, particularly those with a 5+ year horizon, as short-term fluctuations tend to have minimal impact on long-term returns.

Note, that a sensible approach paves the path to wealth creation.

Happy Investing!

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Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.