5 Reasons The Sensex Fell 2,000 Points In 3-Days

Bond yields are rising

In the US the 10-year treasury yield hit 2.87 per cent, on fears that wage levels are rising, which might spark inflation and hence a rise in interest rates.

When bond yield rise, investors are likely to start moving away money from equity to debt. The simple logic is interest rates are going higher and equity valuations are stretched. So, instead of deploying more money at higher levels without capital protection, it makes sense to deploy money into debt with yields rising. What is assured is that at least your capital is protected and you earn something in returns.

Valuations at the moment are rich and the only way to make money in stocks is "buy low" and "sell high".

In India, the 10-year bond yield has jumped to 7.6 per cent from just about 6.7 per cent, eight months ago.

Impact of the US markets on global markets

The US Dow Jones plunged 1,175 points on Monday. This is not something that we see often. While many attribute the same to rising bond yields, the fact remains that there was so such excess built into stock prices around the globe, a sharp fall was waiting to happen.

For the last one year, global markets have only been rising. It has finally fallen and fallen with a vengeance. Even historically, leave alone India, even the US markets were overpriced.

If bonds yield keep rising, we may see a further slide in global stock prices.

Long Term Capital Gains may drive away FPIs

Foreign Portfolio Investors, who have led the rally in the last few years, may not find the market too attractive with the levy of LTCG. They are now likely to see 10 per cent of their profits vanish, which is why they could look at other markets. They sold shares heavily on Monday.

What was a little unfortunate was the fact the government did not do away with the Securities Transactions Tax. When LTCG was scrapped earlier, the Securities Transaction Tax was introduced. However, this time both are retained simultaneously.

Inflows into mutual funds may slow

Mutual Funds which led the rally and the Sensex to a historic peak, may see inflows slowdown or even reverse. The government has levied a tax on the distributed income of equity mutual funds in the Union Budget 2017-18. This means to pay a 10 per cent tax, they would lower your returns by a similar amount.

With no goodies for the middle class in the Union Budget, the disposable income is unlikely to go higher and hence the money into stocks is likely to reduce. Farm income may rise though, given the huge impetus to the farming sector in the Union Budget.

What should you do now?

Even at the current levels, the markets look vulnerable to a further downside. In fact, the Sensex continues to trade at a p/e of 24 times trailing EPS, which is rather expensive. Even if the Sensex companies earnings grow at 20 per cent in 2018-19, we will still have the multiples at hefty levels vs the long term average.

Probably at around 30,000 levels the markets would look inexpensive. So, staying in cash is not a bad idea at the moment.