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What Are “Time Corrections” In Asset Prices?
Sometimes, prices run ahead of fundamentals in a collective euphoric rush; and at other times, waves of pessimism bear down heavily on asset prices, pushing them below even their intrinsic fair value.
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All asset classes go through ups and downs. Sometimes, prices run ahead of fundamentals in a collective euphoric rush; and at other times, waves of pessimism bear down heavily on asset prices, pushing them below even their intrinsic fair value.
The classical definition of a “correction” is - a sustained and heavy drop in price, usually between 10% and 20% of its previous high. Any fall in price exceeding 20% is called a “crash”. And any fall of less than 10% - well, that’s just part and parcel of how all risky asset classes fluctuate. While corrections are frustrating for long-only investors, they generally do not lead to irreparable damage. Crashes, on the other hand, can leave investors reeling for extended periods of time.
What is “Time Correction”?
More recently, economists and market pundits have coined the term “time correction”. Contrary to a price correction, which is expressed in terms of percentage points, a “time correction” is the name given to an extended period of quietude for an asset class, without a meaningful drop in its price.Many pockets of real estate in the Delhi/NCR region have undergone time corrections over the past two years, with prices moving neither higher nor lower. In equities, we have basically seen the SENSEX stuck at the same level Since October ’21, on a point-to-point basis. This is also a time correction.
Though not as damaging as price corrections, time corrections can prove to be quite damaging to investor wealth. More so, they can be frustrating for investors who ae fence-sitting in anticipation of a deep cut in prices.
Why do they occur?
Time Corrections typically occur during periods when there are mixed signals coming in for a particular asset class. Take real estate, for instance. Falling interest rates due to huge repo rate cuts by the RBI since 2020 have buoyed investor sentiment to a degree, but the still massive build-up of unsold inventory still acts as a dampener in many urban areas.
Similarly, equity markets were buoyed by massive liquidity injections by central banks in light of the COVID 19 pandemic, as well as a faster than expected economic recovery – but now, with Omicron disrupting supply chains across the world and valuations already stretched, we have mixed signals coming in.
With bulls and bears equally balanced in their numbers, and neither party willing to give up their stronghold, asset prices enter a stalemate situation and stagnate for extended time frames – leading to a time correction.
As time corrections lock prices into a narrow band, fundamentals sometimes catch up. This can lead to the sparking of a fresh rally in the said asset class. For instance, if the NIFTY were to continue trading in the 17,000 to 18,000 range, while earnings growth picked up, we may well witness a breakout from this range at some stage.
Leverage + Time Corrections = Losses
Leverage – the act of “borrowing to invest”, can prove particularly destructive during time corrections. Say, for instance, you take out an 7%, 20-year loan of Rs. 60 Lakhs to purchase a flat worth 80 lakhs – with the intent of selling it off 5 years later. Even with today’s low interest rates, you’ll have roughly
51 Lakhs outstanding on your loan after 5 years. So, if your property doesn’t appreciate at all in 5 years, you’ll have roughly 29 Lakhs left over after selling it and paying off your outstanding loan – after paying 39 Lakhs (including your down payment and EMI’s to date). So that’s a hefty loss of Rs. 10 Lakhs though the property itself hasn’t gone down in value
Advice to investors
One, don’t leverage to invest unless an asset class is in deeply undervalued territory. Two, don’t fixate on price corrections and sit on the side lines indefinitely waiting for an opportune time to ‘jump in’. Focus on fundamental valuation indicators, which may signal a ‘buy’ even in the absence of heavy dips in price.