Is the Nifty your master or your servant?

Feb 17, 2011

In this issue:
» The world is still cheap when priced in gold
» The stimulus never happened says Nobel laureate Krugman
» It is time investors start taking political risk seriously
» Morgan Stanley's asset class of choice for the next decade
» ...and more!

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 Chart of the day
If you thought that financial markets are rational most of the time, you are not alone. All of us have been brought up on a steady diet of efficient market hypothesis. The hypothesis, academicians argue, implies that markets process all the available information correctly and hence, reflect the correct price levels on most if not all occasions. In other words, the indices are our masters and we should obey their commands.

However, today's chart of the day is likely to put a big hole or two in that theory. Data available with us since 1999 shows that the average P/E multiple that the Nifty index has traded at is around 18x. In other words, this is the ideal P/E multiple that the Nifty should trade at on most occasions. But has the index done so? Certainly not. Even if one considers a range of 16x - 20x, numbers that are quite close to the long term average of 18x, the index has traded in this range only around 27% of the time. This means for a whopping 73% of the time since 1999, the index has traded outside the range of what can be considered as a fair value range. So much for the efficient market hypothesis!

Source: NSE India

Infact, we believe that investors can do their returns a world of good by making the indices their servants rather than their masters. They can do so by forming their own opinion on when should they accept and reject the prices offered by the indices. As can be seen, the index has gone into the undervalued zone a good 35% of the time. A patient investor can easily take advantage of the market swings by entering when the index is in the undervalued zone and exiting when it becomes overvalued. Of course, one would argue that historical movements may not be a correct indicator of the past. But we believe that human nature is human nature and such gyrations could repeat themselves in the future as well. Furthermore, for a growing economy like India, where economic growth is not a problem for another couple of decades, such a strategy could lend itself to some great market beating opportunities.

What do you think? Are the indices your masters or servants? Let us know your views or post comments on our Facebook page.

What would the world be like if gold was still used as currency? Prices of everything may seem to be skyrocketing. And none of us have Midas' golden touch. So, would one need to take a sack full of the precious yellow metal with us when we step out of the house? Well, maybe not. According to research done by Adrian Ash at Bullion Vault, despite prices rising across the board, the world would still look cheap if we measured it in gold.

Gold is not used as a medium of exchange anymore. But, it has not lost its sheen at all as a store of value. Let us now compare the metal versus other popular asset classes. The Dow Jones/Gold ratio is currently below its twelve decade average of 10 ounces of gold per Dow unit. This indicator has hit highs of around 40 during the tech bubble, and slumped to lows of 2 ounces in the 1930s and mid 1980s. Currently US housing is priced at around 112 ounces of gold, while it has averaged 202 ounces over the last 120 years. Buying a house in the US currently hasn't been this cheap in three decades! Commodities also surprisingly, have never been cheaper in terms of gold. They have slumped more than 70% against gold since 2001. This is despite energy, metals, and now food reaching record prices in dollar terms. This data makes it even clearer why your portfolio definitely needs a tint of gold.

If you lend Rs 100 to a person who is already burdened with Rs 1,000 in debt, do you expect him to spend the money immediately? Even if you have lent him the money at zero cost? Most obviously no! But the US Fed's trillion dollar stimulus programs were supposed to work on this flawed assumption. Nobel laureate economist Paul Krugman has given very sound reasoning as to why the stimuli could never have worked in the first place.

In an interview to New York Times, Krugman said, "What's extraordinary about all this is that stimulus can't have failed, because it never happened". Thus it appears that the loose monetary policies that the US Fed has been vouching for have been non events all this while. They had no potential to support economic recovery in the US or in global markets. All that they have done is put cheap money in the hands of people. That too at a time when most would not want to spend it. Instead would prefer to bet the same on speculative deals to earn higher returns and pay back debt. We hope that the Fed is reading as much into its flawed policies as the outsiders are.

Globalisation has indeed made the world a smaller place to live in. But has its impact been so great that it has managed to keep business and politics separate? Not really. If anything, the recent crisis in Egypt has shown emphatically that politics play a dominant role in the way business is conducted. Especially in the emerging economies such as China, India, Russia and the like.

Take oil for instance. Given the sensitive nature of this industry most of the oil behemoths are state run and are driven by political as well as economic considerations. This means that although emerging economies have been growing at a scorching pace, they are not without significant risks. Politics is at the top of the pack with risks such as weak legal systems, makeshift institutions, volatile cities and fragile regimes. This is not to say that there are no political risks in the developed world too. The key here is that companies that are looking to spread geographically need to understand the political landscape of the countries that they are operating in. Indeed, in today's world, just establishing operations in larger number of geographies will not necessarily diversify risk as was originally thought.

The analysts at Morgan Stanley believe that equities will outperform all other asset classes in the new decade. Gold has outperformed in the last decade. And though it may be a safe haven in times of economic distress, the upside on the yellow metal will be limited they believe. On the other hand, while investments in the equity markets remain riskier, it seems likely that they will beat returns from property, fixed income securities and gold during the current decade.

For us, it is certainly not a matter of either/or when it comes to these two asset classes. We believe both stocks and gold are a must have in one's portfolio. But since gold does not have any cash flows of its own and is known to endure long periods when its prices go nowhere, the yellow metal should be a small part of one's portfolio. As for equities, given the India growth story, they should certainly command the lion's share of the portfolio.

Meanwhile, after spending some time in the negative zone earlier in the day, the benchmark BSE Sensex jumped into the positive and has not looked back since then. The Sensex was trading around 175 points higher at the time of writing. Banking heavyweights were seen driving a good part of the gains. While most other Asian indices closed in the green today, Europe has also opened on a positive note.

 Today's investing mantra
"The stock market is a no-called-strike game. You don't have to swing at everything--you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, you bum!" - Warren Buffett

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15 Responses to "Is the Nifty your master or your servant?"

daniel menezes

Feb 20, 2011

Is the Nifty your master or your servant?

Nifty is the master of all and we know this truth and still we ask this stupid question...


dilipkumar shah

Feb 18, 2011

I read your chart of the day with interest and it provides good ideas as well good details and good matter for thought.
As regards PE ratio, I feel that investors can take advantage of this information and make money in the stock market,only that they have toinvest their own money and not the borrowed money


jagdish sanghvi

Feb 17, 2011

I really appreciate a different view point presented almost every day. I can tell you that had I not subscribed to the 5 minute wrap, I would have missed a lot. Basically, this education enhances one's financial maturity.
Now about the master and the servant. There is no doubt that it the servant, provided one has graduated(matured) financially. Nifty/Sensex merely represent either 50/30 stocks. Most of the times it has no bearing on the balance 7000 stocks and their movements.


Aloke Mukherjee

Feb 17, 2011

Yes, the Nifty should be servant. But problem is,as pointed out above, is to know it is really down enough.One cannot wait ad infinitum to make the profit.There should be target time as well as target price.



Feb 17, 2011

For anybody who has heard of Extreme Value Theory, the chart of the day is not a surprise at all.
Averages are for cricketers. If you are in stock market, bet on extreme values. Never sell options. Buy them. If you are in options, you must have been right in most number of trades. But you must have lost a lot in a very few number of wrong trades.



Feb 17, 2011

Whenever you look at a company's PE, you have to also consider the growth potential. The same has to be done with the Nifty. For example, from 2003-2006 a high PE was entirely justified by the growth. The crash of 2008 resulted from the correction of the high PE in 2007 and low growth in 2008 & 2009.
To properly conduct this study, you should compare the PE and the following year's growth. That PEG ratio should stay in a range and exceptions outside that warrant attention.


sunny agarwal

Feb 17, 2011

it did not forget one important thing when your write 73% of the time since 1999, the index has traded outside the range of what can be considered as a fair value range. So much for the efficient market hypothesis! there is something called future earning expectation you ignore this factor completely.


Alexander Kurien

Feb 17, 2011

An intelligent and savy Investor will use all Market Indicies to his personal gain, particularly the volatility aspect. Buy low, and always sell once your
reasonable targets are met, in this game emotions, greed, and market gossip has no place WHATSOEVER !
Also, the Investor MUST NEVER debate to himself too much, because opportunities pass-off too very soon,
just like a passing shower !


Chandravadan Ajmera

Feb 17, 2011

This exacly the observation I have made.I have found that an intelligent investor can earn good returns just observing the indices making an entry and exit at right levels. You can earn 25-50 % yearly returns by rightly following the movement of indices


Tukaram Shetty

Feb 17, 2011

The art of living is very simple, just watch animals but we human being complicate the matter by over using our brain.

If you look any index chart for 10, 15 or 20 years it shows it zigzag movement which gives the simple answer.

Buy in lot when it is close to 15 PE and sell when it is above 20 PE and run out market with your money in cash whenever it crosses 25 PE

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