This leading stockmarket indicator is alarming!

Apr 12, 2010

In this issue:
» Has SEBI just pricked the ULIP bubble?
» Asset prices in India touching uncomfortable levels
» Biggest issue with India's infrastructure build-up
» Marc Faber worries of a Chinese bubble burst
» ...and more!!

------------------ Listen to the sound of money...big money ------------------
If you missed out on The Equitymaster Investment Summit 2010, don't lose heart, or your sleep! We're bringing it to you in a special Limited Edition Investment Summit twin CD pack.

To listen to investment strategies and insights by Ajit Dayal and Bill Bonner on the world economy, India and the biggest risk it faces, the 'must-haves' in your portfolio, ' the 5 categories of investment to build your wealth'....and so much more, click here

 Chart of the day
Warren Buffett calls this ratio as 'probably the best single measure of where valuations stand at any given moment'. His disregard for macroeconomics is legendary. But even he is willing to relax his otherwise strict stance on the subject just for this one ratio. It is the ratio of a country's stockmarkets' total market capitalisation to its economic size or GDP. Call it the 'market cap to GDP ratio'.

Over the years, this ratio has done a very good job of determining long-term returns that an investor can expect from the stock markets. As the chart below suggests, for India, the average market cap to GDP number over the past 2 decades has been 52%. Indian markets were trading near this ratio in March 2009 (when this rally started). And as we stand currently, the markets are back at almost their 2008 peak!

Data Source: SEBI

As per Buffett, a 70-80% range on this ratio indicates that markets are somewhere between moderate valuation and fair valuation. If the ratio exceeds 115% (we are almost there!), the markets are in the overvalued zone where odds of investing are not in the favor of investor.

This ratio is definitely sending some warning signals for the short term. Isn't it?

"Pricking the ULIP bubble," reads one headline in a leading business daily. The article relates to the war of words going on between the stock market regulator SEBI, and insurance regulator IRDA. The bone of contention is the regulation of ULIPs or unit linked insurance plans.

ULIPs are possibly the single-biggest innovation in the field of life insurance in the past several decades. These are also one of the most mis-sold products in the insurance business. Considering that returns from ULIPs are determined by the stock markets, SEBI had been at loggerheads with IRDA as to who is responsible for regulating the product.

Last weekend, SEBI had banned 14 life insurance companies from selling ULIPs without its approval. The IRDA retaliated. It later asked these companies to ignore the ban imposed by SEBI. It also asked them to continue their business as usual.

We believe that since ULIPs have a big component that goes towards investments in the stockmarkets, it is not surprising that SEBI sees itself as a governing body for the same. In fact, SEBI's intention is just to get the insurance companies selling ULIPs to register with it and sell their products after they receive the market regulator's prior approval. With the kind of sharpness SEBI has shown in recent issues concerning the stock market, we feel that any regulation from it in this matter would be a welcome move.

Do you think SEBI is right in taking on IRDA over the ULIP issue? Share your views

You may benchmark your return expectations from investments to the risk free rate of about 8% or so currently prevailing in India. But it's a whole different ball game for foreign institutional investors (FIIs). They come from countries with very low risk free rates of returns. Perhaps one of the biggest reasons they are willing to pay much higher prices for stocks and other Indian assets than the typical domestic investor here in India.

And the result? Asset prices in India have firmly started their upward march once again. These are steadily beginning to touch uncomfortable levels, and may move higher as capital flows into the country continue with full flow. In fact, recent reports state that there is scope for some US$ 2.9 trillion parked in US money market funds to further find its way to emerging markets. And thus, even though RBI may be rife with fears of bubbles in various asset classes like stocks and real estate, prices may continue rising.

Importantly though, the continuance of capital inflows depends on the governments of western economies continuing with their loose monetary policies. Any contraction on that front can easily lead to a quick pull back. Something that does not bode well for asset price stability in emerging markets. And India is no exception to this!

Although stock markets have recovered from the financial meltdown, investors should not expect the same kind of returns they were used to earlier. This is as per Bill Gross, head of the world's biggest bond fund Pimco. According to him, "Instead of 8 to 10 percent in terms of return for risk assets, you should expect 4 to 6 percent. Reduce your expectations."

But not everyone believes this. Jack Bogle, founder of mutual fund giant Vanguard, believes investors can be more optimistic that what Gross suggests. "We ought to be able to get from these earnings levels maybe earnings growth of 6 percent and total returns from stocks a little bit over 8 percent," he says.

In our view, one thing remains constant nonetheless. Investors should look to buy business they can understand, with able and honest managements and at a reasonable price. In the long term, good businesses tend to outperform most asset classes.

Indian markets had a weak outing today. The BSE-Sensex was trading down by around 90 (0.5%) points at the time of writing this. Selling was widespread in engineering and banking stocks. Smallcaps however bucked the trend. The BSE-Smallcap was trading up by 0.3%. Among other key Asian markets, while China was down 0.5%, Japan closed with gains of 0.4%.

Overpromising and under-delivering seems to be the bone of all contention. It is threatening India's long term economic growth prospects. And could go to the extent of derailing India's hope for better infrastructure. As we builds more roads and bridges, investors globally are likening ours to the Chinese economy. Targets like that of building 20 km of roads a day certainly seem compelling. But not without proper execution!

The delays may be due to land acquisition or government policies. However, these coupled with limited government finances have already made a mockery of the targets. If not resolved promptly, India may lose out on potential long term investments. The road building project for example is seeking US$ 41 bn of private sector money. This is unlikely to come in without assurance of reasonable returns in specified period. Thus India's long term prospects could very well remain on paper. Unless the government gets more serious about executing its promises.

The debate over whether China is in a bubble phase continues. However, it seems as if the number of people who believe so, far outweigh those who are against it. Amongst the former is the 'Gloom Boom & Doom' report publisher, Dr. Marc Faber.

Dr. Faber's rationale is quite simple. According to him, China is overdoing it. By 'it' here, he is referring to the overcapacities in buildings and industries. "I think the Chinese economy will decelerate very substantially in 2010 and could even crash," he's told international media.

A bunch of economists and analysts have pointed out at developments that are leading to signs of a bubble situation in China. The key ones are - reconstruction of bridges, construction of a couple of high skyscrapers (amongst the world's tallest) and more real estate space such as malls and offices despite many of them being empty. In our view, all signs are pointing towards a 'pop' in the dragon nation. If and when that happens, it could set the global economy on a path to prolonged slowdown.

 Today's investing mantra
"Often, there is no correlation between the success of a company's operations and the success of its stock over a few months or even a few years. In the long term, there is a 100 percent correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient, and to own successful companies." - Peter Lynch

Today's Premium Edition.

Recent Articles

All Good Things Come to an End... April 8, 2020
Why your favourite e-letter won't reach you every week day.
A Safe Stock to Lockdown Now April 2, 2020
The market crashc has made strong, established brands attractive. Here's a stock to make the most of this opportunity...
One Stock that is All Charged Up for the Post Coronavirus Rebound April 1, 2020
A stock with strong moat is currently trading near 5-year lows.
Sorry Warren Buffett, I'm Following This Man Instead of You in 2020 March 30, 2020
This man warned of an impending market correction while everyone else was celebrating the renewed optimism in early 2020...

Equitymaster requests your view! Post a comment on "This leading stockmarket indicator is alarming!". Click here!

177 Responses to "This leading stockmarket indicator is alarming!"

Sunil Ghorpade

Sep 8, 2010

SEBI is absolutely right



May 12, 2010

It is IRDA WHICH SHOULD REGULATE ULIP as it involves various other aspects too. Like it's a retail product and an insurance too. It got mis sold due to very huge number of distrubutors involved and the maturity level of the masses in regard to the financial products is abysmilly low. SEBI wants to destroy the distribution channel of it as it destroyed MF. Without distribution channel no product can reach to masses nothwithstanding it's qualities etc.


Prasanna Ogale

Apr 27, 2010

Yes.SEBI is 100% right in their move. As long as their motive is to safeguard general investors intrest their such moves would be always welcome.
Congratulations SEBI.Keep It up your good work.



Apr 18, 2010

Position wise, SEBI is right. ULIPs are nothing but various kinds of Mutual funds desguised as insurance products. Considering costs and industry tendency to fleece its retail customers, ULIPs are now a refuge of the AMCs after the recent SEBI crackdown on outrageous Mutual fund charges. So, it is natural for SEBI to crack a whip on ULIPs because it is being used to evade recent SEBI's steps. Regarding IRDA, it is nothing but a party with interest in insurance industry because it is manned mostly by former insurance industry honchos who think only about the interest of the insurance industry top guns. So, anything that IRDA says or does, its applicability must always be decided in the courts wether or not such actions treads into the space of other regulators. Investor associations would do well to take each and every action of IRDA to courts where the action's validity must be decided.


Pravin Jain

Apr 18, 2010

SEBI is absolutely pro-investors and takes care of investors interests. I am a big victim of ULIP schemes.I bought 3 ULIP plans 4 yrs back from 3 different companies ( ICICI Pru Smart Kid plan, Bajaj Allianze and Birla Sun life ) with very high annual premium with an objective to secure future education needs of my kids. While selling it, Advisors had shown me all bloody fudgy returns data and given all false promises on returns alongwith respective company officials. They did not fully share information on high allocation charges, high insurance premium rates etc. Today after 4 yrs, my fund value is less than what I paid to them and returns are zero to negative. Advisors after sale of Policies have vanished. They do not pick up phones and provide absolutely no post sales services. No accountability/ penalty fixed by the ULIP company on their advisors. This is inspite of huge incentives given to them by ULIP companies to sale policies to innocent investors on false promises. Eventually Customers feel cheated / looted by these so called hi-fligher professional comapanies. I strongly feel SEBI must bring laws to fix accountability on these companies, advisors and high cost of policies charged on Customers ( huge intial allocation charges, incentives to advisors) and must ensure that certain minimum returns are ensured on these ULIP plans. Otherwise many people who invested their hard earned money to secure their kids future /for their own future needs after retirement would feel looted / cheated by these so called ethical and professional companies. Goverment thru SEBI must immediatelty intervene to bring accountability on these companies. PRAVIN JAIN


km bansal

Apr 18, 2010

yes. Sebi is right.



Apr 16, 2010

SEBI must have the same right as in the case of other investers, but neither more nor less.


Akshay K Jani

Apr 15, 2010

Sure,Sebi is unstoppable and committed regulatory body.I believe ULIP funds should be equally treated as mutual funds.The insurance part of ulip is the job of IRDA.It is due to prompt actions of sebi we are not finding scams since many years.


Dr. Atul Tiwari

Apr 15, 2010

Yes SEBI is right in doing so. More over SEBI should monitor promises made by ULIPS, which are misleading. They alsways talk about NAV, while it is actually number of units which is reduced during market downturn. They talk about increase in fund value, but never disclose that fund value is not the premium paid by customer (it is calculated after deduction of verious charges). In fact no ULIP has grown enough to show even invested money in customer's account in last 7 years. Now customers are puzzled, because they can not cancel the scheme (their money is trapped) cant stop paing premiums (deductions will continue from their fud to reduc it more). SEBI should monitor their promises, after all these are made on the basis of business, that is controlled by SEBI not by IRDA. IRDA, will just see their insurance promises, it cant take any action against their promises, made to grow the money of investors.


Rajiv Kumar Kedia

Apr 15, 2010

I do not think that SEBI should now try to control the ULIP plans. What were they doing so far? This product is in the market since quite a few years. Also, UTI was selling ULIP plans since 1971. What did SEBI do then ? Why this sudden awareness ? After all these questions are answered, one can very well understand why SEBI wants to have a say in ULIPs.
I feel that when IRDA is there, there should not be two people controlling a single product. IRDA should have the final say. Yes, if they have not done the job well, one should fight against IRDA, but getting another regulator involved is senseless.
This is like the present situation in road digging, where many agencies/ govt. bodies want their permission to be taken for one job.

Equitymaster requests your view! Post a comment on "This leading stockmarket indicator is alarming!". Click here!