Is the ongoing bull market here to stay?

Jun 20, 2014

In this issue:
» SEBI's steps to revive primary markets.
» The real problem for India is...
» Is the IMF confused?
» RBI is all for enhancing transparency.
» and more....

 Chart of the day
When it comes to equity markets, a glance in the past can give a good idea about how things could possibly shape up in the future.

Today, we look at some of the sharp run ups in the Sensex i.e. bull runs in the past and try to gauge what has been the key driver for the same.

As you would be aware, the price of any stock or for that matter an index which is made up of various stocks, is nothing but the EPS multiplied by the P/E earnings ratio of the stock or the index.

For example, the BSE-Sensex at present has an EPS of about Rs 1,352. It currently trades at a P/E of 18.6 times. Multiply the two and you get a figure that is close to the current Sensex level.

And it therefore follows that any future price or index levels will depend on the growth or fall in the EPS and the expansion or the contraction in the P/E multiple.

We tried to go back in time and see which of these two factors i.e. P/E expansion or an increase in EPS has led to the rise in the index. And the chart below is the final outcome of our study. It indicates the weightage both these factors have had in the historical market run ups.

What has driven Sensex in past bull markets?

It may be noted that we have only selected the periods post Jan 1991, and have chosen those bull runs that touched new highs as compared to the preceding one. The start date of those bull runs was the low price touched prior to the run up.

Prima facie, what is interesting to note is the duration of the market run ups. All those upswings which were led by P/E expansions did not last for too long. The cases in point being the market run ups from January 1991 to April 1992, April 1993 to September 1994, October 1998 to February 2000 and March 2009 to November 2010. What is also common is that from the highs, the markets corrected when valuations were quite high; in each of these cases the P/E stood in excess of 24 times its trailing twelve month earnings.

Currently, the Sensex trading at about 18.6 times, thereby indicating that there is no real sign of worry if the past corrections are any indication.

On the other hand, the run ups from April 2003 to January 2008 as well as the current run up i.e. from December 2011 till now have largely been driven by an increase in earnings. The latter cannot be considered as the market peak since the run up is still ongoing at the moment.

But what we can say is that with the market trading close to its long term historical valuations, the focus will be on earnings growth going forward. But if the P/E continues to rise the way it has been in the past three months - i.e. without the adequate support of the earnings growth - it could lead to an overheating situation given the limited scope of P/E expansion.

Thus, it could make sense to not pay too high multiples to stocks and also stay away from the ones which are fundamentally weak but have gone up only in the expectations of better days going forward.

What will drive the Sensex going forward: P/E expansion or increase in earnings?Let us know in the Equitymaster Club or share your comments below.

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As we have pointed out above, earnings driven market rallies tend to be longer lasting in nature. But in the short run, it is the sentiments that play a big role. While we know this to be true, we came across an interview given a gentleman who has experienced it practically. We are talking about Mr. Prashant Jain the CIO at HDFC Mutual Fund. His track record is indeed exemplary. But we were more interested in the lessons that he had learned in his career spanning over two decades. So what are his words of wisdom?

He says quite rightly that compound interest can create huge wealth for investors over the years. However, for that to happen, you must first allow your money to compound. This will only happen if you become a long term investor. According to Mr. Jain, the main reason why investors don't make money in the markets is due to their lack of patience. Both good times and bad times do not last. Thus investors must have the patience to commit to making long term investments in companies with good fundamentals. We could not agree more. We believe that more market participants should take heed of his advice. If they do, they will certainly improve their chances of success in the equity markets.

The IPO market is on a death bed. Hardly any company is tapping the primary market to raise money. So, in order to revive the same SEBI has decided to introduce a slew of measures. These include having reservation and discount for retail investors in Offer for Sale (OFS) mechanism as well as hiking the minimum public shareholding for PSUs. Reservation for retail investors in OFS will increase their participation, while the increase in PSU float to 25% (from 10% currently) will attract investor interest.

While these measures are likely to give a new life to the dormant primary market, we feel that along with such steps, the market watchdog must also tighten its screws over issues ranging from price rigging to market manipulation. We have had many instances where promoters and operators have taken retail investors for a ride. This has happened because regulatory standards in India are weak. We too have our own share of Raj Rajaratnams and Rajat Guptas of the world. However, the only difference is that in India they roam freely unlike the US. But if SEBI tightens its screws on regulatory matters, the confidence of investors in the markets would increase. And this would lead to increased retail participation in equity markets.

Richard Branson, the maverick billionaire once opined that the fastest way to becoming a millionaire is to be a billionaire first and then buy an airlines company. What this signifies is that it doesn't matter if you have the best intentions in the world. But if the problem you are dealing with is fundamentally flawed, your efforts will eventually come to a naught. The Modi Government, which came to power mainly on the plank of bringing back the 'Acche Din', is facing a similar predicament currently.

You see, the fiscal deficit is where the real problem lies for India. And as an article in points out, it should ideally be below 5% of the GDP. Currently though it stands at a steep 7.6% of GDP. And there are absolutely no signs on the horizon that this can come down any time soon. Oil subsidies can't be cut for that can simply give rise to more inflation. Besides, the oil crisis in Iraq is only making matters worse. Also, the previous Government has postponed huge expenditure to the tune of around Rs 1 lakh crore that has to be accounted for this year. And if this is still not enough, there is this huge sum that will have to be accounted for if capitalisation of PSU banks has to turn into a reality. Therefore, try as the Government may, Acche Din could well be some distance away.

Speaking of the banking sector... at the end of March 2014, loans over Rs 2.5 trillion were non-performing in the Indian banking system. That's indeed an alarming figure! Hence, to combat the rising bad loan risks in the system, the Reserve Bank of India (RBI) has raised red flags again. And this time it does not intend to leave any stone unturned to fight out this battle. The central bank has urged bankers to enhance transparency and practice prudent lending. To that effect, lenders are directed to disclose sector-wise advances and non-performing loans (NPLs) in the 'Notes to Accounts' section in their financial statements from the financial year 2014-15 onwards. Not just that. The RBI is also keen to take steps for early recognition of NPAs in the system. The banks now need to classify accounts into a special category based on the number of days their interest payments are pending. This category is known as Special Mention Accounts (SMA). Further, the RBI has also instructed banks to disclose credit information of loan accounts above Rs 5 crores. These measures are indeed welcoming. For they will not only help the regulator track the grey areas in the system, but also help shareholders take wise investment decisions!

Now regulators globally have their tasks cut out. However, the conflicting monetary policy stance in the US and the Eurozone seems to have got even the IMF confused! Well, that is our take on the IMF's suggestion to the ECB to go in for a 'full scale quantitative easing'! Now the IMF has all this while not been in favour of the US Fed's near zero interest rates. In fact it also opined that the US central bank should sooner than later try to raise rates in order to reduce its debt obligations. However, this time around the IMF seems to have contrasting views about the ECB. As per Moneynews, IMF believes that the low inflation levels in the Eurozone call for a large scale asset purchase program. And it has urged policymakers in the Eurozone, who have so far stayed away from QE to consider the same! We can only wonder what it will take for financial regulators in the West to dispel the misconstrued benefits of cheap liquidity. And unless that happens, the evils of cheap liquidity are probably here to stay.

In the meanwhile; the Indian stock markets were trading flat. At the time of writing, the BSE-Sensex was down by 7 points (down 0.03%). Sectoral indices were trading mixed with capital goods and healthcare stocks being the biggest losers, while consumer durables stocks were leading the gains. Most of the Asian stock markets were trading weak with South Korea and Taiwan being the major losers whereas Hong Kong and China were the only markets trading in the green. European markets opened the day on a mixed note.

 Today's investing mantra
"The price of a stock can be influenced by a 'herd' on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person." - Warren Buffett

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3 Responses to "Is the ongoing bull market here to stay?"

Ravi Sundararaman

Jun 21, 2014

Sir, i am a regular reader of "5 minute Wrap up". I feel, it would be a good idea to include the highlights as Titles against each section as well. By this, it would give clarity on the topic reported, rather than moving up and down the news letter (Like the title "Chart of the Day". Sure all readers would appreciate that way of presentation.



Jun 20, 2014

It is interesting to see that the current rise is credited with the EPS growth and not PE, though it has gone to 18.6. It is strange that the rise is halted despite the euphoria behind a full majority government. The pre-election rise was about 15% and post that was about 6-8%. It is widely believed by many that the new govt will bring about economic growth, but it appears the market is not ready to give weightage to that, maybe because the market is not ready to believe the BJP is anyway different than the previous UPA govt, considering that it is not committed on many things, they have spent a lot of money on election expenditure which will prompt them to favour those who funded it etc. Budget too is not likely to be kind on the public. We have already seen price rises continuing. otherwise the market would not have hesitated to go up to 24-25 PE levels too. If the new govt gives the right indications to bring about an allround positivity (not just to the crony capitalists), then there will be expansion on both, EPS as well as PE and the sensex can climb to easily above 35,000 in 2 years time.
But my guess is, probability of the new govt succeeding in it is quite less in the current economic scenario and the govt's mis-directed priorities (satisfying crony capitalists at the expense of the larger economy). So we may have to satisfy ourselves to waiting for the 'good days' for much longer.



Jun 20, 2014

PE expansion precedes EPS normally in a bull run. If EPS follows through you hit the jackpot; otherwise the bloated PE has 'a great fall'.

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