How to recognize a market top?

Jun 21, 2014

In this issue:
» Deepak Parekh: There is no real estate bubble in India!
» What football preaches about investing?
» Modi's first gift to India Inc: Projects worth Rs 210 bn cleared in a jiffy
» Which airline dominates the Indian aviation market?
» ...and more!

Being financial analysts the one question that we are repeatedly asked pertains to the direction of the markets. Where are the markets headed? Is this the top? Do you think we should wait for a correction and then enter?

Being fundamentalists, we have tried and addressed these questions in the traditional way until now. It includes using the fundamental tools like PE bands, market cap to GDP ratio etc. Using these tools, we have communicated our assessment of the current market situation to our readers many times of late.

However, for the time being let us shift our focus from the traditional approach and leave all these jargons aside. And see if there is any other way to spot the direction of the market. We will especially focus our discussion on determining the market top as stocks are scaling new highs currently. Hence, most investors are keen on knowing whether the current rally has more legs or have the markets topped out.

The most conventional non-fundamental approach that determines markets have topped out is when there is a sudden rise in interest towards stocks from non-seasoned participants. For instance, take the case of a person who is least bothered about financial markets suddenly enquiring about stocks. This is the time tested indicator that markets have topped out and is likely to work more often than not.

You may ask what the correlation here is. Well, it is simple. The current euphoria in the markets has overwhelmed people. Those who were sitting on the sidelines like non-seasoned players are feeling left out. And they don't want to miss out on the rally further. Sentiments are high and so they want to jump on the bandwagon soon. But we know what happens subsequently when the bubble bursts.

Remember, the gold rally? When it crossed 32,000 buying frenzy intensified. And we all know what happened to gold since then. Take the case of Rupee if you don't want to dig too much into the past. When it touched Rs 68-69 to the dollar, market was abuzz how Rupee may go down much more against the US dollar. But now Rupee is sitting pretty at Rs 60 to the dollar.

Another indicator which confirms market top is absurdly high level of forecasts. And this is precisely the case now. We have seen number of brokerages coming out with optimistic Sensex targets. Such farfetched optimism is a warning sign to begin with.

A sudden spurt in the number of new demat accounts is another potent indicator. For instance, the number of total demat accounts in 2008 jumped threefold from the level that was prevailing in 2006. And then we witnessed a huge fall in markets during 2009. All the naive investors who bought at market top in 2008 lost money.

And this could well happen now. People buying now may be subject to greater fool theory. Certainly money cannot be made by herding as what most people tend to expect. The best approach is to focus on intrinsic value and not price and buy when very few people are buying. Also, investors should pay heed to fundamentals and valuations. This is the best time tested approach in the long run.

Do you think market has reached its top? If yes, which factors indicate so? Let us know in the Equitymaster Club or share your comments below.

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As we are on the topic of spotting market tops, here is an interesting take on whether the Real Estate market has made a top or not. Chairman of HDFC Mr. Deepak Parekh is of the view that there is no real estate bubble in India!. In other words, the top in real estate market is far distant. This is indeed surprising, as just a few years ago, he had warned that rising home prices could lead to a bubble. What's more, he has suggested that banks and housing finance companies (HFCs) should be allowed to finance land deals. The logic is that as land costs comprise 70-80% of total cost, the sector would get a big boost if financing is made easier.

This argument is nothing new we believe. Bubble or no bubble, the fact remains that home prices are unaffordable for the common man in India. This is the most pressing issue for the sector. Improving access to finance for developers is only one part of the solution. The more important part would be a reduction in prices. This will only happen if there is greater transparency in the industry. In addition to this, faster project approvals and a clear regulatory set up will go a long way to make the dream of affordable housing for all a reality.

The whole world is awash in world cup fever. We thus thought it would be a good time to highlight what the beautiful game can teach us about investing or rather asset allocation in general.

Our task was made simpler by an article in attempting to do the same. It has come up with few interesting and important points about the similarities between football and asset allocation. First, it's all about having the right mix. A strong team as we all know has a good mix of players with different capabilities like attackers, midfielders and defenders. Therefore, a strong portfolio should also have assets with different characteristics like debt, equities and gold. Second, it is criminal to have one strategy throughout in football. Similarly, when it comes to investing, one should go aggressive when the situation calls for it and be defensive at other times. Another important point we believe was about seeking expert advice. No matter how strong the team, it has to have a good manager so that he can bring out the best in all the players. In investing too, it always helps to take the advice of a financial expert who not only has a strong experience navigating different market cycles but also a strong track record. Thus, if one tries to ensure that these points are taken care of, one's investment success can go a long way just as a team with all the ingredients has a good chance of going the distance.

 Chart of the day
Talking about tops, let's see who is on the top of the skies when it comes to aviation. As can be seen from today's chart, it's Indigo. The airline is flying high in terms of market share numbers vis-a-vis its competition. Beating the rivals, IndiGo airlines could fill 82% of its flights on an average during the month of May this year. The second in rank turned out to be SpiceJet with flight occupancy of 81.8%. Thus, IndiGo airlines have successfully maintained its market leader position by flying 1.9 mn passengers during May. Not just that! These airlines have outnumbered its peers on punctuality grounds as well. IndiGo could manage to operate 88% of its total flights on time. SpiceJet followed, clocking 83.8% on punctuality. Thanks to the lower fares during summer vacations, the Indian carriers could witness robust demand. With capacity exceeding demand for quite some time now, the airline industry is not out of the woods yet. While such promotional events can deliver good numbers in the short-term, the long-term prospects still remain hazy for the industry.

Who is the King of the skies?

As Narendra Modi takes up the charge of the country, policy paralysis seems to have become a past thing now. Mr Modi's 'pro-business' ideas are being welcomed as he begins his job. As per a leading financial, Mr Modi's government has given a green signal to projects worth Rs 210 bn. It is worthwhile to note that some of these projects have been held up for decades due to various obstacles. Seven projects including rail projects, hydro electricity projects and power projects have got approval. Not only that, the government has also promised to track the progress of these projects closely. This will ensure timely approvals and production activity on ground.

These quick steps were very much needed as investment climate in India had gone from bad to worse. Clearance of these projects is certainly an encouraging sign. And successful completion of these projects will be an important milestone. If such trends continue, we can be more hopeful of the country's economic prospects.

Global markets maintained a cautious stance in the light of renewed concerns over violence in Iraq and oil disruptions that continued to push up global crude prices. Barring markets in developed economies such as Japan, US, UK and Germany that ended in the positive territory, all the other stock markets have fallen for the week. US markets ended higher on reassurances from the Federal Reserve that interest rates would remain low as the US economy continues to recover. Even though the Federal Reserve in its policy statement cut its monthly bond-buying program from $45 m to $35 m, it left its benchmark interest rates unchanged.

All the Asian markets, except Japan, ended on a negative note. The Japanese market, up by 1.7%, was the biggest gainer among stock markets around the world. Indian markets remained lacklustre over the week due to sharp rise in crude prices that will make rejuvenation efforts by the government all the more challenging. Stock markets in China and Singapore recorded fall of 2% and 1% respectively for the week.

Majority of the sectoral indices in the Indian markets ended the week in the negative territory. Oil & gas (down 2.2%), auto (down 2.1%) and capital goods (down 1.6%) witnessed the highest selling during the week. Consumer durable (up 4.4%), IT (up 2.8%) and realty (up 0.6%) were among the few gainers for the week.

Performance during the week ended Jun 20th, 2014
Data Source: Equitymaster

 Weekend's investing mantra
"I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years" - Warren Buffett

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5 Responses to "How to recognize a market top?"

Andrews W Salim

Jun 28, 2014

Our economy is inching towards a deep trouble triggered by the heavy monsoon failure (deliberately ignored by everybody who matters) besides pathetic economic situation that we already are into.

Only FIIs are making everyday money, by engineering Sensex specific stocks to their tunes. By any reckoning the Indian Stock market has no fundamental strength to sustain this foolishly heightened euphoric level played to the galleries of every FIIs and fund managers. New Govt. will have to come up with one of the toughest Budgets in the recent history of India(Bad luck to the new Govt to start with).If not, this Govt. is not very keen to revive the economy, which is passing thru very difficult times.Operators may take it to a few hundred points too, but I feel the Index is on an unpleasant footing to ditch the majority.
Andrews W Salim. MA (Eco) MBA (Fin)
Ex-Chief Economist & Vice-President, MCX India Ltd.



Jun 22, 2014

Thanks for enlightening on the symptoms of market top..

Like (1)

anwr hussain

Jun 22, 2014

it is good to know that equity research has brought in a new investors programe.
some tips on new investments should be guided to readers thru email to gain confidence.
it is a humble suggestion as i m a senior citizen retired n small investor.
help people like me.

Like (1)

G S Apte

Jun 21, 2014

If many people who were not interested in equity as asset class, have started inquiring about demat accounts, large-caps and mid-caps, and are talking about beating inflation, that itself is a signal that, probably markets are heading towards top, and things might turn out the other way soon.

People should realize by now that, you need to look at all areas of investing all the time, and not just when things are looking bright. In fact, when things look very bright, you can safely assume that, good days always get over fast and bad days stay for a much longer duration than one can think of. So it is important that, you look at balancing your asset allocation at all the time, through out your life time, instead of worrying about what is high and what is low, and you can realize that, you would be the winner by using these simple rules.

It is simple to say and difficult to implement it, but we all should try to adopt this approach in investing.

Like (1)

Carlos de Souza

Jun 21, 2014

Soooo, is Deepak Parekh a LIAR ?? A sycophant who lies through his teeth ?? Your call ??

Like (1)
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