The one everlasting truth about stock markets...

Dec 29, 2014

In this issue:
» Time to be cautious for equity investors
» Overseas investors pour US$ 42 bn in Indian capital markets
» Primary markets likely to witness heightened activity in 2015
» and more....

  Chart of the day
Just two more days to go before the end of 2014. If you look back at the year gone by, it appears to be a year of renewed hope and optimism in the Indian stock markets. The change of government at the Centre infused confidence in an economy that was faltering on multiple fronts. The fall in international commodity prices, particularly crude oil, further provided the much-needed boost by lowering inflation expectations and raising hopes for interest rate cuts.

With 2015 just around the corner, one wonders what the New Year would bring. Will the market rally continue in 2015? Or will we see some major corrections? Which stocks will outperform? Which ones will be duds? Well, we will leave these questions for a later discourse.

For now, we want to share a one-line message from a folktale that goes hundreds of years ago.

The story goes thus... A certain monarch from the Eastern side of the globe once ordered his counsel of wise men to invent him a sentence that would be ever in view. His only condition was that the sentence should hold true in all times and situations. Here is the line that his wise men shared with him:

"And this, too, shall pass away."

In our view, if there is one line that describes the ever-changing, dynamic nature of stock markets, this is it. It's very simple to understand, isn't it? But how challenging to follow!

Just recall how much pessimism there was about the Indian economy in the middle of 2013. People were writing off the India story. Every macroeconomic indicator was sending a negative signal. The political logjam and corruption only exacerbated matters.

And how just some months later investors began to see a light at the end of the tunnel. 2014 has been a journey from hope to optimism. Where from here now? Well, whatever be the future course of the economy and the stock markets, remember that nothing in the stock markets is static or permanent.

Actually, there was a piece of news we came across some days ago that reminded us of this important lesson. According to some financial dailies, the exposure of mutual funds to bank stocks surged to a record high of nearly Rs 706 billion at the end of November 2014. That's 21.23% of their total equity assets under management. In fact, we just checked (see chart below) the sector-wise weightage of stocks in the S&P BSE Sensex. Lo and behold, finance stocks account for 31.98% of free float market capitalization of the Sensex. This is indeed something that should draw your attention and scrutiny. The reason being that the last time the sector had witnessed a similar kind of index weightage was back in early 2008. During the market crash that followed, the weightage had dropped down to below 20%.

Sensex remains over exposed to Finance stocks
*as on 26th Dec 2014

What do you make of this?

Yes, we agree that banking and finance stocks may do very well if interest rates come down and the investment cycle revives. In general, finance stocks are a good proxy play on the economy. If the economy does well, they tend to be direct beneficiaries.

But let us also tell you, all sectors go through their cycles. There can be phases when a certain sector gains a lot of popularity amongst investors. Stocks from that sector may witness a strong rally that may extend for some years. This, consequently, causes their overall weightage in the index to go up. Sometimes this results in bubble formation, which eventually has to go through the contraction cycle.

During various phases of the markets, different sectors have driven the market rallies at different points in time. We would like to bring to your attention that at the peak of the tech bubble, technology stocks accounted for 45% of the index weight.

We are not hinting that banking stocks are due for a correction. But it is certainly something that should not escape your attention. We would suggest you evaluate the sector-wise weightage of stocks in your portfolio. If you feel you are overexposed to a particular sector, you may want to trim down your holdings to more reasonable levels, so that the risks emanating from a particular sector could be minimized. We understand that this may be a bit difficult to do, especially if you have enjoyed solid returns from a particular sector. But we think it is better to be safe than sorry.

Is your portfolio overexposed to any particular sector? Do you think it is a safe investing strategy? Let us know your comments or share your views in the Equitymaster Club.

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2014 has been a year of come back for equity markets that surpassed other asset classes in terms of returns. From a scenario of doom and gloom, the markets surprised in 2014 with Sensex registering 29% return in the year till date. And within equity class, it was midcap and small cap stocks that stole the show with around 52% and 69% returns. On the other hand, it was a dull year for gold and real estate.

While the stock market trend reflects optimism, it also warrants some caution on multiple grounds. First, the diversification. The same is required not just across sectors as we highlighted in the previous story, but across asset classes as well. Investors must note that within equities, the valuations of a lot of small cap and midcap stocks are running ahead of fundamentals. While a real recovery is yet to be seen, the upside and growth factor seems already been accounted for. And this could mean that 2015 might not be year repeat performance for certain asset classes. Hence, avoid keeping all your eggs in the same basket.

And here is yet another reason why taking the recovery in Indian capital markets for granted could be a risky proposition. One of the biggest factors fuelling the stock market rally in 2014 has been hot money inflow in the Indian capital markets. As per an article in Firstpost, US$ 42 bn is the quantum of funds poured in by overseas investors in 2014. More than the growth in the profits of the company, it is this liquidity chasing the Indian stock markets responsible for the rally.

While we cannot comment with certainty about the future trend in foreign institutional investors (FIIs) flows, there have been some global trends that remind us not to take this liquidity for granted. The first is falling crude prices and its adverse impact on oil rich regions that run sovereign wealth funds. If crude prices continue to remain weak, a significant portion of these inflows might be withdrawn from equity markets, taking a lot of gas away from this rally. Second reason that we need to remember is these funds will find their way to the most attractive markets. So far, in a scenario of low interest rates and money printing in the developed economies, the destination has been emerging markets. However, if the US economy recovers and Fed raises interest rates, we might not be able to hold on to the foreign money. And in that situation, the only factor that will determine investors' future returns will be the fundamentals of the stocks they have invested in. Hence, whatever be the scenario, let the bottom up investing approach be your constant guiding factor to pick stocks.

Quite in contrast to the secondary markets, the IPO market seems to be telling a different story.

At Rs 12.6 bn, the amount of money raised in the primary market in CY14 is not only less in comparison to 2013, but also the lowest in over a decade! However, before you draw any conclusions on the basis of this data, here is another interesting piece of information.

As per an article in Business Standard, in 2014, six companies have got the approval from the market regulator to raise around Rs 26 bn through IPOs and follow-on-offers. Also, 10 other companies have filed offer documents with the SEBI to raise Rs 40 bn. What this means is that 2015 could be a year of heightened activity for the primary markets.

As more companies queue up to raise funds via IPO, investors must be extra cautious while betting with their hard earned money on these companies. Almost 7 years back, the euphoric markets witnessed IPOs of DLF Ltd and Reliance Power that till date have not been able to recover investors' money. We hope the lessons learnt the harsh way will not be forgotten this time. With limited record about the financials and management quality, investors should avoid getting carried away by the IPO boom and invest in them only when the company is fundamentally strong and the stock is offered at attractive valuations.

Meanwhile, Indian stock markets continued to trade firm and ended the day on a positive note. At the time of writing, the benchmark BSE Sensex was up by 154 points (0.6%). Barring banking, all sectoral indices were trading in the green with the stocks from the auto and metal spaces leading the gains. Barring Japan and Korea, the Asian equity markets were trading in the green with markets in Hong Kong and Singapore leading the gains. The major European markets opened on a mixed note.

 Today's investing mantra
"Nothing sedates rationality like large doses of effortless money." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Richa Agarwal.

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2 Responses to "The one everlasting truth about stock markets..."


Dec 30, 2014

Agree with the diversification of stocks in the Portfolio. In my opinion if the holding period is for shorter term then it is ok if the stocks belong to a particular sector as it will help to capture the trend movement of that particular growth sector.



Dec 29, 2014

There is no alternate to being cautious --- in equity --- whether at 9000 in 2008 or at 27000 in 2014-- u shd never let ur guard down -- even fr moment--
but ur comparison of banking stks at 2008 and now is skewed-- will share one stat -- BOB income rose from 7000 crs to 39000 crs frm 2008 to 2014 -- eps frm 22.07 to 105 wth all attendant NPA,s _ restructured loans etc -- and cash flow went up frm 2100 crs to 40000 crs -- yes--- and mcap ?? it went up frm 8000 to 31000 crs -- i hope u get wht I am trying to say -- this is nt to suggest where BOB stock will go -- but as per my estimate in next 5 years -- BOB shd be 5000 -- ys 5 times -- by 2019 in election year--- off course movement will nt be one way and linear -- and it shdould nt be that way at all --- but u r nt comparing apple to apple --

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