Will there be riots soon in the market? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Will there be riots soon in the market? 

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In this issue:
» Gold has its best week in more than three years
» What sectors mutual funds are bullish and bearish on?
» Is India amongst the most expensive market globally?
» ...and more!


00:00
The fall in crude oil prices notwithstanding, we believe that the sentiments are still broadly bullish across the globe these days. More so when you look at what stock market indices across the world are doing. A special mention needs to be made of the Indian stock markets which only yesterday scaled their life time highs and are poised to even better it today.

However, as Warren Buffett says, in investing just as in baseball, in order to put runs on the scoreboard, it is extremely important to watch the playing field and not the scoreboard. In other words, just observing the stock prices may be of little use because what will eventually matter in the long run are the underlying fundamentals.

Fortunately, as far as the global economy is concerned, a man who answers to the name of Albert Edwards has done just that. And what he is observing does not make for a good reading! By the way, what is the claim to fame of Mr Edwards? Well, Edwards is the Chief Strategist of the French multinational giant Societe Generale and is known as arguably the biggest bear in Europe right now.

True to his reputation, Edwards is of the view that the global economy is staring at a huge deflationary spiral. And this will soon wreak havoc across most asset classes. What's even scarier is his prediction that this can happen as early as this year! In other words, markets may well riot as per him.

Edwards has supported his prediction on what he thinks is a flawed confidence in the US economic recovery and also an unreasonable faith in the relationship between quantitative easing and the equity markets.

Although valuations are at elevated levels in the US, the profits and margins are struggling as per Edwards. Thus, even a little doubt on this front can send the investors running for cover. And if profits start disappointing, then even the quantitative easing might not help the US stocks to hold their ground like it is happening in the case of commodities right now. It should be noted that the quantitative easing until recently was good for both commodities as well as stocks. However, no sooner did the fundamentals start to weaken for commodities, their prices came crashing down. This thus confirmed that it is fundamentals that matter in the long term and there's no reason why this could be different for stocks.

Well, Edwards' view is what we have also been writing on all along. And this is based on a very simple view we have here at Equitymaster. We are of the view that a crisis is but an integral part of a well functioning economy. In fact it is very useful in the sense that it highlights the excesses in the system.

And therefore it should be allowed to run its course so that the stage is set for a more solid recovery and the next round of growth. In other words, people who had overextended themselves should be made to curb their spending. And business that are out of sync with reality should be allowed to fail so that its assets and resources can be put to more productive use.

However, what the policymakers have done instead is stop the recovery in its tracks and have instead tried to solve the problem of debt with still more debt. Thus, as people like Edwards are finding out, what this has done is set the stage for an even bigger crisis in the future. While we don't know whether the markets will indeed run riot in 2015, all we know is that the next crisis has a very strong chance of being much bigger than its predecessor.

However, the good news is that India's economy is relatively more insulated to these global developments. And its long term structural story will also more or less stay intact. Thus, any significant correction in Indian stocks could actually be a good buying opportunity from a long term perspective.

What do you think? Do you think global equities are due for a strong correction in the near future? Let us know your comments or share your views in the Equitymaster Club.

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01:55
Well it's not just Edwards who is concerned about the global economy. Looks like the moves that the yellow metal gold has been making these past few days is also pointing towards the same issue. As per a famous portal zerohedge.com, gold has had its best 7 day run since 2011 recently. And going by the recent developments, it is poised to move even higher in the days to come. It should be noted that gold and the economy share somewhat of an inverse relationship in that when the economy is doing well, there aren't many takers for gold. Conversely, when an elevated level of risk is perceived with respect to an economic slowdown, people like to move towards the relative safety of gold.

However, as far as we are concerned, gold is a must have in one's portfolio as a great hedge not only towards some form of economic calamity but also to protect oneself from the devaluation of fiat currencies that the central banks across the globe have been undertaking with great intensity these past few years.

02:50   Chart of the day
With the Indian stocks markets continuing to touch new highs, one thing is certain: investors are certainly bullish on India! This can be clearly reflected in today's chart of the day.

Benchmark index, the NSE-Nifty trades at a one-year forward PE of 15.5 times, the second most expensive benchmark index amongst key global markets. Japan leads the pack with its index, the Nikkei 225, trading at a one year forward multiple of 16.57 times, while the US trades closer to 14.15 times (DJIA).

India amongst the most expensive markets globally?
*-S&P 500, India - Nifty; Arg- Argentina

Yes, there are arguments that Indian stocks may still seem attractive given that the earnings cycle is not at its peak and thus there is a high probability of earnings playing catch up, thereby justifying such levels. Not to mention that the broader economic factors such as lower crude price, and its impact on the deficits have added to the buoyancy. Plus with the interest rates scenario being in favour of the country as inflation seems to come under control is something that puts India in a sweet spot.

It may be noted that the average one-year forward PE of the Sensex (we have not calculated the same for the Nifty) has averaged to about 16.7 times. Now while the one-year forward PE figure mentioned may seem attractive, it may be noted that this can easily be changed by taking a lower earnings growth rate.

However, we will not delve upon this topic here. We would like to reiterate the point that we had seen through a study we conducted a few months ago about what kind of market rallies are longer lasting - those led by PE expansions or led by higher earnings. Goes without saying that the latter wins here, hands down. As such, if and when the earnings do catch up, the probability of the 'good times' lasting for a longer time will remain high.

04:10
In anticipation of good times ahead, mutual funds have been making changes to their portfolios. So... what have they been buying? Well, it turns out that 'cyclicals' are the flavour of the season. Those from the banking, automobile, engineering, and NBFC spaces are particularly the ones being sought after. As per data provided by the Mint, banking stocks have seen the largest change in AUM holding - with allocation going up to as much as 21.88% as compared to 17.66% a year ago. Industrial capital goods (allocation up by 1.7% from a year ago) and auto stocks (1.54%) have seen favour from this set of investors as well.

On the other hand, export focused sectors such as information technology as well as consumer non-durables sectors have lost favour from mutual funds. IT stocks - which continue to have the second highest allocation amongst mutual funds - have been the least preferred stocks as holdings have come down from 13.84% to 10.2% over the last year. As per us, maybe it would not be entirely a bad idea for investors to look for good ideas in this space; especially considering that some of the small to midsized companies that have good long term track records seem to be trading at attractive valuations.

04:45
In the meanwhile, the Indian stock markets ended the day on a firm note with the Sensex ending higher by about 104 points. Stocks from the information technology and consumer durables spaces were in demand today, while FMCG stocks ended weak. Mid and smallcaps closed on a dull note. As for Asian markets, the same ended the day on a firm note, while European markets were trading weak at the time of writing.

04:55  Today's investing mantra
"You get recession, you get stock market declines. If you don't understand that's going to happen, then you are not ready and you will not do well in the markets." - Peter Lynch
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This edition of The 5 Minute WrapUp is authored by Rahul Shah and Devanshu Sampat.

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4 Responses to "Will there be riots soon in the market?"

BSBHAT

Feb 14, 2015

There are stocks which are overvalued against their fundamentals. we need to analyze and book the profit. The results except few companies, rest are below normal. Income refunds are not done because they are waiting to collect from this quarter to pay.Is it rosy picture?we pay interest for delayed Itax but why this excuse? so all is not well with the govt and its economy?

Like 

virendra singh

Jan 22, 2015

Equity Master has a view from quite some time that the valuations are stretched in comparison to fundamentals. Those Investors, who are following equity master are bit confused.and look like they have missed the Bus, because markets are running forward on Expressway.

Like 

Satish Munjal

Jan 22, 2015

I THINK MARKET IS DUE FOR STRONG CORRECTION MAY BE IN SECOND QUARTER 2015.

Like 

UJJWAL KUMAR MAJUMDAR

Jan 21, 2015

YES I AM OF THE VIEW THAT THE MARKET IS DUE FOR A STRONG CORRECTION IN 2015.

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