An 80% chance for a market decline? - The 5 Minute WrapUp by Equitymaster
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An 80% chance for a market decline?

Jan 24, 2015

In this issue:
» Currency wars on the rise
» Will ECB's bond buyback program spruce up asset prices?
» Round up on the week gone by...
» ...and more!

  Chart of the day
The week gone by was a good one for the Indian stock markets. The BSE-Sensex gained by over 4% in the past seven days. Market sentiments were already buoyed with the RBI beginning its interest rate cut cycle; to add to that, Mr. Draghi's gift to the world (emerging markets especially) came in as a bonus.

The Sensex continues to make history as the days go by. And in the process Indian stocks are becoming more and more expensive as the earnings growth is not moving in tandem with the rise in prices.

As per the BSE website, the Sensex PE currently is a shade below the 20X figure (based on its trailing twelve month earnings). With this, the Indian stock markets seem to be entering the frothy stage now. We say this because over last two decades, there have been about 4,950 trading days, of which market traded above the 20x mark about one-fourth of the time.

Further, if we remove the 10% extremes during this period, this stat comes down to a little less than 20%. The chart below gives an indication of the same.

Indian stocks entering the frothy zone?

While Indian stocks may not yet be in the 'overvalued' territory (as markets have moved up as high as 22x to 23x), it would not be wrong in saying we are on the border line.

No doubt there are a host of factors pointing towards the achche din continuing from here on. Some of which include:

  • The very high foreign investor interest. 'Never has India been so loved by global investors' read the title of an article published by the Mint recently. An excerpt from the article - 'The Bank of America-Merrill Lynch (BofA-ML) survey of global fund managers for January shows that exposure to India is around four standard deviations above the historical mean among global emerging market investors. '

  • A bigger pipe of cheap money has opened up - ECB stimulus

  • Crude prices are favourable

  • Inflation is seemingly under control leading to lower interest rates expected going forward

  • A bounce back in earnings cycle.
The year-end target for the Sensex is about 14% higher from current levels, as predicted by some major foreign brokerage houses. At the same time, there are reports as to the high probability of the Sensex's EPS consensus being lowered for the current year, given the results for the quarter ended December 2014 not having met expectations due to various factors - domestic and global.

Identifying the rationale for market declines may be easier in hindsight; but when we are amidst bullish phase, there are always reasons one finds as to why things may be different this time around. This has happened in the past, and will definitely continue to happen in the future as well.

The fact that Indian markets are amongst the most expensive global market in the world, coupled with the messy situation across the world, things are bound to take a turn for the worse as and when the tide turns.

Numerous studies (some conducted by us too) have shown that there is an inverse relationship between long term returns and valuations of the broader market. In times such as the present, playing the probability game would be a good approach.

Yes, while the Indian economy may be more insulated from the global economy, and the long term story does remain intact, all of the above mentioned points (plus many more) do indicate that a considerable amount of the upside is already priced in. We believe it would not be a bad idea for one to reassess his portfolio and keep some cash aside to take advantage of any market declines that may occur in the coming future.

With the way the markets have behaved in recent times, do you think Indian stocks have reached the frothy zone? Let us know your comments or share your views in the Equitymaster Club.

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Now that the ECB has finally announced QE, it is important for investors not to get complacent. The last seven days has seen the biggest rally in the BSE Sensex since 2009 over the same duration. The benchmark index, as mentioned above, is quite close to a PE of 20. This is not a time for exuberance. Yet that is exactly what we are witnessing right now. But what is more worrisome is the fact that many investors seem to think that the new round of money printing will benefit most asset classes! This is why barring a few industrial commodities, the prices of many global stock indices and commodities closed up on the day of the announcement.

We do not belong to this group of over enthusiastic investors. Simple logic is enough to understand that all assets won't benefit equally from QE. For example, base metals are good bets only is a strong economic growth scenario. This is clearly not the case in today's world. The fate of stock markets around the world too would be determined by corporate profits in the respective economies. India will be no different. If expectations of economic reforms are belied, no amount of QE can sustain this bull market.

Sample these quotes. 'We are holding a tiger by the tail', says one commentator. There could be a short squeeze on the dollar says another. And there's another one which says we are in a world that is dangerously unanchored.

Well, you have every reason to worry when you hear quotes such as these and that too when they have been spoken from a platform as big as the World Economic Forum in Davos, Switzerland. Please understand that domestic demand in most industrialised nations across the world is a pale shadow of itself. And therefore the only option left for them is to boost exports by way of devaluing their currencies. Little wonder, everyone's worried about the currency wars that this move has given rise to. In effect, what we could see in the times to come is a race to the bottom.

Is this a good thing? Certainly not.

Devaluing currencies in order to boost export driven growth is akin to using quantitative easing to boost domestic demand as per us. Therefore, both appear to be a flawed strategy and having a small portion of one's portfolio in gold is perhaps the best way to counter the huge risks arising out of such moves.

Global markets around the world remained on a firm uptrend in the week gone by. The optimism was fuelled by the European Central Bank's (ECB) decision to launch a bond-buying program in March to stimulate the deflation-hit eurozone. Under the program, corporate and government bonds to the tune of 60 bn euros a month will be purchased. The higher liquidity is likely to drive global equity markets higher. France was the biggest gainer up 6% for the week. Even the German and UK indices registered gains of over 4%. The US markets were up by a 0.9% for the week.

The Asian indices hit new highs as ECB unveiled its 1 trillion euro stimulus package on the last trading day of the week. India was the biggest gainer recording a gain of 4.1% for the week. Each of the Japan, Singaore and Hong Kong indices were up by more than 3%. However the Chinese index was marginally down by 0.7%.

The last trading day of the week saw an uptick in Brent crude due to market certainty after the death of Saudi Arabia's king, Abdullah. However the US crude fell on signs of oversupply. Saudi Arabia's new king, Salman, is expected to continue the OPEC's policy of maintaining output to protect market share.

The Indian stock markets breached the 29,000 level for the first time to end the week at a life-time high of 29,279. Improving macroeconomic conditions coupled with European stimulus measures helped key indices to reach new highs. Barring FMCG, all sectoral indices ended the week on a positive note with the stocks in capital goods, metal and banking sectors leading the gains.

Performance during the week ended January 23, 2015
Source: Yahoo Finance

 Weekend investing mantra
"If investing is entertaining, if you're having fun, you're probably not making any money. Good investing is boring." - George Soros

Editor's note: There will be no issue of The 5 Minute Wrapup on 26th January 2015 on account of Republic Day.

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3 Responses to "An 80% chance for a market decline?"

Gunesh Apte

Jan 26, 2015


This is a very good article about alerting the investors that, we are approaching high valuations in Sensex and Nifty. Most of the time, new investors join the market at such levels, and hence often can not make good money in markets. If investors understand these concepts of valuations and margin of safety, more people can be benefited by investments in market.

At the same time, it is quite difficult to keep booking profits in fundamentally good and solid companies, if one is going to hold those for 10-15 years. This causes dilemma for long term investors, as to whether they should really book profits if the stock is marginally overvalued or not. In such bull market, often the stock price keeps going up and one wonders whether s/he should continue holding good stocks.

Finding a balance between buy/hold strategy (like Warren Buffet) and buy/sell strategy is always a challenge.


rafat merchant

Jan 24, 2015

Yes of course Cautious is the key mkts have raced far ahead of fundamentals

Like (1)


Jan 24, 2015

yes it has courtesy cheap money all around which is not going into increasing wealth and thereby consumption but finding it's way into markets. Even indian companies through some holding cos might be jacking up their prices.Issue is retail investors like us are either losing out or sitting on the fence.

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