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Sensex 40,000 Coming Sooner than Expected

Mar 14, 2017

In this issue:
» Do the Valuations Support a Rise to 40,000?
» Apurva Sheth on Making Big Money from Long-term Trends
» ...and more!
00:00
Rahul Shah, Co-Head of Research

Predicting the markets on a daily basis is usually about as meaningful a coin toss. But not always. Some days you just know which way the indices will move. Today was one such day.

With the BJP scoring massive victories in the recent state elections, it was a practically a foregone conclusion that markets would open strong today. And they certainly did. As we write, the Sensex is perched nearly 500 points higher and looks good to go even higher.

At this rate, we could meet our Sensex 40,000 target much sooner than expected.

And if we do, subscribers can expect a lot more SELL calls from us.

I know this contradicts the prevailing sentiment out there. The elections have emboldened the government and we'll likely see a lot more reforms over the next two to three years. It's a huge positive for the economy and we should all be buying equities, not selling them. Right?

So why take the contrarian view?

An example may help here: Imagine a company that has grown earnings at a certain rate historically and is appropriately valued for continued growth. But then...a sudden change to the management team. The new team promises to take growth to a new orbit.

Now, even if you trusted the new team, would you assume better earnings growth and assign a higher multiple straight away?

Most investors wouldn't see any harm in this. After all, one way to make money in stocks. You invest in a company making a break from the past. You assume a higher-than-historical earnings growth rate and a higher multiple to reflect the new reality, and voila: You are sitting on good gains once the company grows as promised.

But that's not how we make money in our safe stock recommendation service, StockSelect. With this service, it is safety first. Always.

The risk in investing in a company with a new team and a new growth target is that the upside is totally dependent on the expected growth being met. If that doesn't happen, the stock can come crashing down.

In StockSelect, we invest in companies that are priced so low there's a big question mark whether the historical growth rates can ever be achieved again. Often, however, the companies deliver. And that means huge gains for our subscribers.

It doesn't take a genius to figure out where the odds are better. Not only are most new managements unable to bring about significant change, when the high expectations are not met, the downside can be significant.

Please note our original Sensex 40,000 target was not based on reforms bumping up the earnings of Indian companies. It had more to do with profit margins going back to their historical trend.

In fact we feel that it is too premature to start betting on companies on the hope that reforms will bump up their earnings.

Let the other investors do it and take stock prices higher. You can go ahead and help them...by selling your holdings that you believe are fully priced in.

For fifteen long years, we've gotten 80% of our calls right with this approach.

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------------------------------

03:15 Chart of the Day

So, the Sensex seems poised to take off...

But wait!

How can anyone be sure it will happen? What if the US Fed or North Korea or some other black swan, were to spoil the party?

Even if our prediction comes true, when can we expect to see Sensex 40,000? From an investor's point of view, there is a huge difference between waiting a few months and waiting a few years.

Alas! These are questions that no one can answer with certainty. The future is unknowable... But we can make educated guesses.

If we look at the historical valuations of the Sensex, one thing becomes clear immediately. The market is not overvalued. Yes, individual stocks are overvalued, but not the entire market.

However, the markets aren't cheap either.

Sensex Is Fairly Valued

Interestingly, the Sensex P/E hasn't crossed 25 since mid-2008.

If we were to tentatively consider a P/E of 25 as an upper limit, at least in the short-term, we would still get an upside of about 13% from current levels. That's a Sensex level of 33,500.

But if that were to happen in a hurry, it would make the markets overvalued. That would be a cause for worry, not celebration.

That's why we are so focused on earnings growth. The only way the Sensex can make it to 40,000 without entering the bubble zone, is on the back of a sustained earnings recovery.

We haven't seen much evidence of that yet. But we believe a recovery could be around the corner.

Coming back to individual stocks, we believe there are still pockets of value in this market. There are stocks that are clearly undervalued from a long-term perspective. The StockSelect team is in pursuit of one as we speak of their report later this month. Watch this space...

03:45

By the way, did you read what Apurva had to say about trading successfully in this volatile market. On Saturday, Apurva authored The 5 Minute WrapUp and explained how he makes big returns with the help of long-term trends.

He calls it his SCOREFASTTM system.

Here's what Apurva had to say...

  • I knew there was scope to make higher returns by identifying long-term trends. So I set out to build a trading system that could benefit from these long-term trends.

    Now, the best time to get into a long-term trend is just when it is reversing...from down to up. Getting into stocks that have fallen sharply...and are ready to move up...has two main benefits: One, the downside is limited with beaten-down stocks. And two, you can maximise profit potential by staying in them as long as the uptrend lasts. With this approach, we can limit risks while not compromising on rewards.

    I have built my system after studying hundreds of stocks experiencing cyclical up and down trends. In our backtests, this system has generated 50%, 61%, 109% and even higher returns in a matter of just weeks to a few months.

But how can you use this in practice?

Well, you have two options: One, learn the system yourself and apply it. Or allow Apurva do all the work and send you stock recommendations based on this system.

If you're considering the second option, Apurva has good news for you. He has just launched a new trading service based on his proprietary SCOREFASTTM system.

It's called Peak Profit Alert. I asked Apurva about it and this is what he had to say...

  • Peak Profit Alert (PPA) is a service which aims to identify stocks which are on the cusp of a long-term reversal...from down to up.

    There are two main benefits of entering stocks which have fallen sharply and ready to move up. We are limiting risk by recommending stocks which have already fallen a lot so there is limited downside left. Secondly, we maximise the profit potential by staying in the stock as long as the uptrend lasts as we exit only when the trailing stoploss is hit.

    So, you see we attempt to limit risks but do not compromise on rewards. And there is a unique process which helps us do that. I have built this process after observing hundreds of stocks going through a cycle of up and down trends.

    I call it the SCOREFASTTM system. The system derives its name from nine indicators it uses to identify stocks which are on the cusp of a long-term reversal. This system enables us to identify trading opportunities that could potentially generate big returns in as little as a few weeks to a few months.

    Let's check out what indicators form this system.
    1. Stretch Indicator: The stretch indicator tells us how far (in percentage terms) a stock is from its 200-day moving average (DMA). Stocks that have deviated far away from their mean tend to revert back to the mean.
    2. Crash or %Drop: The crash indicator tells us how much (in percentage terms) a stock has crashed from its highs. Stocks that have crashed more than 30% are more inclined to move up again.
    3. Oscillators: Oscillators are indicators like Relative Strength Index (RSI), Moving Average Convergence and Divergence (MACD) and Rate of Change (ROC) help identify a shift in momentum from down to up.
    4. Reversal Patterns: A break out from reversal patterns like inverse head and shoulder, double bottom, rounding bottom, and rectangle patterns often confirms a reversal of trend from down to up.
    5. Entry/Exit: We recommend a stock only after it has witnessed a sharp fall and have limited downside left. And we exit a stock only when the up move has exhausted.
    6. Fibonacci Retracement: Retracement levels are specific intervals or percentages like 38.2%, 50%, 61.8% and 78.6% of the previous move around which the stocks tend to find support or resistance. We look at price action around these levels for identifying an opportunity.
    7. Stock Cycle (Accumulation): The price of every stock moves in a repeating 4-phase cycle: Downtrend-Accumulation-Uptrend-Distribution. We look for stocks that are in the accumulation phase and are ready to move in the uptrend phase.
    8. Support and Resistance: Previous highs and lows act as supports for stocks. So, we look for stocks trading near such multi-month support levels.
    9. Time: Stock prices tend to stay in a range for a while before they can move further up. Once the stock has spent adequate time consolidating gains, one can enter for the big upside.

    That's a comprehensive list of indicators. Only when all the above conditions are met we will make a recommendation to buy a stock.

    And given that these conditions are so stringent we wouldn't have more than 20-24 recommendations in a year. And that's fine as we want to look for only those stocks which could potentially generate big returns. For us quality is more important than quantity.

    Some of the stocks in our backtest have gone up by 50%, 55%, 100% and even more...in just a few weeks to few months. So, you can be sure that you will get only those recommendations which pass the SCOREFASTTM test and have the potential to be big winners.

You can know more about Peak Profit Alert here.

04:45

After opening strong, the Indian stock markets were trading positive on the back of the favorable state election results. All sectoral indices were trading in the green. At the time of writing, the BSE-Sensex was trading up by around 488 points. The biggest gainers were banking and capital goods stocks.

The BSE Mid Cap index is trading up by 1.5%, and the BSE Small Cap index is trading up by 1.1%.

04:55 Today's Investing Mantra

"Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a fly epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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