Is the stockmarket rise justified? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Is the stockmarket rise justified? 

A  A  A
In this issue:
» US looks to inflation to solves its problems
» Unexpected drop in Ireland's GDP highlights risks from the PIIGS
» Indian FMCG on capacity expansion overdrive
» US$ 1 bn market cap companies hit all time high
» ...and more!!

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00:00  Chart of the day
We may be tempted to think that the Indian markets have finally started moving upwards for some solid and substantial reasons.

And that's quite natural actually. When we hear news of any positive development, we're quick to search for a positive reason that could be attributed as the cause for that development. As soon as we find one, we fixate on it. To the point that we don't even stop to think that the reason we have chosen might not have anything at all to do with the positive development.

The media has been quick to attribute the recent rise in the markets to various positives like 'India's expected GDP growth' and 'an expected 20% corporate earnings growth' etc. etc. But a closer look reveals that these things were known even a few months back, when the Sensex was stuck at the 17,000 level. Then why this sudden rise now?

Today's chart of the day may offer some pointers.

FIIs have been aggressively pouring in investments into the Indian markets. So much so that their buying has managed to take the markets higher despite net selling by domestic mutual funds. Since the markets have touched 17,000, FIIs have poured in a hefty US$ 11.2 bn into Indian stocks, fueling the rise from then on. And FIIs as the only cause can surely be singled out. This is because during the same time, domestic mutual funds have actually been net sellers to the tune of US$ 2.5 bn.

Data Source: Business Standard

And so, the actual reason for this sudden rise may be nothing more than mere liquidity. Liquidity that is sloshing around the globe. Liquidity, especially from developed countries, where huge amounts of stimulus spending and low interest rates is what governments have desperately resorted to. If indeed this is the only reason for the rise, it makes for some very shaky foundations for stock prices to be based on.

When it comes to economic matters, everything right now with respect to the US and India is as different as chalk and cheese. Inflation is no exception. It has remained out of the comfort zone in India for quite some time now. And the policy makers are fighting hard to bring it under control. The US on the other hand is beset with problems of exactly the opposite kind. Here, the threat of deflation is looming large and the US Fed seems to be willing to do all it takes to light atleast some fire under inflation. This, the experts believe, would make the enormous burden of debt bearable and would perhaps kick start the much needed spending and investment activity in the economy. Alas, things are not as easy as they sound. The inflation valve is not your ordinary valve. Here, the flow of the fluid cannot be set as per one's desire. More often than not, the target is either overshot or undershot. Thus, try as the US Fed could, there are very strong chances that the inflation spirals out of control. And the sad part is, by the time the US Fed would realise, it would be too late. No wonder, gold prices are going through the roof.

That said, when it comes to managing the financial system of the world's largest economy, possibly no one knows better than Paul Volker. This ex-chief of the US central bank was in charge of the safekeeping the US during its very volatile days of the early 1980s. Inflation then had reached a peak of 13.5%, and Volcker brought it down to 3.2% through his successful and strict policymaking.

Now, in what would be his most scathing remarks on the state of affairs in the US, Volcker has come down heavily on the entire US financial system. And he has not spared anyone! Bankers, business schools, and regulators, all have come in the line of fire.

He has even heavily criticized the Fed for being 'a little too infatuated with its own skills and authority'. As he's said, "I think it's fair to say there was a certain neglect of supervisory responsibilities, certainly not confined to the Federal Reserve, but including the Federal Reserve, I only say that because the Federal Reserve is the most important in my view."

We are all familiar with the Eurozone crisis. It was triggered last year with Greece declaring its huge debt problem that led to questions about the stability of the Euro. Portugal, Italy, Ireland, Greece and Spain were collectively referred to as the PIIGS. These were the countries facing supernormal debt problems. It was feared that if the PIIGS went under, the Euro would collapse and the Eurozone itself may cease to exist.

However, in recent times, things were getting better as these countries started to take austerity measures. Last week, Ireland and Spain even managed to garner demand for their bonds. But things are still not good. Ireland reported a drop in its GDP numbers yesterday sending out a new wave of panic that the PIIGS may still not be out of the water. Amidst these renewed fears, opinion on Europe remains divided. Some experts think that the Euro will not fall substantially and will eventually strengthen against the dollar and other currencies. The others think that the problems in Europe will continue to grow and the growth of the region will remain sluggish.

India is growing. And growing fast. Not just in fancy numbers and macro talk. The fact is visible on the ground. In aspects investors would greatly be interested in. Take FMCG companies for instance. With growth comes prosperity, and with prosperity comes high consumption. Hence, one would expect FMCG companies to expand in terms of reach as well as products. And so it is.

Some of India's leading FMCG companies including Nestle, Coca-Cola and Tata Coffee are investing over Rs 18 bn in the next few months to expand capacity or for inorganic growth. Nestle India is investing Rs 9.5 bn to set up two units to manufacture instant noodles and infant foods in Karnataka and Haryana. It also announced the setting up of a research & development centre at Manesar at an investment of Rs 2.3 bn. The centre will develop products specifically aimed at the Indian market. Coca-Cola India is investing Rs 5.5 bn to set up a greenfield beverage plant in Karnataka. Quite clearly, with India growing, it is also consuming. And international FMCG giants are betting big money on this fact.

Indian stockmarkets have been on an upward trajectory for some time now. As a result, many companies have entered the billionaires club. Infact, the number of Indian companies with a market valuation of over US$ 1 bn has hit an all-time high according to a study conducted by the Economic Times.

Not just that, there have also been many new entrants to this club. As on date, the total number of billion-dollar companies (based on the current exchange rates) stood at 207. In comparison, this number stood at 206 in January 2008. That was when the markets hit an all-time high. Not surprisingly, this number had more than halved in early March 2009. FIIs apparently use the billion dollar market capitalization as a filter to make investment decisions. But we urge you dear reader, not to fall for the same. After all, investment has to be made in stocks if the price which they are trading at is attractive. Investing in equities because the market cap is rising will only burn your fingers at some point.

After opening weak, markets picked up momentum and were trading well in the green at the time of writing this. The BSE-Sensex was trading 112 points higher. Gains were seen in the consumer durables and realty space. IT stocks were however trading flat with a negative bias. The rest of the Asian majors were trading flat, with the exception of Japan, down 1%.

04:55  Today's investing mantra
"Acknowledging what you don't know is the dawning of wisdom." - Charlie Munger
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9 Responses to "Is the stockmarket rise justified?"

UMR Perumal

Sep 25, 2010

Of late you have been writing frequently about the current valuations of Indian market. Your view is that the market is in general fully priced. This you have said based on PE Ratio and Yield of NSE Index.

I see another measuring rod i.e. Price to Book value. Price to BV as on date is only 3.88 whereas it was 6.55 when it peaked in 11 Jan 2008. If that parameter is to be considered, then the stock price should go up by another 65 percent to catch up with the previous peak.

Can you give your valued comment in the 5Min wrap up on the current valuation based on price to BV.


R Sathyamurthy

Sep 24, 2010

The stock prices have moved on shaky grounds, as you rightly pointed. So, stop blaring out "inviting" emails to investors that says "I told you before about this stock at this price and it is now quoting here!". Your double play sucks.



Sep 24, 2010

yes indian economy is very strengthen and growing fastly,after 2015 india are becoming an most powerful country among the world so our market is so attractive and touch an new high after every minor or major correction,



Sep 24, 2010

Are you playing Devil's advocate? After suggeting sensex would touch much higher levels by 31 Aug 10 now you are expressing doubts about this bull rally. You can not run with hares and hunt with wolves. Make up your mind.


lakshman pardhanani

Sep 24, 2010

You clearly have the foresight and integrity to warn potential investors about the risks attached to investing at this point in time. Very refreshing to see. When the time is right, I shall certainly consider investing in one of your funds.



Sep 24, 2010

I am inclined to believe that the scalilng of SENSEX to 20K is largely due to FII funds pouring in. I feel the domestic contribution will take a year to make a difference.



Sep 24, 2010

e x c e l l e n t+ !



Sep 24, 2010

yes, it is very temperory sensex going high.
almost covering this month 30th sept, there weill be short fall in the market.



Sep 24, 2010

the number of Indian companies with a market valuation of over US$ 1 bn has hit an all-time high according to a study conducted by the Economic Times. has came o a higher extend to incease mans identification

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