Stockmarkets: Where to from here?

Now that is the type of odds any investor would take any day. As per a leading daily, a random portfolio of stocks created during the lows of March would have resulted in every second stock doubling over the next six months or so. In other words, even if the other half of the portfolio did not move at all, it would have still meant an annual return of 100%.

However, investors who are feeling disappointed on missing out on the rally and want to atone for the same by investing at current levels, better watch out. A lot of experts feel that the rally may have outlived itself, at least in the short run and hence, expecting similar returns to the ones achieved in the past few months could be nothing short of an exaggeration.

In fact, an analysis conducted by our team a few days back based on dividend yield of the benchmark Nifty and the expected future three year returns had also revealed that returns over a medium term period from here on could at best be 10%-12% based on historical data.

Of course, the returns can be higher provided earnings of India Inc. grow at a faster rate than what was witnessed in the past. However, with the Indian economy expected to grow in the region of 6.5%-7%, any such possibility looks remote indeed.

The second factor that might take markets higher than what fundamentals warrant could be the excess liquidity in the global markets. But as it has been proved umpteen number of times in the past, reliance on these inflows without an eye on fundamentals is not without its share of risk. A substantial chunk of such inflows tend to have very short term goals and hence, little signs of trouble and they could disappear just as quickly as they came in, leaving investors in the lurch. Thus, either waiting for the markets to undergo some meaningful correction or not expecting outsized returns would indeed be among the best strategies to have.

Now, a model to predict human behaviour
Are you under the impression that financial markets always get asset prices right? At least that is what the Wall Street analysts armed with their models and spreadsheets thought so. What they instead witnessed is the biggest financial crisis in the world since the Great Depression. So where did these 'financial engineers' go wrong?

As per The New York Times, the crux of the failure was the mathematical models of risk that suggested that all those complex financial instruments were safe. While these models took into account the expected returns and the default risks of the instruments, what they failed to capture was human behavior and its potential for widespread panic.

As a result, a new focus of research has emerged which is trying to model the mechanics of panic and the patterns of human behavior. We are not sure how that will eventually pan out. More importantly, will it be fool proof? Will these models turn out to be entirely right given how difficult it is too predict human behavior? We remain skeptical as of now.