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Stockmarkets: Time to turn rational - Views on News from Equitymaster
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  • Oct 6, 2004

    Stockmarkets: Time to turn rational

    The current rally on the Indian bourses reminds us of those early months of the year 2000 and also of the more recent January 2004 when the Indian indices created history, once again, by breaching the most sought after and magical figure of 6,000 on the Sensex. In fact, there are already talks amongst marketmen of the index making new lifetime highs. But, amidst all this, what we tend to overlook is what happened next i.e. post the index highs. Now, here we do not intend to be tagged as spoilsports, but we do believe that it is better to exercise caution now (especially when stock markets are ascending at rocket speed) than to regret later.

    In a bull market, it generally happens that investors tend to build astronomical expectations from equities and they start to assume that stocks across the equity universe would provide them with handsome returns (which they do in the short-term, but at considerable risks). Thus, when the index heavyweights run up, the focus shifts to mid-caps, however, when in a bear market, these are the most neglected stocks due to lack of positive sentiments. The former is what is precisely being witnessed in the current bull run also. The chart above shows the NSE Nifty and the CNX Mid-cap 200 index behaviour in 2004. Apart from the fact that the mid-cap index has outperformed the Nifty during this period, another point worth noting is that while the Nifty has still some way to achieve its new high, the mid-cap index is comfortably trading at levels much higher than its January 2004 highs.

    When investors find themselves amidst a bull run, they tend to get attracted towards mid-cap stocks because valuations of these look relatively cheaper when compared to index heavyweights. More often than not, the main reason for buying a mid-cap stock is "It is a turnaround story!" And, after a certain point in time, investors tend to neglect fundamentals and valuations and expectations rise even higher. Often, it is a forgotten fact that larger companies, with their financial muscle and balance sheet, are always in a better position to capitalise on any upturn. Of course, the larger company has got to be managed by a credible group.

    Our advice to investors at the current juncture would be that before building any kind of expectations, it is important to look at parameters like the company's management, the business model of the company and its past track record. In a market like India, which remains relatively under researched, there will be certain companies worth investing for the long term, which need to be identified. Now, here, while we accept the fact that availability of economic, sector and company data are not easily accessible to a retail investor, which makes research a tough job, an alternative to this could be to invest through mutual funds, which are managed by professional money managers. Nonetheless, if one still wants to invest directly into stock markets, then not only should the investments be scattered amongst mid-caps and heavyweights from diverse sectors, a staggered investment approach is also a good discipline to follow.

    Among other things to be kept in mind are those of return expectations and investment horizon. The return expectations have to be rationally driven, as super normal profits (akin to 2003) are not always possible. We believe returns in the region of 15% per annum over the next few years from equity investments is a reasonable expectation. Investors must remember that the additional returns (relative to the risk free rate of return on government bonds) on equities come bundled with the high risk involved in them.

    Apart from expectations, investment horizon also plays an important role because timing the market and trying to catch the troughs and peaks is a very difficult task. However, over a longer period of time, one can be reasonably sure of the returns that one can get from a good investment. We would like to conclude here by asking investors to remember the following saying by one of the world's foremost investment guru, Mr. Warren Buffet,"Investors should be fearful when others are greedy, and greedy when others are fearful."



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