Key Factors that Led to Sensex's Historic Rise from 57,000 to 67,000

With every passing day, the Indian stock market is making new lifetime highs.

In fact, the Sensex has closed above 67,000 and the Nifty has closed in on 20,000.

But the main action is in midcaps and smallcaps. After a correction earlier this year, the stock market is back on its way up. Investors and traders have returned with a vengeance looking for the best midcap stocks to buy and the best smallcap stocks to buy.

In fact even the IPO market is showing some signs of life. Due to the positive market sentiment, investors would be eager to consider investing in IPOs again.

In this editorial, we will consider two questions.

• What are the reasons behind the rising stock market?
• What should investors do now?

First the reasons for the rising market...

The extremely simple, one word answer to this question is liquidity.

By that we mean there is a huge amount of money flowing into stock markets around the world, which is driving up stock prices.

So this leads us to know why so much money is flowing into the markets these days.

And this is not an easy question to answer.

The main reason why investors and traders pump in money into stocks is because they believe that stock prices will go up, i.e. they are 'bullish'.

So why is everyone bullish now, especially considering the fact that everyone was 'bearish' just a few months ago when the market was falling?

If you read the financial news, you will get many reasons.

• The US will avoid a recession this year
• The US Fed is near the end of its interest rate hiking cycle
• Corporate profits are at record highs
• Inflation is falling which is helping consumer spend money

In India we have additional reasons.

• Better than expected monsoons against an expectation of El Nino
• Decline in raw material costs which is the biggest lever for margin expansion
• China plus 1 in some sectors
• GST collections hitting all-time highs every month i.e. strong consumption
• Positive FII flows over the past 3 months
• Steady rise in SIPs i.e. strong retail participation

This is all true.

But here's the real reason...

As per an old piece of market wisdom, the only thing we can say for certain about stock prices is that they will be uncertain.

This is a little ironic because the market hates uncertainty. After all, we associate uncertainty with fear and fear with falling stock prices.

But that's only one side of the coin.

What's the other side?

Narratives.

Everyone who invests their hard-earned money in the stock market know they can't predict stock prices...but they still try.

Why?

It's because we like to think we are in control of our money. Narratives helps us feel comfortable about investing. It keeps fear away. Most importantly, it helps our minds fight back against uncertainty.

Benjamin Graham, the father of value investing, once famously said, 'In the short run the stock market is a voting machine. But in the long run it's a weighing machine'.

By 'weighing machine' he meant stock prices will move based on fundamentals alone...in the long run.

What does 'voting machine' mean?

It means that in the short run, stock prices are driven by people's emotions. These emotions are greed and fear...and its derivatives like FOMO.

Uncertainly fuels fear.

Narrative fuels greed.

Think of all the stories you've read about why a stock is great. They were all narratives.

We're not saying narratives are bad. But they are less about explaining something to you and more about making you feel good about your decision to invest.

The market is filled with narratives right now about why the market will keep going up. And that's why it is going up.

So what should you do? Is it the right time to jump in to the market? Should you wait on the sidelines? And if you're holding stocks now, should you sell, continue to hold or buy more?

Let's find out...

Should You Buy Stocks Now?

We can answer this question in two parts.

The first part is for those who have already bought stocks. The second part is for those who haven't bought any stocks yet. These are either new investors or returning investors.

Let's answer the question for existing investors...

If you already own stocks and are looking to buy more, then you have to be very selective.

Chances are you already have at least some good stocks. Do you really want more? You will have to first decide if you want to add more shares of the stocks you already own or buy new stocks.

This is not an easy decision. You could consider selling the bad stocks in your portfolio and investing the funds received in your good stocks.

If you're convinced you have invested in only good stocks, then perhaps you don't need any more. You could consider investing fresh funds into these same stocks.

To make these find of decisions, the valuations of the stocks will be very helpful.

Let's stay you own a stock and want to know if you should buy more of it or buy a different stock. How do you go about it?

First look at their valuations. Compare their PE ratio and PB ratio. The lower the better.

Be aware that stocks from different industries shouldn't be directly compared like this. But still, this comparison will give you a rough idea on which stock is cheaper.

Then check the trend in the stock prices. If one stock has run up a lot and the other stock has not, then study the lagging stock seriously. It may have more upside potential. On the other hand, it may be lagging the market for a good reason. Find the reason.

Also check their growth prospects. If one stock is going to face short-term headwinds but the other stock is growing without any problems, then the second stock might be the logical choice, all other things remaining equal.

Finally, reflect on the reason you bought the stock you are holding in the first place. Did it achieve the target price you had in mind when you bought it?

Perhaps you think that buying the stock was a mistake in hindsight. In that case, your decision is simple.

Has it outperformed or underperformed the market? Check the Sensex or Nifty level when you bought the stock and the level now. Compare the percentage gain in the index to the percentage gain in the stock. This exercise is always useful. Equitymaster's Intelligent Portfolio Tracker can do this for you.

After asking yourself these questions and digging into the fundamentals and valuations of both stocks, you might come to the conclusion that the stock you're holding is the better choice.

In that case, your choice come down to just holding on or buying more of it. This decision will depend on how much the stock has run up already. If it has gone up a lot (say it has doubled or tripled), you can consider a partially sale and take some money of the table.

Now what if you're a new or returning investor and haven't bought any stocks yet?

Well, you have the advantage of starting with a clean slate. Yes, this is an advantage because you don't have any burden of thinking about existing stocks in your portfolio.

Also, returning investors should forget about any past losses as long as you've learned from them. Remember, profits are always made in the future.

Choose you stocks carefully. Avoid stocks that have run up too much. Don't buy the most overvalued stocks in India.

You can consider solid choices like the ones in the following stock screeners...

• Top growth stocks
• Most undervalued stocks
• High RoE stocks
• Debt free stocks
• Consistent compounding stocks

We also highly recommend reading this editorial - Your Long Term Investing Checklist.

Here's an excerpt...

• It's said that in the stock market more than 90% of traders lose money in their trading activities in the long term.
  
  Among the remaining 10%, most don't make much profits, certainly not enough to sustain a good lifestyle. Only about 1% of all traders make consistent profits which can justify taking up trading in the first place.
  
  And it's only a small fraction of this 1% who actually get rich from trading in the long term. Yet almost every trader thinks he/she can beat these odds and get rich by trading in stocks.
  
  This is a fallacy.
  
  But there is no reason to be disappointed. The stock market offers a simple way to beat the odds and beat the market. It requires you to become a long term investor.
  
  In this regard, the Buffett quote above, is particularly illuminating. The market does indeed reward those who successfully apply the rules of long-term investing.

Now this leaves us with only two other options to consider.

• Should you hold on to your stocks?
• Should you sell your holdings?

As far as holding is concerned, the answer is yes but only if the following criteria are met...

• You are investing for the long-term
• The fundamentals are strong
• The original reason you bought the stock is still valid
• The stock has not run up so much that it has become overvalued
• There are no concerns about the integrity of the management

As far as selling is concerned, if any of these points are not met, you should seriously consider selling, either partly or fully. And in the case of any doubt about the integrity of the management, it should be a complete sell.

There is also another reason why you should consider selling.

This is when you have identified a better alternative. If you have carefully evaluated a stock and found it to be better than the one you have in your portfolio, in terms of both fundamentals and valuations, it's usually a good idea to switch.

Your money would be put to better use. After all, there is no need to become attached to the stocks in your portfolio. Your goal should be to maximise your profits from the market rally.

Happy investing!