The stock market seems to have gone wild. Is there any sense left in the sensex is what the retail investors are debating. They are clueless as to the gravity-defying Sensex's vertical journey - from 6000 level to 11000 in a span of just 18 months. Do the long term economic fundamentals and growth prospects justify the vertigo-inducing steep climb? Naturally, the ordinary investors have begun to entertain doubts. His grey cells are buzzing with questions as to whether the steep vertical movement of sensex is real and sustainable. Or it is a bubble to burst any moment? His quandary is understandable. Should he buy into fresh stocks? Or remain invested if he is already in. Or should he shed some of his extra flab to revert to his original asset allocation?
From 6000 in January 2005 to around 11000 now (end March), Dalal Street simply has been in an unprecedented dazzling mode for the past 18 months. So much so that the zealots of its northward movement are exuding confidence that there is no stopping of it now.
But there is a strong counterpoint which is also being hotly debated: is it a short-term euphoria packaged with long-term strong fundamentals or is it too much of liquidity chasing too few stocks? The prime base of the counter viewpoint is that with dividend yield of 1.3 and the price earning (P/E) ratio of 20.2, the market is apparently precariously poised.
But first things first. The strongest point rallied in the favour of the 'unstoppable sensex' argument is that this rally was long overdue. It was in early 1990s that immediately after taking to reform route, India was billed as an 'emerging economy' by none other than the guardians of global economy like the World Bank and the International Monetary Fund (IMF).
Growth Story
Though the fits and starts pattern exhibited during the large part of 1990s in furthering the liberalization programme kept a whole lot of global investors in a skeptical mode, things began changing around Circa 2000 when experts and academics began talking at length about India (of course, alongwith China) as the potential drivers of global economy in seminars and lectures.
The BRIC theory later propagated by Goldman Sachs further galvanized the Indian growth story and since then global investors have shown unprecedented interest in the Indian market. Their 'Go India' stance has further been strengthened by the continuous exceptional faring of Indian economy (with GDP growth now firmly in 7-8.5% category). The icing on the cake is: the much needed capital formation exercise too has registered a major upshot in last couple of years.
Apart from these, there are also a host of reasons to directly suggest that Indian economic bandwagon has got into top gear if viewed through a long-term prism. There are projections of GDP growth rate even touching double digit levels in not so distant future (both the Prime Minister and Finance Minister have started talking of this magical number as achievable), and then there is that theory which says that India will have the largest battery of young working population by year 2020. Something in the range of 600 million!
The long and short of these facts is that Indian growth story has a very sound plot and the recent spurt in stock market index has to be seen in this perspective. As one of the first thing which has fired up in anticipation of India becoming a leading economy in not so distant future.
So Far, So Good
Nobody is doubting the glorious projections and great expectations notwithstanding the fact that a lot needs to be done on infrastructure front like power, roads and ports to sustain the mammoth movement of the economy in the future. India is definitely arriving on the global economic stage and arriving with a bang. Not only that, it is all slated to consolidate its position on this stage in the time to come.
However, one question which should not be lost in the din of dazzling stock market index is: how sustainable it is given its abnormal jump within a very short time span? This is a pertinent question specifically from the point of view of millions of common investors who often get confused when market marches north unabatedly. What is there in it for them in the short to medium term? Is everything going to be as smooth as it could get for them in the short-term horizon? There are some concrete reasons to doubt that investors dabbling in the stock markets will continue to have a walk in the park.
First and foremost is the fact that the Indian stock market is presently liquidity-driven. FIIs and Domestic Institutions seem to have unleashed large amount in their kitty to ride on the wave of a soaring sensex. But the worst thing about a liquidity-driven market is that it has that unmistaken character of a fickle entity.
Momentary Interest?
From a stratosphere, it can sink with a thud if players involved could lose even momentary interest for one self-serving reason or the other. And that could be detrimental for common investors. Secondly, with the global integration of the Indian economy, any upheaval of any kind anywhere could also have a bearing on it and that could be a spoiler for the grand party on the Dalal Street.
For instance, none can speak in definitive terms about the global crude scenario and with our very high reliance on imported crude, a further rise in its international price (many in the international market are ready to bet on this proposition) would tend to slacken the fast moving pace of the Indian economy. And with stock market being the most immediate and direct barometer of the economy, it could mean bad news for the market players.
What To Do
Now the issue is: what a small investor should do when the market gets into a gaga mould when only limit for the Sensex seems to be the sky. The only effective prescription at this juncture could be: to resort to a pragmatic financial planning exercise.
To be more precise, rebalancing of one's investment portfolio and realigning it in a fashion that it has in-built shock-absorbing mechanism. For instance, if someone had put 40% of all his investments in equities, time has come for him to rework his exposure to this asset class because his 40% allocation may have grown to 50-60%. Investor should pull out part of the money from the equity and put it in debt, cash or some other assets with a view to adhere to his originally planned allocation of 40%. They may also consider dividing their portfolio into two components - strategic i.e. Long term perspective (core) and tactical short term investment.
Golden Rule
The golden rule which must be remembered here is that one should shape his portfolio according to his own long term needs and not as per the market situation. One may ask why to bring down the exposure in equity when they have been giving such high returns in the recent past? The answer could be best provided in the form of a question: what is the guarantee that equity will continue to provide hefty returns?
Another thumb rule of the financial market is that no asset class could continue to remain the top performer on a sustainable basis. Looking at the example from our own market: while debt was the flavour of the season for quite a sizeable spate since 2000, equity snatched this prized position since 2004-05. So different asset classes have their own share of highs and lows at different points in time and this fact should not be ignored at any cost.
One may also ask why park your money in debt instruments when returns from them are no longer attractive? The answer is straight: the risk element attached with them is far less vis-à-vis equity and if one has high exposure in equity, a similar or slightly less percentage of exposure in debt will act as the balancing factor. An investor should look at overall possible returns and not on the returns he is getting from the best performing asset class in last one year.
Optimism & Hype
For an average investor who often fail to realize that in the stock market, the line between optimism and hype is too thin (and many of us are rightly confused as how to dub the present condition in the stock market), it is imperative to have a portfolio which could have enough safeguards. While there are pulls and pressures of the greed factor, the pragmatism simply lies in not getting carried away by them.
The foreigner giveth. Then he taketh away. Or so it is in the case of India's main stock index, the Sensex. For those who have no clue, the Sensex is a bundle of 30 of the largest stocks on the Bombay Stock Exchange. It is the Dow Jones Industrial Average (DJIA) of India. And in the last three or four years, it's been one of the hottest places in the world to put your money - thanks in large part to an onslaught of institutional dough. While I visited India a few weeks ago, the fiery Sensex finally poked through mythical - and psychological 10,000 mark and then immediately inched closer to 11,000 level.She joined the illustrious bedmates of the Dow, Hong Kong's Hang Seng and Japan's Nikkei.
Even though the Bombay Exchange is the oldest stock exchange in Asia, its 3,500 companies have a combined market cap of only $466 billion - compared to GE's cap of $355 billion and Microsoft's massive |
On paper, 10,000 seems as good a number as 7,775 or maybe 11,280. Maybe so in the general, dispassionate sense. But as far as investor sentiment - or exuberance in this case - 10,000 makes an extremely important milestone. Encouraged by the rampant growth in India - and the corresponding gains in the stock market, foreign institutional investors shoveled money into the Indian market throughout the Sensex's frenzied seven and a half months run from 7,000 to 10,000. (Here one wonders whether the foreign investment forced the same run up that it tried to harness and profit from.)
Now you may ask how it could possibly happen that a short time of heavy institutional ramping could affect an entire market. Here's how. Even though the Bombay Exchange is the oldest stock exchange in Asia, its 3,500 companies have a combined market cap of only $466 billion - compared to GE's cap of $355 billion and Microsoft's massive $255 billion. So, with a market that small you can see why frothy inflows of buying can force some upward momentum.
Which brings us back to our psychological milestone of 10,000. In a self-prophetic swoop, the foreign institutions started taking profits after the Sensex glided over the 10,000 hurdle. So, for the first time all year, foreigners became net sellers, taking profits just as cavalierly as when they pumped money into the market months before. Funny how that works. But will the Sensex stay in the 5-digit realm?
In short, I have no idea. What I do know is that the average company on the Sensex is expensive at nearly 20 times earnings and four times book. Normally that means India's favorite exchange is due for a steep correction. But who knows? If the basket of BSE carries on its 5-year average annual growth rate over the next year, in Feb '07 we'll see it solidly in the 5-digits with a tasty score of 13,567. That might be pushing it a little, though…let's compare it to it's five-digit friends.
If the Sensex chose to imitate the DJIA, it would stumble around in a sideways stasis for the next 5 years. Or, to slap a Nikkei comparison on the Sensex, it would lose 33% in the next 2 years only to climb up to 12,002 in 2011.
Or, everything could simply fall apart in the event of widespread scandal(s) - it IS India we're talking about here. Your guess is as good as mine…it's tough to accurately predict where an index will go based solely on its recent past performance. It's also not perfectly relevant to compare the Sensex to the other indices in the illustrious 5-digit club. But we use what we have and go from there.
That said, the foreign institutions will probably start pumping money back into India if there's a substantial pullback. They will most likely jump back in once some value re-enters the market. Combine that possibility with the domestic mutual funds recent swath of buying and you might have an argument for continued confident buying in India, both from within and without. You wouldn't believe how many ads for new mutual funds I saw splayed all over India, specifically in Mumbai and around Dalal Street, where the BSE stands.
After all, India has a savings rate close to 30% - massive compared to America's - and one wonders what would happen if the common Indian family tapped into some of that rupee stockpile and plugged it into the chugging market.
