There is a class of stock market participants that believes in Systematic Investing Process (SIP). Of course, financial advisors, mutual fund managers and various other vested interests love to push SIPs. And why not! It is in the interest of fund managers to get a steady stream of money to invest (and increase the assets under their management).
Under a SIP, the investor invests a fixed sum in a stock or a mutual fund regularly preferably over long periods. The logic behind a SIP is that the investor buys more units of the fund when the markets are down and less when markets are up. Over time, a SIP is supposed to generate superior returns for the investor.
In one of my previous blogs, I had given some empirical evidence showing how a SIP is in reality an inferior investing strategy (http://shashankjogi.blogspot.com/2008/07/comparing-5-investing-strategies.html). It generates lower returns and yet is subject to the same kind of risk and volatility.
Why?
There is one important aspect of investing that a SIP misses out on. And it is an exit strategy. There is no mention of selling in a SIP. In reality, it is selling that counts! Intelligent selling is the key to above average returns. Why is selling so important even if you are a long term investor? Here is an example that clarifies this matter.
Look at the following annual returns in 2 portfolios:
Portfolio A: 15%, -5%, 100%, -40%, 10%
Portfolio B: 15%, -5%, 100%, -10%, 10%
A rupee invested in portfolio A would become 1.44 after 5 years. This implies an annual return of 7.6%
Similarly, a rupee invested in portfolio B would have become 2.16 after 5 years, implying an annual return of 16.7%
Now note the annual returns of the 2 portfolios. In 4 out of the 5 years, the returns are exactly the same. In year 4, portfolio B managed to avoid large losses achieving a loss of 10% compared to a loss of 40% in portfolio A. Just one year made all the difference!
In one of my earlier blogs I had discussed how downside volatility in returns is harmful for your portfolio (http://shashankjogi.blogspot.com/2008/07/avoid-price-volatility.html). Investors seeking above average returns should try to cut out such volatility from their portfolios.
So how do we cut out large downsides in our portfolio? Typically, although not always, large negative returns occur when markets run up excessively and become expensive. Be it in 1992, 1994, 2000 or 2008, valuations get very expensive and what follows is a crash. If an investor can stay out of most parts of the crash, he/she would be able to avoid large losses, and hence be able to generate significantly above average returns.
Returning to our focus on SIPs, SIPs do not require the investor to sell. Hence in a SIP, an investor's portfolio is subject to large downsides that the markets undergo when the process of expensive to reasonable occurs.
Instead, let us modify our SIP investing approach. We maintain our discipline of investing regularly using a SIP when the markets are not expensive. If they get expensive, we sell all our holdings and wait on the sidelines with cash. When markets correct and stocks become reasonable again, we restart the SIP. (One can use many methods to determine what is expensive and what is reasonable).
So what does empirical evidence suggest?
I looked at data on the BSE Sensex from 1995 till September 2008. I set up a SIP investing the same fixed amount every first trading day of the month. I set up a simple criterion for establishing when markets are expensive (to sell all equity holdings) and when they become reasonable again (to restart the SIP again). Lets call this a modified SIP. Then I compared this with a normal SIP without any selling decision.
Standard SIP: CAGR = 14%
Modified SIP: CAGR = 22%
And the modified SIP made only 2 selling decisions over a 13 year period! Practically no short term capital gains. So no tax liability! And the volatility and equity swings in a modified SIP turns out lower than those in a regular SIP.
(I could send the details for those who are interested)
How does a difference between 14% and 22% shape up over 20 years?
On an initial investment of Rs. 1 lakh:
At 14%, Rs. 1 lakh becomes Rs. 13.74 lakhs
At 22%, Rs. 1 lakh becomes Rs. 53.35 lakhs, nearly 4 times that at 14%!
A few simple sell decisions can convert a mediocre return into a excellent return with very significant difference in the end result for investors.
Clearly, investors should sell. While this is the most obvious statement one can make about investing, many investors do not sell. And SIP investors do not sell either.
Incorporating a selling discipline in a SIP can significantly boost returns. The modified SIP looks like a better approach to systematic investing than the conventional SIP advisors love to push.
Sunday, September 28, 2008
Friday, August 15, 2008
Investing Myths - 2
Investing Myths....(Continued from the previous post)
Myth 4:
Asset Allocation is the key to investing success:
A big fat lie!
The investment community loves to push this idea. Allocate your money across various assets. Have a clear plan of how much of your money should go into equities, how much into debt, how much into real estate, how much into gold, etc.
The basic idea behind recommending an asset allocation plan is that when one asset class goes down, some other will go up. Also there would be an automatic rebalancing of portfolio, selling when an asset goes up and buying when it goes down. Buy low, sell high! How nice!
Except that is it far from nice!
Asset allocation is good if two conditions are satisfied:
1.) The assets have no co-relation or are negatively co-related with one another. i.e. the movement in one asset is independant of the movement of the other asset (un-corelated) or if one asset moves up, the other moves down (negatively co-related).
But in real life, stocks and bonds (paper assets) are positively corelated. Gold and stocks might be negatively corelated. Even this relationship breaks down at times. Over the last 5 years, all assets have gone up, stocks, bonds, real estate, commodities, art, etc. Sometimes all assets go up together, sometimes all come down together.
2.) The assets offer more or less, equal return prospects over time. If we assume that bonds will give lower returns than stocks, creating an asset allocation between bonds and stocks will lower overall returns (but also offer lower volatility).
Asset allocation, the way the investment community preaches, lowers portfolio volatility but also lowers returns. I had written a post earlier demonstrating the returns from one particular asset allocation method. The link is: http://shashankjogi.blogspot.com/2008/07/comparing-5-investing-strategies.html
There is no substitute to ability.
Myth 5:
Now that the market is down, it’s especially attractive and you should buy all you can and just hold it.
Being down does not equal attractive. Markets move from extremes of optimism and pessimism. Hence valuations move from seriously overvalued to seriously undervalued on and off. When prices fall, even 30-50%, it does not automatically make stocks attractive. If you are a value investor, you should buy when stocks are cheap, regardless of the extent of rise or fall in a stock.
Again, the investment community loves to give Warren Buffet's example. If Warren Buffett holds on through 50% drops, because then things really are a bargain, then you should do so as well.
In reality, Warren Buffet buys stocks when they are quoting at 50 paise to the rupee. Most of us do not have the capability that he possesses. We get misled by expensive stocks masquerading around as value stocks. We do not have an understanding as deep as Buffet has about most businesses. So we tend to pay Rs 2 for a stock worth Re.1, thinking that we are paying Rs.2 for something worth Rs.4.
How many people bought stocks into the first crash in January 2008? Many did and now they are stuck. We saw a period between 2000 and 2003 when stock prices went down 50%. After each 10% fall, stocks looked better but kept going down. So many highflying stocks on the tech bubble have vanished now.
The bottomline is:
-There is a time to buy and there is a time to sell.
-There is an environment when stocks do well and there is an environment when stocks do poorly.
-Stocks go down for good reasons.
-Understand the reasons, evaluate if there is merit and then buy. Not just because stocks are down.
Myth 6:
Stocks are an excellent hedge against inflation
Yes, but only if...
Have you heard how stocks give returns much higher than inflation, while with Fixed Deposits and bonds, inflation makes real returns tiny? So the Sensex has given an 18% compounded return over the last 29 years while inflation has been 8% on an average. Doesn't it show the power of equity investing in trumping inflation?
But why did stocks not beat inflation in the period 1992-2003? The sensex gave a negative 3% return compounded. Stocks not only lost money in nominal terms, it also lost more money in real terms. Stock market investing over this period impoverished investors, in general.
Stocks do well in a low and stable inflationary and low and stable interest rate environment. Both, high inflation and deflation are bad for stocks. If you recall, the mid to late 1990s was a period of high inflation 8-10% and rising interest rates. The period between 2000-2003 was a period of a global recession and a slowdown in the Indian economy. We then saw a period of low inflation (4-6%) and low interest rates between 2003-2007 which was one reason among many that fuelled the bull market in stocks.
Over the last 30 years, favourable conditions on a general basis ensured that stocks do well. Who is to say how the future will be like? Will it be like the 1970s where inflation was high and interest rates were ratched up? Or will calmer times return. The answer to this question will determine whether stocks are able to beat inflation by a whopping margin. A blanket statement saying that stocks are good against inflation is assuming such good times will remain.
I have merely highlighted a few myths that are commonly held. There are many more. A wise investor will always look for reason and evidence in any such statements before accepting such assertions.
Myth 4:
Asset Allocation is the key to investing success:
A big fat lie!
The investment community loves to push this idea. Allocate your money across various assets. Have a clear plan of how much of your money should go into equities, how much into debt, how much into real estate, how much into gold, etc.
The basic idea behind recommending an asset allocation plan is that when one asset class goes down, some other will go up. Also there would be an automatic rebalancing of portfolio, selling when an asset goes up and buying when it goes down. Buy low, sell high! How nice!
Except that is it far from nice!
Asset allocation is good if two conditions are satisfied:
1.) The assets have no co-relation or are negatively co-related with one another. i.e. the movement in one asset is independant of the movement of the other asset (un-corelated) or if one asset moves up, the other moves down (negatively co-related).
But in real life, stocks and bonds (paper assets) are positively corelated. Gold and stocks might be negatively corelated. Even this relationship breaks down at times. Over the last 5 years, all assets have gone up, stocks, bonds, real estate, commodities, art, etc. Sometimes all assets go up together, sometimes all come down together.
2.) The assets offer more or less, equal return prospects over time. If we assume that bonds will give lower returns than stocks, creating an asset allocation between bonds and stocks will lower overall returns (but also offer lower volatility).
Asset allocation, the way the investment community preaches, lowers portfolio volatility but also lowers returns. I had written a post earlier demonstrating the returns from one particular asset allocation method. The link is: http://shashankjogi.blogspot.com/2008/07/comparing-5-investing-strategies.html
There is no substitute to ability.
Myth 5:
Now that the market is down, it’s especially attractive and you should buy all you can and just hold it.
Being down does not equal attractive. Markets move from extremes of optimism and pessimism. Hence valuations move from seriously overvalued to seriously undervalued on and off. When prices fall, even 30-50%, it does not automatically make stocks attractive. If you are a value investor, you should buy when stocks are cheap, regardless of the extent of rise or fall in a stock.
Again, the investment community loves to give Warren Buffet's example. If Warren Buffett holds on through 50% drops, because then things really are a bargain, then you should do so as well.
In reality, Warren Buffet buys stocks when they are quoting at 50 paise to the rupee. Most of us do not have the capability that he possesses. We get misled by expensive stocks masquerading around as value stocks. We do not have an understanding as deep as Buffet has about most businesses. So we tend to pay Rs 2 for a stock worth Re.1, thinking that we are paying Rs.2 for something worth Rs.4.
How many people bought stocks into the first crash in January 2008? Many did and now they are stuck. We saw a period between 2000 and 2003 when stock prices went down 50%. After each 10% fall, stocks looked better but kept going down. So many highflying stocks on the tech bubble have vanished now.
The bottomline is:
-There is a time to buy and there is a time to sell.
-There is an environment when stocks do well and there is an environment when stocks do poorly.
-Stocks go down for good reasons.
-Understand the reasons, evaluate if there is merit and then buy. Not just because stocks are down.
Myth 6:
Stocks are an excellent hedge against inflation
Yes, but only if...
Have you heard how stocks give returns much higher than inflation, while with Fixed Deposits and bonds, inflation makes real returns tiny? So the Sensex has given an 18% compounded return over the last 29 years while inflation has been 8% on an average. Doesn't it show the power of equity investing in trumping inflation?
But why did stocks not beat inflation in the period 1992-2003? The sensex gave a negative 3% return compounded. Stocks not only lost money in nominal terms, it also lost more money in real terms. Stock market investing over this period impoverished investors, in general.
Stocks do well in a low and stable inflationary and low and stable interest rate environment. Both, high inflation and deflation are bad for stocks. If you recall, the mid to late 1990s was a period of high inflation 8-10% and rising interest rates. The period between 2000-2003 was a period of a global recession and a slowdown in the Indian economy. We then saw a period of low inflation (4-6%) and low interest rates between 2003-2007 which was one reason among many that fuelled the bull market in stocks.
Over the last 30 years, favourable conditions on a general basis ensured that stocks do well. Who is to say how the future will be like? Will it be like the 1970s where inflation was high and interest rates were ratched up? Or will calmer times return. The answer to this question will determine whether stocks are able to beat inflation by a whopping margin. A blanket statement saying that stocks are good against inflation is assuming such good times will remain.
I have merely highlighted a few myths that are commonly held. There are many more. A wise investor will always look for reason and evidence in any such statements before accepting such assertions.
Monday, August 11, 2008
Investing Myths - 1
There are many investing myths that go around as gospels and the ultimate truth in investing. As humans, if someone repeats something sensible sounding repeatedly, for a long enough period, we start believing it to be true. We then do not question its validity and take it for granted. Thats how we are.
Many of these myths are held even by professionals in the investing arena. Some are lies perpetuated knowingly or in ignorance. Some are damn lies, but statistics tell a different story!
I have highlighted a few of them. Take a look:
Myth 1:
You should buy and hold to make money.
Now, how many times have you heard mutual fund managers and other experts stating this? They have 'well chosen' examples to substantiate their claims. Buy and hold stocks for the long run and you will be rich at the end. Afterall, the logic goes, stock markets reflect corporate fundamentals, which in turn are derived from economic fundamentals. For growing economies like India, economic fundamentals in the long run remain positive.
First, how long is this long run? For most people, 10 years is long enough. Over 10 years, stocks always do well.
Or do they?
A quick look at history will reveal different results. There have been many period in the past where stocks have gone nowhere in a 10 year period.
-From 1992 to 2003, the BSE Sensex went down 33% (aggregate not CAGR). Indian GDP grew at close to 6% in real terms during this period.
-The US stock markets have shown many long periods of poor performance inspite of positive economic growth. Between 1964 and 1982, US stock markets gave a 0% return inspite of growing at a 3% real growth rate. Till date, any index investor in the USA would have got no returns for money invested in 1998, a period of 10 years gave no returns.
-The Japanese markets peaked out in 1989 and after nearly 20 years, is still down 60% from those highs.
Experts love to say that stocks should go up because GDP will grow. Not true!
-The Chinese economy is the fastest growing economy in the world, growing at breath taking speeds of 10% or so over many years. Yet its stock market went down 50% from 2001 to 2004. It is down 60% from the peaks hit last year! China might win many gold medals at the Olympics, but its stock market is perhaps the worst performer in the world!
-Someone who had invested in the Indian BSE Sensex in Feb 2000 would have got a compounded return of 10.9% from stocks till date. Not a return to die for. During this period, the Indian economy recorded a 7% real GDP growth.
Let me state this very clearly. Stocks do well in an environment of low and stable inflation and interest rates. Rising inflation and (often hence) rising interest rates are bad for stocks (USA from 1969-1982). A deflationary (falling prices) environment means economic contraction, which is also bad for stocks (Japan from 1989).
Stocks are good for the long run if your starting point is good. If you start off at the begining is a bull supercycle, stocks will give great returns. If you start off at the lower end of valuations, stocks will give good returns. If you are caught in a bear supercycle, stocks will languish.
Stocks are not always a good buy and hold asset class...No asset class is! Each asset class needs a particular environment to do well.
Myth 2:
You cannot time the market.
By this, if someone means catching tops and bottoms precisely by design (and not by accident), I agree. But this is not what market timing is about. By market timing I mean buying when conditions are in your favour and selling when they are against you. Even if you can imprecisely time the markets, in an inperfect manner, your returns will get boosted. I had earlier written a post on this blog showing how one particular market timing strategy achieves superior returns with less risk and lower volatility. (Link: http://shashankjogi.blogspot.com/2008/07/comparing-5-investing-strategies.html)
Market timing is THE essence of successful investing. Traders try to time the markets. Even long term value investors time the market, buying when stocks become cheap and selling when they get expensive. Momentum investors time the market and buy when momentum starts building up and sell when momentum starts fading or reversing.
So do not hide behind the cover of "I dont have time to trade" defense mechanism. You dont need to look at the market every day or every week. Learn how to time the markets, afterall it is your money.
Myth 3:
Making money is all about picking stocks.
Another big myth!
No doubt, stock picking is important. You want to be in a stock that goes up. But merely picking a winning stock is of little significance if you get the other things wrong. You will not make much money.
What are the other things?
Intelligent exits and proper volumes of purchase
Not much fun in picking up Unitech at 100 to see it go to 550 and then back to 130.
You need to sell sufficiently high to benefit from the big price move.
And you need to buy in good volumes on such stocks to make significant money. Your 'position sizing' needs to be correct. Buy too little and you wont make much money. Buy too much and you run the risk of large losses if losses come about.
Look at the portfolios of various mutual funds. 90% of the variance in their performance comes from position sizing, i.e.from their decision on how much to buy. Only 10% comes from superior stock picking.
You don't need to be a great or even a good stock picker to make a lot of money.
Being average is fine as long as you follow a few cardinal rules in investing:
-Trade with the trend. That is where large profits originate.
-Let your profits run but cut your losses short
-Manage risk. Buy enough to make you a bundle, but short of anything that could lose you a lot of money.
Continued.....
Many of these myths are held even by professionals in the investing arena. Some are lies perpetuated knowingly or in ignorance. Some are damn lies, but statistics tell a different story!
I have highlighted a few of them. Take a look:
Myth 1:
You should buy and hold to make money.
Now, how many times have you heard mutual fund managers and other experts stating this? They have 'well chosen' examples to substantiate their claims. Buy and hold stocks for the long run and you will be rich at the end. Afterall, the logic goes, stock markets reflect corporate fundamentals, which in turn are derived from economic fundamentals. For growing economies like India, economic fundamentals in the long run remain positive.
First, how long is this long run? For most people, 10 years is long enough. Over 10 years, stocks always do well.
Or do they?
A quick look at history will reveal different results. There have been many period in the past where stocks have gone nowhere in a 10 year period.
-From 1992 to 2003, the BSE Sensex went down 33% (aggregate not CAGR). Indian GDP grew at close to 6% in real terms during this period.
-The US stock markets have shown many long periods of poor performance inspite of positive economic growth. Between 1964 and 1982, US stock markets gave a 0% return inspite of growing at a 3% real growth rate. Till date, any index investor in the USA would have got no returns for money invested in 1998, a period of 10 years gave no returns.
-The Japanese markets peaked out in 1989 and after nearly 20 years, is still down 60% from those highs.
Experts love to say that stocks should go up because GDP will grow. Not true!
-The Chinese economy is the fastest growing economy in the world, growing at breath taking speeds of 10% or so over many years. Yet its stock market went down 50% from 2001 to 2004. It is down 60% from the peaks hit last year! China might win many gold medals at the Olympics, but its stock market is perhaps the worst performer in the world!
-Someone who had invested in the Indian BSE Sensex in Feb 2000 would have got a compounded return of 10.9% from stocks till date. Not a return to die for. During this period, the Indian economy recorded a 7% real GDP growth.
Let me state this very clearly. Stocks do well in an environment of low and stable inflation and interest rates. Rising inflation and (often hence) rising interest rates are bad for stocks (USA from 1969-1982). A deflationary (falling prices) environment means economic contraction, which is also bad for stocks (Japan from 1989).
Stocks are good for the long run if your starting point is good. If you start off at the begining is a bull supercycle, stocks will give great returns. If you start off at the lower end of valuations, stocks will give good returns. If you are caught in a bear supercycle, stocks will languish.
Stocks are not always a good buy and hold asset class...No asset class is! Each asset class needs a particular environment to do well.
Myth 2:
You cannot time the market.
By this, if someone means catching tops and bottoms precisely by design (and not by accident), I agree. But this is not what market timing is about. By market timing I mean buying when conditions are in your favour and selling when they are against you. Even if you can imprecisely time the markets, in an inperfect manner, your returns will get boosted. I had earlier written a post on this blog showing how one particular market timing strategy achieves superior returns with less risk and lower volatility. (Link: http://shashankjogi.blogspot.com/2008/07/comparing-5-investing-strategies.html)
Market timing is THE essence of successful investing. Traders try to time the markets. Even long term value investors time the market, buying when stocks become cheap and selling when they get expensive. Momentum investors time the market and buy when momentum starts building up and sell when momentum starts fading or reversing.
So do not hide behind the cover of "I dont have time to trade" defense mechanism. You dont need to look at the market every day or every week. Learn how to time the markets, afterall it is your money.
Myth 3:
Making money is all about picking stocks.
Another big myth!
No doubt, stock picking is important. You want to be in a stock that goes up. But merely picking a winning stock is of little significance if you get the other things wrong. You will not make much money.
What are the other things?
Intelligent exits and proper volumes of purchase
Not much fun in picking up Unitech at 100 to see it go to 550 and then back to 130.
You need to sell sufficiently high to benefit from the big price move.
And you need to buy in good volumes on such stocks to make significant money. Your 'position sizing' needs to be correct. Buy too little and you wont make much money. Buy too much and you run the risk of large losses if losses come about.
Look at the portfolios of various mutual funds. 90% of the variance in their performance comes from position sizing, i.e.from their decision on how much to buy. Only 10% comes from superior stock picking.
You don't need to be a great or even a good stock picker to make a lot of money.
Being average is fine as long as you follow a few cardinal rules in investing:
-Trade with the trend. That is where large profits originate.
-Let your profits run but cut your losses short
-Manage risk. Buy enough to make you a bundle, but short of anything that could lose you a lot of money.
Continued.....
Monday, August 4, 2008
Retirement Planning and Stock Market Returns
Retirement planning is good.
It helps you in having adequate funds when you retire from active worklife and in the rest of your life thereafter. It ensures that retirement is pleasant and you can goof off all day long without getting caught at it.
But any planning involves assumptions.
And retirement planning involves assumptions of returns on money deployed, among other things.
Today, there are a host of products that are available to help you plan for retirement. Without passing judgements over whether such products are good or not, we have many products sold by reputed names. Almost all have a 'paper asset' (stocks and bonds) inclination, that they will invest your money in equities or in debt or a combination of the two.
In the past 5 years, the Indian stock markets have seen spectacular returns and the frontline indices have given 35%+ returns compounded.
Buoyed by such handsome returns, Sales departments of many fund houses have been selling their retirement products on the basis of high return assumptions. While nobody talks about 35% returns going into eternity (such a return would leave the BSE sensex at a level of 11.8 crores after 30 years from its value of 14600 today!!), is the commonly assumed return even of 15-20% possible?
Fund managers would have us believe that a 15-20% return from the stock markets of a fast growing country like India is imminently possible over the long run. After all, they demonstrate that the BSE Sensex has grown from 100 in 1979 to 14600 today. This translates into a return of 18.75% compounded over 29 years. So why should it not grow, if not faster, at least at the same rate in the future?
India's GDP grew in nominal (real terms + inflation) terms at the rate of 13.8% from 1979 till 2008(estimates). Going into the future, it is difficult to imagine nominal growth rates higher than 13-14%. Why? Here is why.
If India grows at 10% in real terms, it is likely that inflation would have to be low, at around 4% or so. But since growth brings in inflationary pressures, a higher inflation would be met by higher interest rates, which would drive down growth rates (as also cut down corporate earnings). The best we can hope for is a high growth rate (7-9%) and low inflation (4-6%) thereby giving a nominal return of 13-14%.
To see what has happened over the last 5 years of high growth, India's GDP has grown at a nominal rate of 13.6%. In the past, we have occassionally grown at 15-16% nominal, but in all cases, it was because inflation was high at 9-11% with real growth being at 5-6% or less. Such period of high inflation were followed by periods of low real growth.
Ok, but why is it difficult to get 18% from stocks over a 30 year period?
Currently the market capitalization of India stocks (value of all stocks listed on the stock exchange) stands at around 1.1 times India's GDP (market cap to GDP ratio = 1.1). Whether this ratio suggests overvaluation or undervaluation is a matter of debate. Some people argue that this is a high number sugesting stocks are overvalued. Others respond by saying that this tool is not a accurate measure since new companies get listed and also corporate debt gets replaced by equity boosting the market cap of stocks.
Regardless of arguments and counterarguments, we note that this ratio stood at about 0.25 in March 2003. It stood at about 0.6 in March 2000 at the height of the technology bubble. It stood at 0.32 in 1979 (considering Sensex growth as the proxy for market cap growth).
It also stood at around 1.5 in January 2008.
We got handsome returns from stocks over the last 5 years because stocks were indeed deeply undervalued. We got our 18.75% returns from stocks since 1979 because stocks were undervalued.
We got a drubbing on the stock markets since January this year because stocks were overvalued. I reckon at at 1.1 times, we still are not undervalued. (With a PE ratio of 18.2, a Price:Book ratio of 3.8 and a dividend yield as low as 1.26, stocks still do not look cheap to me).
Even during the 'mother-of-all-bubbles' technology bubble in the USA, the market cap to GDP ratio of all US stocks was 1.9.
While we may not be able to say whether stocks are somewhat cheap or expensive using this ratio, very high values (>2) have perhaps not been attained even in prior bubbles. Similarly, very low values perhaps suggest undervaluation.
So if the Indian stock markets keep growing at 18.75% for the next 30 years and the Indian economy grows at 13% nominal, at the end of 30 years, the market cap to GDP ratio of Indian stock market would become an improbable 4.8!! Thus Indian stocks would be valued at 4.8 times the total output of the country. A extremely unlikely event considering that it has never happened.
It is more likely that market cap to GDP ratio would be around 1 after 30 years, giving a likely return of 12.6% on the stock markets. Even if you assume this ratio to be 1.5, stock returns would then be 14.1%.
Thus, the likely scenario for stock market returns for long retirement durations is likely to be between 12 and 15% and not the 15-20% as many assume.
Note also that since most of our money would be with fund houses (through retirement accounts and ULIPs and such), returns post their expenses and mortality charges (for ULIPs) would be lower to the tune of 2-3%. So on average, such retirement funds would generate 10-12% over the very long run.
There definately will be some outperformers. But most accounts will not outperform the broader markets. In addition, it is also very difficult to generate outperformance over long periods consistantly. Many funds perform well and then slip up later.
As far as building a corpus is concerned, a difference of 3% per annum in returns (between 12% and 15%) makes a lot of difference to the amount required to be saved per month. At 12%, to achieve a corpus of Rs.10 crores after 30 years, you would need to save aproximately Rs. 34500 per month. The same figure would be Rs.19100 per month at 15% rate of return, Rs. 10500 per month at 18%. Small differences in returns does make a big difference in the amount required to be saved and invested.
In closing, I would like to say that it is always a prudent practise to have a realistic (perhaps even conservative) estimate of returns you would get on your retirement money. You dont want to overestimate expected returns and realise at retirement that you will fall short of the money you need into retirement.
It helps you in having adequate funds when you retire from active worklife and in the rest of your life thereafter. It ensures that retirement is pleasant and you can goof off all day long without getting caught at it.
But any planning involves assumptions.
And retirement planning involves assumptions of returns on money deployed, among other things.
Today, there are a host of products that are available to help you plan for retirement. Without passing judgements over whether such products are good or not, we have many products sold by reputed names. Almost all have a 'paper asset' (stocks and bonds) inclination, that they will invest your money in equities or in debt or a combination of the two.
In the past 5 years, the Indian stock markets have seen spectacular returns and the frontline indices have given 35%+ returns compounded.
Buoyed by such handsome returns, Sales departments of many fund houses have been selling their retirement products on the basis of high return assumptions. While nobody talks about 35% returns going into eternity (such a return would leave the BSE sensex at a level of 11.8 crores after 30 years from its value of 14600 today!!), is the commonly assumed return even of 15-20% possible?
Fund managers would have us believe that a 15-20% return from the stock markets of a fast growing country like India is imminently possible over the long run. After all, they demonstrate that the BSE Sensex has grown from 100 in 1979 to 14600 today. This translates into a return of 18.75% compounded over 29 years. So why should it not grow, if not faster, at least at the same rate in the future?
India's GDP grew in nominal (real terms + inflation) terms at the rate of 13.8% from 1979 till 2008(estimates). Going into the future, it is difficult to imagine nominal growth rates higher than 13-14%. Why? Here is why.
If India grows at 10% in real terms, it is likely that inflation would have to be low, at around 4% or so. But since growth brings in inflationary pressures, a higher inflation would be met by higher interest rates, which would drive down growth rates (as also cut down corporate earnings). The best we can hope for is a high growth rate (7-9%) and low inflation (4-6%) thereby giving a nominal return of 13-14%.
To see what has happened over the last 5 years of high growth, India's GDP has grown at a nominal rate of 13.6%. In the past, we have occassionally grown at 15-16% nominal, but in all cases, it was because inflation was high at 9-11% with real growth being at 5-6% or less. Such period of high inflation were followed by periods of low real growth.
Ok, but why is it difficult to get 18% from stocks over a 30 year period?
Currently the market capitalization of India stocks (value of all stocks listed on the stock exchange) stands at around 1.1 times India's GDP (market cap to GDP ratio = 1.1). Whether this ratio suggests overvaluation or undervaluation is a matter of debate. Some people argue that this is a high number sugesting stocks are overvalued. Others respond by saying that this tool is not a accurate measure since new companies get listed and also corporate debt gets replaced by equity boosting the market cap of stocks.
Regardless of arguments and counterarguments, we note that this ratio stood at about 0.25 in March 2003. It stood at about 0.6 in March 2000 at the height of the technology bubble. It stood at 0.32 in 1979 (considering Sensex growth as the proxy for market cap growth).
It also stood at around 1.5 in January 2008.
We got handsome returns from stocks over the last 5 years because stocks were indeed deeply undervalued. We got our 18.75% returns from stocks since 1979 because stocks were undervalued.
We got a drubbing on the stock markets since January this year because stocks were overvalued. I reckon at at 1.1 times, we still are not undervalued. (With a PE ratio of 18.2, a Price:Book ratio of 3.8 and a dividend yield as low as 1.26, stocks still do not look cheap to me).
Even during the 'mother-of-all-bubbles' technology bubble in the USA, the market cap to GDP ratio of all US stocks was 1.9.
While we may not be able to say whether stocks are somewhat cheap or expensive using this ratio, very high values (>2) have perhaps not been attained even in prior bubbles. Similarly, very low values perhaps suggest undervaluation.
So if the Indian stock markets keep growing at 18.75% for the next 30 years and the Indian economy grows at 13% nominal, at the end of 30 years, the market cap to GDP ratio of Indian stock market would become an improbable 4.8!! Thus Indian stocks would be valued at 4.8 times the total output of the country. A extremely unlikely event considering that it has never happened.
It is more likely that market cap to GDP ratio would be around 1 after 30 years, giving a likely return of 12.6% on the stock markets. Even if you assume this ratio to be 1.5, stock returns would then be 14.1%.
Thus, the likely scenario for stock market returns for long retirement durations is likely to be between 12 and 15% and not the 15-20% as many assume.
Note also that since most of our money would be with fund houses (through retirement accounts and ULIPs and such), returns post their expenses and mortality charges (for ULIPs) would be lower to the tune of 2-3%. So on average, such retirement funds would generate 10-12% over the very long run.
There definately will be some outperformers. But most accounts will not outperform the broader markets. In addition, it is also very difficult to generate outperformance over long periods consistantly. Many funds perform well and then slip up later.
As far as building a corpus is concerned, a difference of 3% per annum in returns (between 12% and 15%) makes a lot of difference to the amount required to be saved per month. At 12%, to achieve a corpus of Rs.10 crores after 30 years, you would need to save aproximately Rs. 34500 per month. The same figure would be Rs.19100 per month at 15% rate of return, Rs. 10500 per month at 18%. Small differences in returns does make a big difference in the amount required to be saved and invested.
In closing, I would like to say that it is always a prudent practise to have a realistic (perhaps even conservative) estimate of returns you would get on your retirement money. You dont want to overestimate expected returns and realise at retirement that you will fall short of the money you need into retirement.
Thursday, July 31, 2008
Don't look at your portfolio every day
Suppose I offer you a bet: I flip a fair coin. If it lands up heads, I pay you Rs 2000. If it lands up tails, you pay me Rs.1000.
Would you accept the bet?
Rationally speaking, you should accept the bet. If the coin is fair, there is 50% chance of heads and a 50% chance of tails.
So the expected outcome is 0.5*2000-0.5*1000 = 500
You would expect to win, on average, 500 rupees per flip of the coin.
Most people however do not accept the bet. Why not? Because there is a 50% chance of losing Rs. 1000. Behavioural scientists have estimated that in humans, the pain of a loss is more than the pleasure of a profit. Some studies show that on average, humans value the pain from a loss at 2.5 times the pleasure from an equal gain. Thus we are likely to feel pained 2.5 times as much in losing Rs. 1000 as the pleasure of making Rs 1000. Alternatively speaking, the pain from a Rs 1000 loss is equal in intensity to the pleasure of a Rs. 2500 profit.
What implications does this have on investing? Many, but we shall discuss one.
If you are an investor with a portfolio, your portfolio is going to fluctuate every day depending upon what the market does. If your portfolio goes up, you will feel pleasure. If it goes down, you will feel pain. So, if you look at the value of your portfolio every day, you will swing between pleasure and pain. You would have a emotional roller-coaster ride, feeling happy one day and sad another day.
Assume you indeed are such an investor who looks at the value of your portfolio daily. If you had been invested in the Nifty-50 since 1991, here is what you would see (I shall spare you the statistical calculations):
Chance of making money = 52%
Average Daily Profit = 1.26%
Average Daily Loss = 1.27%
So 52% of the times you would have felt happy making money while 48% of the times you would have felt the pain of losing.
Assume that each percentage gain gives you one unit of pleasure. So one percentage of loss would give you 2.5 units of pain.
Considering 4308 trading days, the total pleasure accruing to you will be 0.52*4308*1.26*1 = 2822 units of pleasure.
And the total pain you would feel would be 0.48*4308*1.27*2.5 = 6565 units of pain.
So you would have an emotional balance of 2822-6565 = 3743 units of pain.
Overall, you would have felt a lot of pain!! OUCH!!!
Instead, you decide that you would look at your portfolio only once every year on 31 March of each year.
During this period, this is what you would have noticed:
Chance of making money = 66%
Average Yearly Profit = 59%
Average Yearly Loss = 15%
Total number of periods = 17
Your emotional statement would look like this:
Pleasure = 0.66*17*59*1 = 662 units of pleasure
Pain = 0.34*17*15*2.5 = 216 units of pain
Net Balance = 662-216 = 446 units of pleasure.
Overall you would have felt some amount of pleasure rather than net pain experienced in the first case.
Also note that your chances of making money go up from 52% to 66%
And in both cases, you make the same amount of money.
So, by not looking at your portfolio once every year rather than once every day, your chances of making money over the period of observation goes up and you feel more pleasure.
Extending this even further, If you chose to look at your portfolio over longer periods, the chances of making money go up further to 75% (3 year period) and 77% (5 year period).
By taking a longer term view of your portfolio, you increase the chances of making money over that horizon. Not only that, you also are saved of the emotional turmoil of pain and pleasure and overall face much less emotional stress and tension.
Ergo, don't look at your portfolio all to frequently. It will only drain you emotionally without adding a paisa to return.
Would you accept the bet?
Rationally speaking, you should accept the bet. If the coin is fair, there is 50% chance of heads and a 50% chance of tails.
So the expected outcome is 0.5*2000-0.5*1000 = 500
You would expect to win, on average, 500 rupees per flip of the coin.
Most people however do not accept the bet. Why not? Because there is a 50% chance of losing Rs. 1000. Behavioural scientists have estimated that in humans, the pain of a loss is more than the pleasure of a profit. Some studies show that on average, humans value the pain from a loss at 2.5 times the pleasure from an equal gain. Thus we are likely to feel pained 2.5 times as much in losing Rs. 1000 as the pleasure of making Rs 1000. Alternatively speaking, the pain from a Rs 1000 loss is equal in intensity to the pleasure of a Rs. 2500 profit.
What implications does this have on investing? Many, but we shall discuss one.
If you are an investor with a portfolio, your portfolio is going to fluctuate every day depending upon what the market does. If your portfolio goes up, you will feel pleasure. If it goes down, you will feel pain. So, if you look at the value of your portfolio every day, you will swing between pleasure and pain. You would have a emotional roller-coaster ride, feeling happy one day and sad another day.
Assume you indeed are such an investor who looks at the value of your portfolio daily. If you had been invested in the Nifty-50 since 1991, here is what you would see (I shall spare you the statistical calculations):
Chance of making money = 52%
Average Daily Profit = 1.26%
Average Daily Loss = 1.27%
So 52% of the times you would have felt happy making money while 48% of the times you would have felt the pain of losing.
Assume that each percentage gain gives you one unit of pleasure. So one percentage of loss would give you 2.5 units of pain.
Considering 4308 trading days, the total pleasure accruing to you will be 0.52*4308*1.26*1 = 2822 units of pleasure.
And the total pain you would feel would be 0.48*4308*1.27*2.5 = 6565 units of pain.
So you would have an emotional balance of 2822-6565 = 3743 units of pain.
Overall, you would have felt a lot of pain!! OUCH!!!
Instead, you decide that you would look at your portfolio only once every year on 31 March of each year.
During this period, this is what you would have noticed:
Chance of making money = 66%
Average Yearly Profit = 59%
Average Yearly Loss = 15%
Total number of periods = 17
Your emotional statement would look like this:
Pleasure = 0.66*17*59*1 = 662 units of pleasure
Pain = 0.34*17*15*2.5 = 216 units of pain
Net Balance = 662-216 = 446 units of pleasure.
Overall you would have felt some amount of pleasure rather than net pain experienced in the first case.
Also note that your chances of making money go up from 52% to 66%
And in both cases, you make the same amount of money.
So, by not looking at your portfolio once every year rather than once every day, your chances of making money over the period of observation goes up and you feel more pleasure.
Extending this even further, If you chose to look at your portfolio over longer periods, the chances of making money go up further to 75% (3 year period) and 77% (5 year period).
By taking a longer term view of your portfolio, you increase the chances of making money over that horizon. Not only that, you also are saved of the emotional turmoil of pain and pleasure and overall face much less emotional stress and tension.
Ergo, don't look at your portfolio all to frequently. It will only drain you emotionally without adding a paisa to return.
Wednesday, July 30, 2008
New Blog
I have started a new blog with the title "Current Issues". The link to this is as follows:
http://shashankcurrentissues.blogspot.com/
The new blog is intended to discuss current developments and issues relating to the financial markets with a bias towards the Indian stock markets.
The current blog (titled "On Investing") shall discuss general principles on investing and trading.
http://shashankcurrentissues.blogspot.com/
The new blog is intended to discuss current developments and issues relating to the financial markets with a bias towards the Indian stock markets.
The current blog (titled "On Investing") shall discuss general principles on investing and trading.
Saturday, July 26, 2008
What long term charts tell us
Asset classes follow long cycles.
Consider stocks for example. Empirical evidence suggests that stocks follow long cycles (called secular cycles) that last many many years, sometimes even more than a decade. We see evidence of secular bull cycles followed by secular bear cycles both lasting for long periods.
A secular bull cycle is a period when stock prices generally rise over time.
A secular bear cycle, in contrast, is a period when stock prices either fluctuate in a broad range (if corporate earnings keep going up) or stock prices go down (if corporate earnings fall).
Each cycle is characterised by a change in the P/E ratio of stocks and the markets as a whole.
In a secular bull cycle, P/E ratios start at low levels and keep rising to end at a absurdly high level. This accompanied with rising corporate profits means a fast rise for prices.
In a secular bear cycle, there is a compression/fall in the P/E ratio of the markets. P/E ratios start at very high levels and keep falling overall till they become very low. If corporate profits rise, they compensate the fall in PE ratios and the markets remain range bound. If profits also fall, it is a double whammy for prices.
How do such cycles start?
Each secular bull cycle starts with low valuations. Markets are really cheap but there is very little interest for the same. There is general apathy and dis-illusionment among people regarding stocks. Trading volumes are low and retail participation is also low. People's savings as a percentage of their total savings is also very low. The secular bull cycle is preceeded by a long secular bear phase where many people have ended up either losing a lot of money or not making anything. The secular bull cycle needs a catalyst to trigger it off.
Each secular bear cycle if the mirror image of a secular bull cycle. It starts off with the end of the secular bull cycle. Valuations get very high. Prices have shown a parabolic upmove. Mass particpation is high, frenzy pervades the markets and people are very optimistic. There are million reasons thrown around as to why "it is different" this time around and why high valuations are justified. It starts off with a big bust in the secular bull cycle.
However, a secular cycle does not mean that prices keep moving up or down all the time. There are counter-cyclical moves that happen on and off within the larger supercycle. Secular bull cycles witness bear markets lasting a while and secular bear cycles witness bull markets that also last a while. But such counter-cyclical moves do not change the direction of the secular cycle.
Let us now look at the long term chart of the stock market to see what it tells us.
The chart for the BSE Sensex from 1979 till June 2008 is shown below.
Despite my efforts to make it clearly visible, the chart does remain a bit hazy. For the original chart, you can go to the following link:
http://www.chartsrus.com/chart.php?image=http://www.sharelynx.com/chartstemp/free/chartind1CRUl.php?ticker=^BSESN
The chart is in log scale so as to bring out the ups and downs better. The X axis represents time and Y axis represents the value of the sensex. You would note that since the chart is in in log scale, the Y axis numbers are spaced unevenly.
We see that from the period 1979 till about 1992, the markets had an upswing marked by some corrections on the way. The sensex went up 42 times or thereabouts in a period of 13 years starting at the value of 100 in 1979 and ending in 4200+ in 1992. i.e a 42+ fold increase in value! This was a secular bull cycle
Even this secular bull cycle was interrupted by bear markets and sharp corrections. There was a bear market that started in 1986 and lasted till 1988 correcting by about 40% or so. Then there was another sharp pullback in 1990 that gave back 30-35% of its value.
Also note that every such bear market has occured after a sharp upmove. I call this a mini-bubble within the overall secular bull market.
From the period of 1992 top till about 2003, the sensex was largely range bound in a secular bear cycle. Note that even secular bear cycles have the occassional bull runs (1993-95, 1997-98, 1999-2000). But each get sold into and the market falls back either back into a range or lower still.
So with little piece of history, let us analyse what is happening currently.
Revisit the chart to see that from mid 2003 onwards, we are in a secular bull cycle again. Recall the mood and the sentiment in 2003, recall the valuations then and recall the period before 2003. Conditions were ripe for a secular bull cycle and that is exactly what we have seen.
Prices have been generally up since 2003. Prices broke out of the broad range establised between 1992-2003. Valuations also rose in PE terms. Participation has increased. The bull cycle was interrupted by corrections in 2004 and 2006, but that did not change the general direction of the market, which was up. Each time the markets made a new high. This was also characterised by high earnings growth of Indian corporates.
Note however that in 2008, this secular cycle has been interrupted by a bear market. In January 2008, valuations hit a mini-bubble level. People were enthusiastic about stocks and prices were rising very sharply. Everything looked rosy and the stage for a bear market was set. And we have got a counter-cyclical bear market within a secular bull cycle.
Why is it only counter cyclical and why does this not signal the end of the secular bull run? Because valuations got 'only' to mini-bubble levels and not to totally absurd levels. Participation was nowhere as high as is witnessed at the end of a secular cycle. There was some frenzy but not a total mania.
Markets will peak out and the current secular bull cycle will end when earnings growth peaks out as also expectations of earnings growth peak out. This has some distance to go, maybe 6-8 years or so, who knows. Going by history, we could see much higher levels, even to the tune of 50000+ on the sensex before the markets peak out in this secular cycle.
So what about the current bear market? How long could it last and how low can it go?
Looking at previous bear markets, it could last for 2 years or so. So assuming it started in Jan 2008, it could go on till end of 2009. It would start exactly the way a secular bull market starts, though in a lesser degree. People would need to give up hope and lose interest in stocks for the secular bull run to resume again. Right now, there is too much hope among the retail investors that we could see the resumption soon, just as we saw it in 2004 and 2006.
How low could it go?
The current PE ratio of the Nifty stands at 18.17 as per NSE data. Bull markets dont commence at such high PE ratios. Valuations need to come down to lower levels, say 12-14. Assuming that the bull market resumes by late 2009, assuming a forward PE ratio of the markets at 10-12, and assuming a EPS for Sensex at 1050 for FY2010, we can say that the market could go down to anything between 10500-12600. This would be about a 40-50% correction from the top, which is in line with prior bear markets as well.
So all is not lost, far from it. There will be opportunities in the future, very profitable opportunities, in my opinion.
PS:
Assets like Gold, Silver, Crude Oil, all are showing signs of being in classic secular bull cycles. So while in the near term, we dont know what could happen to their prices, my own sense is that there is a long way to go up for these commodities before they peak out...so Gold at $980/ounce or crude at $148/barrel may not be the eventual peaks.
Crude at $200 could be very bad for India and may upset the extent of the secular bull cycle case...India imports 76% of its crude oil. India's oil import bill this year will be around $110 billion to $120 billion. This is 11-12% of our GDP...we would be handing over 12% of our total income to foreign countries! What would that do to our currency and what would that do to a neutral currency like Gold? The wise investor stays alert...
Consider stocks for example. Empirical evidence suggests that stocks follow long cycles (called secular cycles) that last many many years, sometimes even more than a decade. We see evidence of secular bull cycles followed by secular bear cycles both lasting for long periods.
A secular bull cycle is a period when stock prices generally rise over time.
A secular bear cycle, in contrast, is a period when stock prices either fluctuate in a broad range (if corporate earnings keep going up) or stock prices go down (if corporate earnings fall).
Each cycle is characterised by a change in the P/E ratio of stocks and the markets as a whole.
In a secular bull cycle, P/E ratios start at low levels and keep rising to end at a absurdly high level. This accompanied with rising corporate profits means a fast rise for prices.
In a secular bear cycle, there is a compression/fall in the P/E ratio of the markets. P/E ratios start at very high levels and keep falling overall till they become very low. If corporate profits rise, they compensate the fall in PE ratios and the markets remain range bound. If profits also fall, it is a double whammy for prices.
How do such cycles start?
Each secular bull cycle starts with low valuations. Markets are really cheap but there is very little interest for the same. There is general apathy and dis-illusionment among people regarding stocks. Trading volumes are low and retail participation is also low. People's savings as a percentage of their total savings is also very low. The secular bull cycle is preceeded by a long secular bear phase where many people have ended up either losing a lot of money or not making anything. The secular bull cycle needs a catalyst to trigger it off.
Each secular bear cycle if the mirror image of a secular bull cycle. It starts off with the end of the secular bull cycle. Valuations get very high. Prices have shown a parabolic upmove. Mass particpation is high, frenzy pervades the markets and people are very optimistic. There are million reasons thrown around as to why "it is different" this time around and why high valuations are justified. It starts off with a big bust in the secular bull cycle.
However, a secular cycle does not mean that prices keep moving up or down all the time. There are counter-cyclical moves that happen on and off within the larger supercycle. Secular bull cycles witness bear markets lasting a while and secular bear cycles witness bull markets that also last a while. But such counter-cyclical moves do not change the direction of the secular cycle.
Let us now look at the long term chart of the stock market to see what it tells us.
The chart for the BSE Sensex from 1979 till June 2008 is shown below.
Despite my efforts to make it clearly visible, the chart does remain a bit hazy. For the original chart, you can go to the following link:
http://www.chartsrus.com/chart.php?image=http://www.sharelynx.com/chartstemp/free/chartind1CRUl.php?ticker=^BSESN
The chart is in log scale so as to bring out the ups and downs better. The X axis represents time and Y axis represents the value of the sensex. You would note that since the chart is in in log scale, the Y axis numbers are spaced unevenly.
We see that from the period 1979 till about 1992, the markets had an upswing marked by some corrections on the way. The sensex went up 42 times or thereabouts in a period of 13 years starting at the value of 100 in 1979 and ending in 4200+ in 1992. i.e a 42+ fold increase in value! This was a secular bull cycle
Even this secular bull cycle was interrupted by bear markets and sharp corrections. There was a bear market that started in 1986 and lasted till 1988 correcting by about 40% or so. Then there was another sharp pullback in 1990 that gave back 30-35% of its value.
Also note that every such bear market has occured after a sharp upmove. I call this a mini-bubble within the overall secular bull market.
From the period of 1992 top till about 2003, the sensex was largely range bound in a secular bear cycle. Note that even secular bear cycles have the occassional bull runs (1993-95, 1997-98, 1999-2000). But each get sold into and the market falls back either back into a range or lower still.
So with little piece of history, let us analyse what is happening currently.
Revisit the chart to see that from mid 2003 onwards, we are in a secular bull cycle again. Recall the mood and the sentiment in 2003, recall the valuations then and recall the period before 2003. Conditions were ripe for a secular bull cycle and that is exactly what we have seen.
Prices have been generally up since 2003. Prices broke out of the broad range establised between 1992-2003. Valuations also rose in PE terms. Participation has increased. The bull cycle was interrupted by corrections in 2004 and 2006, but that did not change the general direction of the market, which was up. Each time the markets made a new high. This was also characterised by high earnings growth of Indian corporates.
Note however that in 2008, this secular cycle has been interrupted by a bear market. In January 2008, valuations hit a mini-bubble level. People were enthusiastic about stocks and prices were rising very sharply. Everything looked rosy and the stage for a bear market was set. And we have got a counter-cyclical bear market within a secular bull cycle.
Why is it only counter cyclical and why does this not signal the end of the secular bull run? Because valuations got 'only' to mini-bubble levels and not to totally absurd levels. Participation was nowhere as high as is witnessed at the end of a secular cycle. There was some frenzy but not a total mania.
Markets will peak out and the current secular bull cycle will end when earnings growth peaks out as also expectations of earnings growth peak out. This has some distance to go, maybe 6-8 years or so, who knows. Going by history, we could see much higher levels, even to the tune of 50000+ on the sensex before the markets peak out in this secular cycle.
So what about the current bear market? How long could it last and how low can it go?
Looking at previous bear markets, it could last for 2 years or so. So assuming it started in Jan 2008, it could go on till end of 2009. It would start exactly the way a secular bull market starts, though in a lesser degree. People would need to give up hope and lose interest in stocks for the secular bull run to resume again. Right now, there is too much hope among the retail investors that we could see the resumption soon, just as we saw it in 2004 and 2006.
How low could it go?
The current PE ratio of the Nifty stands at 18.17 as per NSE data. Bull markets dont commence at such high PE ratios. Valuations need to come down to lower levels, say 12-14. Assuming that the bull market resumes by late 2009, assuming a forward PE ratio of the markets at 10-12, and assuming a EPS for Sensex at 1050 for FY2010, we can say that the market could go down to anything between 10500-12600. This would be about a 40-50% correction from the top, which is in line with prior bear markets as well.
So all is not lost, far from it. There will be opportunities in the future, very profitable opportunities, in my opinion.
PS:
Assets like Gold, Silver, Crude Oil, all are showing signs of being in classic secular bull cycles. So while in the near term, we dont know what could happen to their prices, my own sense is that there is a long way to go up for these commodities before they peak out...so Gold at $980/ounce or crude at $148/barrel may not be the eventual peaks.
Crude at $200 could be very bad for India and may upset the extent of the secular bull cycle case...India imports 76% of its crude oil. India's oil import bill this year will be around $110 billion to $120 billion. This is 11-12% of our GDP...we would be handing over 12% of our total income to foreign countries! What would that do to our currency and what would that do to a neutral currency like Gold? The wise investor stays alert...
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