When nobody wants to buy something, it naturally loses its value. The value of something that is not in demand naturally tends to be lower than what it is really worth. This is the state of equities now. Look around you and you will find that the last time people chose equities as their preferred investment was in 2008. The past four years of painful wait has left investors tired and dejected. So much so, that people are selling equity on every rise and exiting the stock markets. Clearly, investment fatigue is at its peak. From experience, I can confidently say that a bull run is usually born when the fatigue peaks.
Can a bull run actually be predicted?
Bull runs always defy logic. But, they unfailingly follow a pattern. A number of economic events need to fall in place and liquidity flows into stock markets must rise quickly. Bull runs take off when people logically expect markets not to rise. Yet, if you are a contrarian thinker, you can sense when the markets refuse to follow the logic and start breaking away. High levels of pessimism among retail investors are another good indicator to predict a bull run. Most bull runs start off when retail investors vigorously sell stocks and larger players absorb their selling.
How do I say a bull run is about to be born?
Between 2009-2011, we saw everyone flock to buy three asset classes. Real estate, gold, and debt dominated the investment choices. Today, realty prices are at their all-time high, gold is at its all-time peak and interest rates are clearly peaked out. None of these three are attractive investment choices. Yet, investors are flocking to buy them. On the contrary, capital allocation to equity investments is at its lowest in five years. In fact, money is continuously moving out of equity mutual funds. Investor aversion to equity is at its peak. This naturally leads to a sharp dip in valuations. Pessimism always tends to be overdone. We are in that mind state right now about equities.
When fundamentals look at their weakest, how can a bull run be born?
Every Bull Run is born only when the fundamentals look very weak. Earnings of the Sensex remain static for two or three years. At the end of that phase, the earnings start to grow again. The Sensex earnings were virtually static between 2008-2010. For three years the Sensex EPS went nowhere and hovered between 833 and 834. History has an important lesson here. When earnings don’t grow for long periods, it tends to compensate quickly in subsequent years. The Sensex EPS hovered between 266 in 1997 (the year of the dream budget ) and 272 in 2003. Between 2003 and 2008, the Sensex earnings trebled to 833. The Sensex rose from its 2003 high of 5920 to its 2008 high of 21206.
This Bull Run was no accident. It happened because interest rates kept falling to hit a 10 year low. Liquidity hit a 10 year high. When interest rates are lowest and liquidity is highest, the earnings of companies grow at their fastest. The only spoiler is inflation. Always inflation will lead to the bursting of every bull market bubble.
What causes a bull run to gain momentum?
Falling interest rates.
Rising liquidity.
Rapidly expanding earnings ( E.P.S).
As inflation falls over the next two years, we will see interest rates drop and liquidity rise. Corporate earnings will grow faster as interest costs drop. The earnings growth tends to gain momentum within two years of the interest rate cycle turning. Over the next two years we will see the return to growth. The stock markets will only respond after returns convincingly establish that growth is back. A swift rise in the markets will then leave the investors stunned. This is how every Bull Run shocks and awes the investor. The next Bull Run will be no different.
How does the Sensex gain valuation?
Pardon me for saying the plain truth. The Sensex gains from two things. One, the outperforming companies take the leadership of the Sensex and become its growth engines. Usually, it is four or five companies, to begin with. Over time, the numbers grow. The second and most important contributor to Sensex’s gains is the restructuring of the Sensex. Stock exchanges tend to replace nonperforming companies with performers. This improves the composition and delivers a positive drag to the Sensex. You will notice that key indices are in the middle of a churn of companies. This bodes well for the indices.
Will the markets gain rapidly?
Unlikely, given the weak economic numbers, Nifty will remain in a range between 5200 and 5600. The changes in the nifty’s composition will take effect only slowly. As the economy gradually picks up growth momentum, more companies in the nifty will start reporting better numbers. This will help the markets break out of the range given above. But, that is going to take time. Liquidity from FII’s can however change all assumptions and investors must closely monitor FII fund flows.
What should investors be doing now?
Investors must use this range-bound market to buy quality. When markets are in a sidewards movement, it is the best time to build a portfolio for the next Bull Run. Buying price bargains should happen when equity is out of favor. A stock-specific approach should be followed and investors would be better off avoiding trading. Blue chips must be bought now and held for many years. Investors must understand that there will be underperformance for a while and confidence will return only over a longer period.
Trading vs. investing – which is a better idea?
Trading is a strict no-no. If you try trading now, you will end up selling your winners and hanging onto the losers. Moreover, if you have bought a company with high visibility of performance, by trading you would have settled for a very small profit. If you had chosen to remain an investor, such stocks will turn out to be your multi-baggers.