Except for the ‘secondary corrections’, which may happen in the future, the market appears to be on the rise
There are five major factors which affect stock markets: economic, monetary, fundamental, technical and psychological. Let's look at the current market condition based on these five factors.
Technical Factors: The market is looking positive, technically. The Nifty made an all-time high of 6,357 in January 2008 from where it crashed to 2,520 in March 2009. From there, the new bull market started and it touched a high of 5,182 in October 2009.
However, it consolidated at that level, moving in a narrow range of 5% to 8% over 11 months. In September 2010, the Nifty shot out of this narrow range and is approaching an all important level of 6,130. The market might decide to correct from there or keep rising. If it does correct, it would be a boon for long-term investors because it will be a secondary correction of the primary bull market. The correction could take the market to, say, around 5,400 or, in the worst case, to 5,050. These levels would be an excellent buying opportunity. In the second case, the market would break through the important resistance of 6,130 and would very soon make a new high and, most probably, move on to close to 7,000 over the next few weeks or even months and may correct after that.
Fundamental Factors: The Sensex P/E ratio is 15.8x FY2011-12E earnings which are at a 10% premium to the long-term 10-year average. The Market-cap/GDP ratio is at 1.1x which is below its all-time high of 1.8x touched in January 2008. The earnings yield ratio of the Sensex is 5.3% compared to 8% yield on bonds (10-year G-Sec) and the earnings yield/bond yield ratio is 0.66x as compared to the long-term 15-year average of 0.88x. The Sensex P/E is at a premium of 30% compared to other emerging markets. All this indicates that, currently, the market is fully valued or slightly overvalued. Is this over-valuation justified? The positive factors which might support valuations are: GDP growth of 8% to 9%; implementation of key reforms like the GST, Direct Taxes Code and oil pricing mechanism; FII inflows; bank credit growth; boom in capital expenditure, private consumption and corporate dividend payout; and a stable political regime. The negative factors are: fiscal deficit; higher inflation; social unrest; and Maoist attacks.
Macro-economic Factors: Macro-economic factors are important in predicting long-term returns but not really helpful in predicting short-term price movements. In fact, often, it is the opposite, i.e., the stock market is the barometer of the economy and signals in advance how the economy would perform. In January 2008, when everything appeared rosy and all forecasts of the economy were bullish, the stock markets were telling us (in fact, screaming at us by hitting lower circuits) that the situation was not as rosy as it appeared to be. First, the stock market corrected and then the economy slowed down.
Monetary Factors: We are close to the end of hardening of the short-term money-market rates; long-term rates are anyway steady, which is good news for equities. Hence, currently, the monetary factors are positive as far as equities are concerned.
Psychological Factors: Unlike the last time, when the Sensex hit 20,000 or the Nifty hit 6,000, there is not much euphoria, at present. The market has actually, and literally, climbed a wall of worry to touch these levels. There has been very narrow participation. This means that we have certainly not reached a peak. Hence, the market is well placed as far as psychological factors are concerned and it has to go to much higher levels until the current fear gets converted to greed and we reach some kind of psychological peak of thoughts, words, views and action.
In sum, barring the 'secondary corrections' which might happen at the current levels or around 7,000, the market will remain bullish.
(Mehrab Irani is an investment manager with Tata Investment Corporation Ltd. He has nine years of experience in investment research, portfolio management and investment banking. The views are personal.)