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Raging Bull

The stock market is dangerously close to the January 2008 highs. Find out whether you should buy, hold or sell your stocks at this juncture.

Arindam Bhattacharya Arindam Bhattacharya
Twenty years ago, Gordon Gekko told us that greed is good. That the primeval desire for more works. The words of the ruthless corporate raider played by Michael Douglas in the 1990 Oscar award-winning film Wall Street would have been priceless investment advice in October 2008, when the Sensex crashed by 34% in 17 trading sessions.

They made eminent sense in March 2009, when the BSE benchmark dipped to a multi-year low of 8,160. But today? Should you follow Gekko's advice now when the stock market is close to the 2008 peak?

One disturbing aspect of the current stock rally is that it is riding a tsunami of hot money from abroad. We witnessed this in 2007, when FIIs pumped in Rs 70,940 crore in the Indian equities, pushing up the Sensex by 32%. They pulled out in 2008, but were back with a bang the next year.

This year, the net FII investment in equities has already touched a record Rs 1,05,000 crore. However, this global hunger for Indian equities could wane if the US economy suffers. Analysts are divided over whether the US economy will relapse into a double-dip recession. A double-dip is a recession followed by a shortlived recovery, which is followed by a deeper recession.

 WHY YOU SHOULD BE FEARFUL...
  • The rally has been fuelled largely by FII inflows. The net FII investment in equities this year has touched a record Rs 1,05,000 crore. But this can quickly reverse if the US economy falters or domestic corporate earnings slow down.
  • Inflation forecasts have been revised upwards and policy rates may be hiked by 50-100 basis points. Interest rate hikes and rising input costs could put further pressure on margins and depress corporate earnings.
  • Corporate India's earnings momentum is beginning to wane. Despite encouraging GDP data, the 2010-11 earnings forecast of several companies has been revised downwards. At current valuations, FII investors will be intolerant of any unpleasant surprises.
  • Several IPOs are expected to hit the market over the next 3-6 months. This could suck out liquidity from the system and impact market valuations in the short term.
  • Recent manufacturing data indicates capacity constraints and pressure on margins due to a sharp increase in input prices and a slower increase in output prices due to the increased competition from imports.
...AND WHY YOU SHOULD BE GREEDY
  • Near 0% policy rates in the developed markets are likely to sustain the strong inflow of portfolio investments from abroad.
  • India's relatively low exposure to global structural risks and its above-average growth prospects make it a magnet for global capital flows.
  • Despite rich valuations, Indian markets are priced at 18-19 times the projected 2010-11 earnings, and 15-16 times the projected 2011-12 earnings, which are close to the long-term average of 14.5 times.
  • Many key bellwethers have not participated in the rally. Certain large-cap stocks in high-growth sectors still hold the potential to deliver steady returns over the next two years.
The US economy has followed the first two legs of this scenario very closely. Adding to the worry is the performance of the Dow Jones Industrial Average Index since July 2009.

The trendline closely fits its movement between May 1936 and February 1938 during the Great Depression.

The fragility of the US recovery may not be the only reason for FIIs to pull out. The deadly combination of rising interest rates and higher input costs is also threatening to squeeze margins and whittle down corporate earnings.

"If inflation does not fall to 5% within the next 3-6 months, interest rates could rise higher than currently anticipated," says a Mumbai-based broker.

Though food prices might drop due to the good monsoon, inflation won't be tamed so easily. Manufacturing data suggests that industries are facing capacity constraints, which could hamper supply and lead to higher prices of manufactured products.

The large number of public issues scheduled to hit the market over the next 3-6 months is another concern.

These issues, which are combinedly worth over Rs 60,000-70,000 crore, will suck out the liquidity from the market. The Coal India Ltd IPO alone will account for Rs 15,000 crore.

The public issues have the potential to cause stock prices to fall or stagnate in the near term.

What happens if these bearish scenarios come true? Will foreign investors pull out? Will we see a repeat of the 2008 crisis? Experts don't think so.

The Indian economy has a relatively low exposure to global structural risks. Exports account for less than 22% of India's GDP, thus ensuring that the economy chugs along on domestic consumption alone.

"This partly insulates India from higher risks to growth in the advanced economies," says rating agency Fitch in its quarterly Global Economic Outlook.

There is another reason to be optimistic. The Nifty is trading at close to its all-time high levels and its price to earnings (PE) ratio is dangerously close to 26. But if you look at the projected earnings of the Indian companies, this number falls. The Nifty is valued at 18-19 times the projected 2010-11 earnings, and 15-16 times the projected 2011-12 earnings. This is no higher than the 15-year long-term average.

To conclude, stock prices are as high as they were three years ago, but the risk quotient has come down. The financial world has become a more cautious place after the previous bear attack.

"The factors that led to the 2008 meltdown are now known. We are aware of the problems in the US economy, the real estate bubble that led to the sub-prime crisis and the perils of leveraging," says Tushar Pradhan, CIO of HSBC Mutual Fund.

This hindsight serves as a warning on where things could go wrong. In the following pages, we tell you how to control the risk in your portfolio through careful stock-picking and astute asset allocation.

 DON'T LOOK AT THE SENSEX

With the Sensex at more than 20,600 points, is the market fully priced? I don't know. When I started investing in 1979, there was no index. This means the Sensex reaching the 'landmarks' of 1,000 to 10,000 to 21,000 have meant nothing to me. It's just another number-as good as knowing that there were 729 weddings in one week in Delhi.

If your daughter is 5 years old, and you are saving for her wedding, how does it matter whether the market touches 21,000 or not? Similarly, if you are saving for your daughter's wedding in the next month, why on earth are you still in the equity markets? You should be invested in safe options such as bank fixed deposits. Most equity investors lose money not because of what the market does, but because of what they do or don't do. Let us concentrate on a few things that we must do.

Get rid of non-performers: Over the years, you might have accumulated some shares that are not performing well. If the shares haven't moved up when the market is nudging 21,000, they are unlikely to grow.

Learn about asset allocation: Distribution of your investment across various instruments depends on your risk appetite. If you decide to spread your investments equally between debt and equities, and the equity component goes up to, say 75%, due to a rising market, it's time to rebalance.

Define your goals: Most investors save for some financial goals, clearly penned down or at least well thought out. Not having a goal means you want to create wealth or save for retirement.

A confused investor might worry whether he should book profits as the markets are at record highs or stop investing. Wealth can't be created by timing the market. Most of the wealthy people I know have been in the markets for 30-50 years. Let's have a look at some investment lessons.

Compounding works: There is no need to guess what Einstein said about compounding. The longer you stay invested, the more you gain.

Invest in right instruments: If you need money after a few months, invest in short-term instruments such as fixed deposits. If you need money in 2030, invest in equities irrespective of the market level.

Learn investing or outsource: If you don't understand the equity market, either sit and learn about it or invest in a well-managed equity fund through a systematic investment plan.

P.V. SUBRAMANYAM
Financial Trainer, Iris
 
SURESHOT WAYS TO LOSE MONEY
'This time it's different,' are the four most dangerous words in investing. Here's what not to do at these heady levels if you want to avoid losses.

Enter late, leave early: Small investors usually start buying when everybody else wants to pack up. Worse, the late entry is usually followed by an early exit if their stocks don't do well. More losses, more pain.

Borrow to invest: Investing borrowed money is the second biggest folly of small investors. You don't know when you might be required to pay back. Of course, the biggest folly is getting too greedy and investing in futures.

Invest for the short term: It's a paradox that many Indians invest in the PPF for retirement that is 25-30 years away and buy stocks with a 2-3-month horizon. Taking a short-term view will only lead to disappointment. Invest in equities only if you intend to hold them for at least 3-4 years.

Invest a lump sum: Systematic investment is perhaps the best way to buy stocks. But who's got the time or the patience? Why not invest a big amount and reap bigger gains? This might have made sense when the index was floundering at 8,000. Not when it is zooming above 20,000.

Buy on tips: You are driving to work when you get an SMS about a stock that is poised to zoom. Do you call up a broker and place an order? Or do you reach office and read up on the company? Many investors choose the first option. It's less cumbersome, but also a convenient way to lose money.

Buy the IPO lottery: The IPO market is buzzing again. Before you invest, find out more about the company. IPOs no longer ensure high listing gains. The shares of NHPC are languishing at 10% below the issue price of Rs 36.