Where are Equities headed?

There are only two conventional / text book ways to assess equity markets – fundamental and technical. And if both fail to explain – then the third one never fails i.e. emotional. 

So the good part is that people are no longer talking about the 25% correction Nifty has seen from it’s peak levels seen in Jan-20.

Instead of the expected panic, there seems to be a sense of calm and acceptance – atleast after the initial shock. As if the expectation from Covid was that things should have been much worse. 

Instead the bad part is that people are now worried about why the markets are up 15% in April!!This rally from 8600 (31st Mar) to 9550 on Nifty (29th Apr) has caught everyone by surprise – bulls and bears alike. 

Well for the fundamental purists it’s a nightmarish jigsaw to solve. And am sure most of the fundamental research guys are falling short on logic or ratios to explain this puzzle. Nifty is now trading at almost 21 times trailing PE. Even if we stretch our imagination and assume a 5% EPS growth for the year – it is still trading at about 19 times on this FY earnings. 

Now 19 times is not scary expensive but it’s not dirt cheap either. And remember, this is on a base of 5% EPS growth which would mean that companies would have to drastically cut costs in light of the seriously challenged revenue forecasts.

19 times is not the red zone considering average historic multiple on Nifty. But 19 times is for sure not the “sell your house and buy equity” zone. Earnings problem is not new to India. Without Covid also, the average earnings growth of Nifty companies for last 10 years has been a paltry 7% CAGR. Yes, it’s taken a full decade for Nifty to double the EPS figure. 

So if a market is growing earnings at 7%, why should it trade at a 21 times premium? This, I fear, is a question no fundamental analyst can answer with aplomb.

All you find is blithe replies which point towards a miracle decade ahead, replete with double digit earnings growth. For the record, last time India saw a 20%+ earnings growth (Nifty EPS) was in FY 2011. 

So we can safely conclude – Markets are behaving irrationally when we look at it purely from the view of fundamental values.

Now let’s assess it from a Technical perspective.

Markets on the downside broke 7800 level on Nifty which was the pre-demonetisation level and considered as a strong support level on charts. We tested and broke that level ferociously on 23rd March and made a low of 7610 on Nifty. Which is the bottom of this fall, so far. So from a low 7610 to 9550 today, it’s a good 38% retracement on the lost 4500 Nifty points.

For all who are in awe and shock – here’s some food for thought: in the same period, the world’s largest index, S&P 500 has retraced 50% of its lost points from the lows of 2237 made on 23rd March. 

So from a Technical perspective, this rally can continue to surprise and perhaps pull a rabbit of another 400-500 points on Nifty.  

And last, but the most important part of this rally – Emotional !

Yes, in the very short term – there’s only one factor which drives the market i.e. emotions (or to put it economically, liquidity).

Imagine this: Suppose your son’s monthly school canteen expenses are Rs. 5000. Mom comes into the picture to rally against junk food and starts the habit of giving him home food every day. But you feel your kid is under stress and being an indulgent father, give him Rs. 20000. Your parents visit and you convince them to give him a one-time gift of Rs. 1 lakh.

Any guesses as to how your child will behave? Not only will your kid eat junk and splurge on unnecessary things. He will ensure he sponsors the excesses of his friends also.

 The son in the story is the S&P500 index. The disciplining mother is the media watchdog suggesting austerity measures as the need of the hour. However, they are overlooked by the benevolent father Donald Trump who has convinced the generous grandparents or the US Fed – unleashing a $2Tn bazooka!!

Oh for all those wondering – all global markets are thick friends of this son (i.e. S&P500). They sail together. And while sinking – mostly the Emerging markets bear the larger brunt considering they mainly depend on the largesse that this son can spare.  

How long will this party last? Till such time that central bankers and governments of the world keep feeding the markets with cheap liquidity, risky assets will continue to fly and surprise one and all.Economy and markets are two different things and smart investors never mix them.  

 So what should investors do?:

If you are a fundamental investor with a long term view in mind – this market is blasphemy. Stay away from heroism. Do not, I repeat, do not mortgage your house to borrow money and invest in equities. Buy in small chunks. Break your investing kitty to enter the market frequently. Have patience.

If you are a technical investor – there is some more juice. Extract it. Don’t go overboard. Know where to draw the line.

If you are an emotional investor – make hay while the sun shines. Celestial Stars, Trump, Federal Reserve and Central Banks of the World are playing on your side. Go play the shots. Although here again, I would caution you to pocket mark a specific sum of money. If emotion can take you up on the roller coaster ride, they can bring you crashing down as well.

As usual, the markets never fail to confuse or lead to second guessing, while being entertaining all the while.