Sensex At 52 Weeks Highs What To Do Now

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SENSEX AT 52 WEEK HIGHS – WHAT TO DO NOW? Alok Agarwala -OSTOFTHECLIENTSFEELTHATTHEYCANMANAGETHEIRlNANCESWELLONTHEIR OWN)FTHISISTHERESPONSEFROMYOURCLIENTSTHENMAKETHEMUNDERSTANDTHE NEEDOFPROFESSIONALINVESTMENTADVICETHROUGHTHISARTICLEh7HYDOTHEY NEEDINVESTMENT!DVICEv

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ndian Equity markets have been on a roller coaster ride since 2008. Having seen one of the sharpest and swiftest falls in their history, they have regained much of the lost ground in 2009, to be just ~20% below their all time highs reached in January 2008. The rise since March 2009 has been particularly sharp with the benchmark BSE Sensex almost doubling itself in just 8 months. This upside has been led firstly, by a global surge in confidence in equities after global banks were allowed not to disclose mark to market losses in their balance sheets, secondly by the injection of huge liquidity in global financial markets amounting to a few trillion US dollars leading the frozen global financial markets to thaw, and lastly by signs of a global economic recovery led by the Asian emerging markets of India and China. Better than expected results from large US banks, on the back of the new set of mark to market regulations, only added to the relief. Emerging economies of India and China coupled with their commodity exporting counterparts including Mexico and Brazil showed remarkable resilience in the wake of the financial crisis and were the chief drivers of

the recovery engine which saw their equity markets rise sharply. In India, the equity markets were given a further uplift by favorable election results which decreed the formation of a stable reform oriented government without the support of left parties. Benchmark indices rallied to hit their respective upper circuits the day election results were declared. It has not looked back since then. The sharp rally in stock markets has however left investors flummoxed as to the extent of the rise and the occurrence of a correction. Ever since the ~20% jump on May 18, 2009, investors who had shunned equities after the collapse in 2008, have been waiting for a downside to enter the markets. To their dismay, there have not been many opportunities to do so since then. Understandably, the individual investor on the street is now worried of investing and getting stuck at the top, particularly after the harrowing experience in 2008. But the flip side to this caution has been a loss of opportunity. Even after May 18, 2009, when the BSE Sensex closed at 14300 levels, it has risen by another 21% to touch 17400 levels in October 2009. This is just about the frontline index. Certain mid cap and small cap stocks have even gone up ADVISORS

by even more. In the meantime, those who were waiting on the sidelines have continued to do so, as downsides during this period have been few and too swift to be able to capitalize on them. 7HATTHENSHOULDINVESTORSDONOW 7HATSHOULDBETHEFUTURECOURSEOF ACTION First let us see where and how equity markets are placed in terms of fundamentally and technically. In terms of fundamentals, the Sensex is trading slightly above the fair valuation mark. In terms of Price Earning Ratio (PE) the Sensex is trading at a trailing PE of more than 20 which is higher than its last 10 year average. In terms of forward PE it is trading at a FY10E PE of 16-16.7 and a FY11E PE of 14.5-15, which is at the upper end of the fair valuation range. Compared to the expected double digit growth in Sensex EPS over the next 18 months, there is not much room for upside in the near term. The above chart shows that over the last 10 years, the Sensex has gone near the 20 PE (trailing) mark 5 times. Three out of five such times, the Sensex NOVEMBER 2009 | 5

has fallen back sharply, correcting by about 11% to 25%. Two times it has breached the mark and stayed above it and both the times it has resulted in the formation of a bubble – first the tech bubble in late nineties and then the real estate bubble in 2007. This is the sixth time in the last ten years that the Sensex is hovering at the 20 mark. But the chances of a bubble being formed and Sensex continuing above the 20 PE mark for long seem to be slim. Technically, the markets seem to be a bit stretched and are due for a short term correction of about 15-18% from the present levels. However, having regard to the quantum of money waiting on the sidelines in the form of potential FII, domestic mutual fund and retail investors, it seems that downsides will be met with strong buying support. Accordingly, the markets are likely to move in a wide range of about 20% in the near term. FIIs have been net buyers over the last eight months on the trot, having poured in more than Rs. 74000 cr. (~$15bn) since March 2009. On

the contrary, domestic mutual funds seem to have participated in this rally with much less vigor as they remain net sellers to the tune of Rs. 600cr during the period, primarily due to hefty profit booking in September and October 2009. The recent rally has thus been led by huge liquidity flowing in from overseas which in turn was supported by improving outlook for global equities. Indeed, the rally since March 2009 has been a part of a global rally in equities. So much for decoupling! As with other liquidity fuelled rallies seen in the past, it is very tough to predict the top in such a rally as many investors who have been through the first half of 2008 and the last five months of 2009, would vouch for. Waiting for the peak to exit, and corrections to enter can be a painful process in the case of such rallies. For sure, equity markets can remain irrational longer than you can remain solvent. 7HEREISDECOUPLINGTHEN Without doubt, growth in

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developed world will remain sluggish in the medium term whereas that in India is likely to be much faster and closer to the rate of 9%, targeted by the government. This makes us believe that Indian equities have just embarked on the next leg of the multiyear bull-run such as and probably even more explosive than the one seen during 2004 to 2007. The actual decoupling is thus about to start. Going by the way global macroeconomic environment is shaping up India is being treated more as a hedge investment against global risks amongst global investors. This has to do with its dependence on domestic consumption (exports contribute only 17% to India’s GDP as compared to approx. 40% in the case of China), low Debt to GDP ratio, a robust and relatively under-leveraged banking system, less leveraged corporate balance sheets and its being a net importer of commodities. These factors place India in a much favorable position, as compared to its emerging market peers, most of whom rely on commodity exports to maintain their growth. It is then but now that the much-awaited decoupling should begin. %QUITY )NVESTMENT 3TRATEGY n FOR EXISTINGINVESTORS It really does not make sense to put lump sum amounts in equities at present unless you are a passive investor who is investing with a long term goal in mind and does not mind seeing a downside of approx. 20% in his/her investment. For savvy investors who are looking to guard against downside, it is time to follow a quick entry and exit strategy in your tactical portfolio. With the markets likely to trade in a range, the strategy to be followed for your tactical portfolio is one of buying on dips and exiting at a predetermined level of gains and then reinvesting the gains in equities. For instance if you invest at

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an NAV of Rs. 10 with a target return of 10% you should redeem the profit part once the NAV rises to Rs. 11. The profit part thus redeemed can be put aside in money market securities and ploughed back into equities thereafter, in a systematic manner spread out over a certain period, either by way of a Systematic Transfer Plan (STP) or a Systematic Investment Plan (SIP) in order to take advantage of rupee cost averaging. "ENElTSOFTHEABOVESTRATEGY You avoid getting trapped at the top Capital is protected from possible downside Your profits are en-cashed and kept separately – a bird in hand is better than two on the tree; moreover, this strategy enables you to be able to take advantage of any sharp downsides in the markets as you will then have ready cash to deploy at lower levels Profits are redeployed either at a more attractive level or in a systematic manner over a period of time to reduce volatility You are not worried about

corrections in the market as you are already sitting pretty on your gains and after some time you might have recovered your initial capital with the investment consisting of profits which have been redeployed. This will help in increasing your confidence and patience which is so important in creating wealth from equities

%QUITY )NVESTMENT 3TRATEGY n FOR FRESHINVESTORS Investors bringing in fresh capital might not be willing to invest the entire money in one go at present. They should look forward to invest over a period of time by way of STP or SIP to protect themselves from short term fluctuations and benefit from rupee cost averaging. Alternately, savvy investors can choose to buy on dips in a staggered, self disciplined manner. For instance, one can choose to buy on dips of 1000 points from the recent peak or alternately whenever the Sensex reaches or breaches a certain level, say 15000. Once fully invested thus, investors can then follow the targeted entry-exit strategy as enumerated above with respect to their equity investments.

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