Let us
imagine a scenario in which all of us want a market which rises every single
day and our money is multiplied every day - the dream bull run.
From
watching television and reading the papers it appears as if almost all
investors have made big losses on the market. But, on the other hand, when I
look at the performance of the Sensex over the past few years, the scenario is
quite different; the benchmark index has appreciated progressively from a level
of 7,000 in March 2005 to 11,000 in March 2006, and moved upward to 14,000 in
March 2007, today, as I write this article, it is at the 15,300 level. Looking
at this positive performance, we may wonder why there is so much negativity.
Admittedly, the market has plummeted from its top of 21,000 and has also
notionally eroded the value of your portfolio. But it is important to remember
that this correction is a particular characteristic of markets, and of any bull
run. No stocks, not even a good quality stock, goes up in a linear fashion,
instead it tracks sideways, consolidates for a few months and than suddenly
goes up in a burst, and continues to appreciate from its foundational strength.
It then may suddenly collapse like a house of cards, but takes away only some
of the gains.
Though
creating wealth is an innate quality of our market, volatility cannot be wished
away completely. Staggering your investments across your investment
period,rupee cost-averaging and diversifying your investments are some of the
steps than can help mitigate the impact of volatility, but you cannot totally
remove the pain of volatility. In fact, pain and happiness are integral to our
markets and are opposite sides of the steps that can help mitigate the impact
of volatility, but you cannot totally remover the pain of volatility. In fact,
pain and happiness are integral to our markets and are opposite sides of the
same coin. It's just the way you look at it that makes the difference.
Currently, everyone on D-street is in a state of remorse. That's not
surprising, in view of the fact that our markets, after soaring euphorically to
21,000, have been southward bound with no relief in sight. Sure this creates
anxiety and pain, and nobody likes pain; after all, it hurts. Yet, sometimes,
such pain must be welcomed. In fact, as surprising as it may seem such pain
always lays the foundation for long-term prosperity!
Let us
imagine a scenario in which all of us want a market which rises every single
day and our money is multiplied every day - the dream bull run. On the face of
it, such a scenario looks great, doesn't it? Everyone would be elated by a
trend like this, as our portfolios would reap extraordinary returns. We would
increase our equity allocation and redeploy our profits back into the market
because this is natural human behavior. There would be no losers, and everyone
would be happy. But, if this scenario would be true than imagine the valuation
that the market would reach in a few years, and consider the catastrophic
consequences that would follow due to hugely inflated asset prices. The fact
that high valuations eventually disappoint can be substantiated by a number of
historical examples. From 1990 to 2000, blue-chip stocks like Hindustan Lever
and Castrol were the darlings of investors. They had given superior returns
over the decade, thanks to their stupendous business performance. After that
honeymoon period, however, over the past seven years, apart from
dividends,investors have barely earned anything from these stocks in terms of
capital appreciation. Such phenomena have occurred not only among individual
stocks, but in the whole market as well, Our market gave sub-standard returns
from 1992 to 2002. This was because prior to 1992 - recall Harsha Mehta's dream
Bull-run and just before the bubble burst; the market was trading at a P/E of
35x. It took ten years of painful waiting, from 1992 to 2002, for corporates to
add profits to their balance sheets, for valuations to come back to a realistic
range ie. P/E of 12x.
Similarly,
this time the market was threatening to cut loose at the 21,000 level. There
were several reasons for this and we know them well. At this level, the Sensex
was trading at a forward P/E of 19x, a level at which fundamentalists may not
raise any alarm. However, if the market had continue on its upward journey, it
would have become increasingly expensive, leading to inferior asset quality.
Now, if the markets had remained at such exuberant valuations for a longer
period of time and we had continued putting more money in and taking profits at
excessive levels, our portfolio assets would be super-inflated and we would
certainly pay the price later. Notably excesses may sustain for a long
period-three to five years or even longer - as we did observe in the Japanese
market in the 1990's Yet, the fact remains that all such excesses have to
eventually correct - and culminating into real pain. In fact we should consider
ourselves fortunate that the day of reckoning for Indian markets arrived
earlier than it did in the Japanese markets, which nosedived after rallying
continuously, leaving investors crushed and miserable. So what should we do in
the current scenario?
The only
way to avoid this is to invest in markets consistently - this helps in
averaging out our purchases. So, as investors, we should pray that these
"pains" come frequently, thus helping us acquire stocks at good
valuations, and exuberant phases must get truncated at regular intervals to
avoid our investments getting locked in the markets at dizzy heights and
ultimately ending in real pain.
Coming back
to current market levels; in India their is nothing to worry about, as India is
currently at the cusp of an investment and consumption boom, this boom will
have a positive impact on companies which are directly and indirectly a party
to this development. Thus Indian equities are set to offer 15% tax-free
compounded growth. So, my dear friends, just flip the coin and you will see the
gain beyond this phase of pain. If you do that and stay with equities, you will
reap the benefits provided by the markets and ride the Indian bull for a long,
prosperous time.