Now that the Sensex has crossed the 8000 mark for the first time, the bubbly is out on Dalal Street.
Those who have already invested in the market can't wipe the grin off their faces. What makes the news all the more sweeter is that there have been no shortage of experts who had been issuing doomsday warnings almost everyday.
Nevertheless, the Sensex rose by 1000 points in the last 55 trading sessions.
But the past is history -- what matters is what should an investor do now.
Should an investor book profits?
Should he make new investments?
These are the questions we need to answer.
Hey, it's not just India!
The first thing to remember is that the market has been driven up by inflows from Foreign Institutional Investors. They've pumped in over $7.5 billion in the Indian stock market this year, and it is this flood of money that has taken the Sensex to new highs.
The money is not just pouring into the Indian market. Money is also being invested in other emerging markets. This is a generic term referring to the financial markets of developing nations.
Last Thursday, for instance, the South Korean stock market also reached a record high, while emerging markets ranging from Asia to Latin America are either at record or multi-year highs.
Nor is the action limited to stocks. In the last couple of years; money has also flowed into bonds and commodities. Just as stocks are traded on a stock exchange, raw material or semi-finished products such as metals, grains, rubber, cotton, coffee and gold that are traded on a commodities exchange.
Why is this happening?
On the one hand, good growth in emerging market economies has served as a pull factor for foreign investors.
On an international front, emerging markets are viewed as having tremendous growth potential and hence provide lucrative returns. However, they are also viewed as posing significant risks due to political instability and corruption.
On the other hand, this deluge of money is the result of very low interest rates in the US and other developed markets.So in a bid for higher returns, the investors look abroad.
Hence, investors, particularly hedge funds hungry for higher returns, have scoured the world looking for assets to buy. Hedge funds operate like mutual funds. They manage the investments of very wealthy individuals and institutions. They are more aggressive and are known for making risky investment bets.
This inflow of money into the country was also helped by the fact that the dollar was weakening, which made assets denominated in other currencies appreciate.
Let's say $1 = Rs 35
If the dollar weakens, it would mean $2 = Rs 35.
So, investors who invest in the Indian market in rupees will get more dollars when they sell their investments to take their money abroad.
When will the inflows cool down?
This most crucial question to ask and the most difficult one to answer.
Recall how the market tottered last month when FIIs began to sell their investments for a few days?
One theory is that so long as real interest rates (interest rates minus expected inflation) remain low in the US, funds will continue to flow out to higher-yielding assets (investments which give a higher return). So the money will come into India.
Another points out that the housing industry in the US is booming which, in turn, has led to money flowing into mutual funds in that country. These mutual funds are investing in other countries.
When the bubble bursts, the flows will disappear.
At the same time, however, there's little doubt that the US Federal Reserve (the central bank like the RBI in India) will do all it can to ensure a soft landing in the US, which means it will make sure that interest rates don't rise too far too fast.
That should ensure continued inflows to emerging markets such as India.
Moreover, new classes of investors such as pension funds and Japanese investors are long-term in nature.
However, nobody can predict for certain whether foreign investors will continue to buy into the Indian market.
All one can do is keep a wary eye on the daily FII figures put out by the Securities and Exchange Board of India, the market watchdog. You can see them on the SEBI website.
Are stock prices not too high?
Isn't the Indian market now overvalued, and won't that lead to international investors funds seeking other, cheaper destinations?
Most analysts feel the Indian market is now more expensive that several other Asian markets. This means, they are paying much higher rates for stock investments than they would pay in other emerging markets.
However, earnings growth for Indian corporates is higher, given the superior performance of the Indian economy.
Nevertheless, at 8050, the Sensex PE of 16.7 is certainly not cheap. Let me explain.
EPS = net profit/ number of shares
Earnings Per Share is the net profit a company makes divided by the total number of its shares. The purpose of this ratio is to tell you how well the company is doing.
PE = market price/ EPS
The PE ratio of a stock is the market price divided by its EPS. This tells you how other investors view the stock.
A company will have a high PE if investors hope their earnings from the stock will increase; this is is why they buy the share. This increase in demand will result in the share's market price rising.
To understand these ratios in detail, read Spot a good stock. Win big!
The PE ratio of the Sensex is around 16.7. This means if we add up the price of all the 30 Sensex companies and divide it by their EPS, the result would be 16.7.
Is that high?
Some say yes, others say no.
Brokers say that, historically, bull runs have peaked at a much higher Sensex PE.
They also say that the strong growth in the earnings of companies justifies the high valuations.
The Indian market also has breadth and depth which makes it very attractive. That is why more and more foreign investors believe that they need to have a presence in the Indian market.
When a small change in share price causes large transactions (buying and selling) to take place, the market is said to have depth. The smaller the price movement and the larger the transaction, the deeper the market.
The breadth of market refers to the number of stocks and volumes being traded.
Should you sell now?
It all depends on what returns you were expecting when you invested your money. It's always a good idea to have a target in mind and book profits (sell your shares and make a profit) when that target is reached.
If you have made the profit you wanted, then you could look at selling.
Should you invest now?
That's up to you. But here are a few thoughts to keep in mind.
1. Invest only in stocks that have comparatively low PE multiples -- banks, for instance, are an attractive option.
2. Investing in large caps is also a good idea because, in times of trouble, individuals always invest their money in quality and stable companies.
3. Investors should look to invest regularly in the Systematic Investment Plans of mutual funds; this would ensure that not all their investments are made at the top of a market. Since this requires you to invest a little amount every month, over time, your investments even out.
Read Mutual funds give great returns to understand the benefits of investing via an SIP.
A closing thought
Much depends, of course, on the ability of the investor to bear risks.
But it's worth remembering that, at 8000, the risks are higher and the possibility of rewards lower.
Whether or not a bull run is on, buying shares is risky.
The only precaution you can take is to play as safe as possible. This means you need to do your homework. Don't just buy a share because your neighbour is doing so. Buy because you believe in the company and are willing to stay on for the long haul.
In short, caution must be the watchword.
Illustration: Dominic Xavier
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