At the outset, let me warn you that this is a preachy, ranty post. As equity markets are breaking all records, there is much chest-thumping in India about the rise of domestic savers and our lower dependency on foreign flows (buying) to prop up the markets.
While it’s heartening to witness the remarkable success of the 20-somethings who have put their faith in the market and are unwavering with their SIPs, it’s important to recognize that some of this confidence may be bordering on blind faith and overconfidence.
Foreign institutional investors have been selling or have been limited in their participation. They have invested about USD 2.6bn this year, compared to USD 22bn in 2023. Some reports say that $70bn of domestic money has flown into the market since 2022.
Experts after experts are warning about lofty valuations; it appears as if their advice needs to reach the targeted audience.
You can hear them here, here & here.
Why am I ranting? Isn’t it good that the equity markets are rallying? The portfolio value of Indian investors is going up; it’s a happy scene! There are enough other “experts” who claim that it’s India’s time to shine and that our markets have finally found their place in the sun.
Let me explain. There is something called price and something called value. When we go to buy anything physically or online, we assess. We buy something after we look, compare, and decide the price is worth the value. Sometimes, the value is snob appeal or status symbol like a Louis Vuitton, a Hermes handbag, a high-end Mercedes car, or an extravagant wedding. Are they worth the exorbitant price?
No.
Clearly, these high-end purchases give us some other nonfinancial gain for consumption purposes.
On the other hand, we buy financial assets primarily for investment purposes. We want some cash flow from the investment, like dividends or interest, also we may expect price appreciation.
For example, when we buy gold, we believe it’s a store of value and think its value will appreciate in the long term. Whenever we sell it, we will turn a profit. Likewise, in stocks, we want dividends, or we want prices to go up.
If you look at history, it’s evident that markets move cyclically…. There is mania, panic, and crashes. An oft-repeated example of Tulipmania in the 17th century is that the price of a bulb of tulip rose manically. People were trading a single bulb for the equivalent cost of five acres of land. People bought it because they could sell it for a much higher price in the short term, and it was a lucrative trade.
This tulip trade went on for a long time, and some people made a killing. But one day, someone realized that this was a foolish trade. The price paid was too high for the value. There were too many sellers and no buyers, panic set in, and the people holding the tulip contracts lost a lot of money.
Financial history has many such bubbles, and history repeats itself in different forms as human nature hasn’t changed. We are all fearful and greedy, one after the other.
Returning to our indices, click alongside for the performance of the Nifty 50, Returns of Nifty50.
Nifty50 has given a compound return of about 12+% in the last 24 years, though its performance has not been linear. In the previous 24 years, there have been five instances when Nifty has returned negative returns in a calendar year, and in five cases, single-digit returns that wouldn’t even beat fixed deposit returns.
If one had invested in the top at the beginning of 2008, the portfolio’s value would have dropped 50%. Only if one had stayed invested until 2010 would one have gotten their principal back. You would need a lot of emotional resilience to remain invested after the portfolio value drops 50%. This kind of volatility is not for the faint-hearted; the fiercest bull falls prey to panic and redeems to protect the rest of their capital. I am not suggesting that the market is at the top and will drop 50%; all I am saying is that it’s known to happen. And it requires courage to stay invested when there is doom all around.
My grouse is that investors investing Rs 23000cr or more in SIPs every month need to understand or think about the value or price of stocks vis a vis their earnings.
Fund managers’ compensation and performance are measured against their peers and the market. So, while they voice caution and are uncomfortable with the prices of certain stocks, they are still compelled to buy them. They may try to invest in stocks that are not overpriced or keep cash. But because of the continuous run-up in the indices, they feel FOMO or are mandated to jump in to buy. This creates a self-fulfilling loop of prices going up as more and more money enters the market.
Currently, the Nifty 50’s PE is about 22 times one-year forward earnings, almost the long-term average. The PE ratio of 22 indicates you are willing to pay Rs 22 for Rs. 1 of the company’s profits. Or, 22 years of accumulated earnings will be used to compensate for the price you are paying for the company. Remember that many companies are reporting declining quarterly profits and are being downgraded. The number of companies expected to post lower profits next year is increasing, making these valuations expensive.
Midcap and Smallcap PEs are even higher. Typically, they trade at a discount to the large caps, but now they are trading at a premium. Although these smaller companies can grow faster and the higher price can be justified, they can also crash and burn.
Companies like Zomato or Nykaa are growing at jet speed and have made a small profit. They are trading at a PE of 125 and 234, respectively. Venture funds that have a risk appetite invest in these high-growth companies. They should, as they create the ecosystem and environment for these companies to thrive.
But an average Rahul or Simran should consider whether they want to invest in high-risk, high-return companies. Some of them have doubled in price, and some have also crashed. These are games that wealthy people play, and one can play as long as one knows the game or risk only a small percentage of one’s portfolio.
Investing is a long-term loser’s game. Don’t lose money, and that’s your win.
Few experts can or are willing to predict a crash outright; no one knows what will happen. Who knows whether more buyers or sellers will be on a given day? Many people’s collective sentiments or moods are impossible to understand or predict.
It is also against the fundamental business model of fund management to predict a bust, as they earn fees from assets under management. Rarely will they ask you to stop investing; it is against their self-interest, and they will look foolish if markets keep rising. One needs to read between the lines to gauge what the experts infer.
The rally can last months or even years.
You can only look at the price and see if you get the corresponding value. If the market is going up consistently, one can play momentum and trade, but again, you have to understand the game and play accordingly.
The SIP or domestic investor is not dumb; the only thing is that they are convinced by the narrative that you can never lose with SIPs. In a growing economy, if you have an infinite holding capacity financially and emotionally, you probably will never lose money if you can stay forever. Cycles turn.
But an average saver will need his savings for his own consumption—a house, education, holidays, medical needs, whatever.
Only the wealthy have unlimited holding capacity no matter what happens to the market. They have other sources of income or a huge pool of savings. They are not the people this blog is preaching to.
We can smirk at the foreign institutional investors who are missing the rally and gains, but it would be foolish to ignore their actions completely. They are sharp, profit-hungry investors, and if they stay away, they may be finding our companies or indices are fundamentally overvalued.
Promoters after promoters sell their stakes every week, foreign holding companies sell their shares. If the promoters feel they are getting a good price and are getting out, it should be a cause for concern. They know their own companies and their prospects best.
Companies with not-so-great business models launch initial public offerings and get oversubscribed hundreds of times. These are classic signs of bubbles forming and market complacency.
No one likes to be a party pooper, but you gotta say it as you see it. The Stock market is the only place where experience doesn’t count for a lot, as every day is new. The rules, opportunities, and threats are constantly changing. It keeps you on your toes.
When the market gets red-hot, you should step aside, ruminate, and be wary before you SIP.
Neeta
Well explained.