Summit 10K on Mount Nifty – commence your descent till the time weather is good!

Summit 10K on Mount Nifty – commence your descent till the time weather is good!

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It was only yesterday that, the Nifty closed above 10,000 for the first time ever and we already have today’s headline shrieking Expert take: Why the bets on Nifty hitting 12,000 by next year are on”

The Nifty is around 18 times 1 year forward earnings (estimated by so called market experts) ; which puts the one year forward earnings estimate at Rs 555 . Now this is against the 12 month trailing (TTM) EPS of Rs 395 which means a 40% expected jump in earnings. How feasible is that !

None of this seems impacted by the GST settling down blues; nor by the China border row . Of course a 25 bps drop in interest by the RBI will also not impact corporate earnings or stagnant credit uptake or capex, just as the past ones have done nothing for them.

However, in the real world the corporate earnings are going no where as yet and the TTM EPS has shown a growth of about 4.5% pa over the past 24 months. Today we may all be floating on hope as we have been over the past two years.

The harsh truth is that, the run away Nifty growth has nothing to do with our economic fundamentals, interest rates or for that matter anything else Indian. 

Its only because of our share in the flood of FII driven liquidity flowing into MSCI emerging markets . The combination of low oil prices and FCY inflows have held the USD / INR fairly steady; a factor which seems to have further encouraged FIIs. 

This liquidity is a result of the asset buying programs of the US Fed, the European Central Bank and the Japanese Central Bank.

All three of them have realised their respective monetary policy measures seem to have outlived their utility and are anxiously aware of the need to get matters back to normal as soon as they possibly can. They have yet to announce a time frame for this but, have off late been making increasingly louder noises in an attempt to catch the attention of the global markets so as to get them prepared for a “real world wherein money will once again cost to rent”. This will be an environment, many in today’s market may not have seen and lived through – it will prove a paradigm shift in our investment thinking, processes and return expectations.

Any market despite all the liquidity flooding in has to eventually measure up to corporate earnings. Therefore, even if the actual withdrawal of liquidity is yet to get underway, I am not sure that, for how long these FIIs will continue to buy into our markets, when MSCI India’s price-earnings ratio; which was at a 60% premium 2 years ago is now about 40% higher than the multiple for MSCI Emerging Markets. 

This means for us in India and for that matter in most other emerging markets too, all future buying will mean buying the same few assets which are already expensive at even higher prices !

The US markets are possibly the best place to see the full blown impact of this liquidity flood. 

This graph (below) very clearly demonstrates how the markets in the US have grown with the US Fed balance sheet. The situation is very similar with MSCI Emerging Markets when we include the ECB and JCB liquidity inflows.             Source: Business Insider (27-07-2017) 

Screen Shot 2017 07 27 at 9.38.25 AM
Well even if you don’t want to take my word on this – one can’t  ignore Mr. Howard Marks (Founder CEO Oaktree which has $101 Bn under management – and has Warren Buffet for his self proclaimed fan); who outlined his concern that the markets are entering “too bullish territory” and that a bubble could be forming. Click here to read his 22 page long memo to his clients.

For those who do not have the patience to go through it , this is what the seasoned investor lists as the top 9 ingredients for cooking up a boom or a bubble :

  • A benign environment – Good times make investors complacent (Marks says volatility measure VIX  is hitting all time lows everywhere).
  • A grain of truth – The catalyst of a boom is typically real, but it gets overblown.
  • Early success – People who made big gains early on, will turn to the so-called “fool in the end” to cash out of their investment.
  • More money than ideas – Money backs even lackluster investment ideas because of a glut of capital. (In India even a 25 bps interest rate seems good enough reason)
  • Willing suspension of disbelief – People convince themselves that “this time is different” and a correction could never happen ( being cautious is seen as a sign of weakness or lack of faith in the “long term growth story”)
  • Rejection of valuation norms – Think dot com bubble. This is when people start saying the price of an asset is never too high to get in.            ( some of our so called experts are even claiming that “the bull run has just started!”)
  • The pursuit of the new – Everyone and their dog make money – actually they brag about it too. (look at the rush of individuals to push money into equity mutual funds, especially from the B15 – No B15 is not a bomber although it may well turn out to be one eventually- B15 is the acronym used by our mutual fund industry to describe their small town markets where distributors are paid premium commissions to “expand” the investor base and markets)
  • The virtuous circle – What ever the price the underlying asset is worth it and remains unaffected and the markets can only push its price higher. (the Indian investors follow FIIs to add fuel to liquidity fire).
  • Fear of missing out – FOMO can be a powerful thing. So powerful that when all the other ingredients are present, people will ignore them because they don’t want to lose out on making money.
Howard Marks, obviously knows that, every party has to end and reminds us of that by quoting the then (2007) Citigroup CEO Chuck Prince’s :  “When the music stops, in terms of liquidity, things will be complicated” – Marks says the Prince quote remains as relevant in today’s market conditions even after 10 years have passed.

If that was for the US, then the situation in India is no different – where opportunistic market participants supported by an all singing and dancing media are hard selling to the hapless individual investor the story of how “the bull run has just started and why they should keep investing more in FOMO”!

The individual investor has invested about Rs 135,000 Crore into mutual funds (85% into equity) in the 12 months to June 2017 .

In his memo Howard Marks says “Today I think most investors know the good times will end someday, as Prince did, but for now they feel they, too, have no choice but to dance … in other words, there’ll be a time for caution, just not today”

The other day a friend posted this on LinkedIn and asked “does this mean we are reaching the end of this bull run” ? I am not sure but it seems like both lines are going in the same direction – will the stocks turn into tulips?

No one can look into the future (at least thats what I believe!) and therefore, one could reasonably conclude that, no one can ever tell you for sure, if its too early to protect ourselves from the impending drop in global equity valuations.

Even the more honest fund managers have hinted that, it may be up to another 2 years before we see a material turn in corporate earnings. They talk about moving into “asset allocation funds” which basically is Mandarin for “cut your exposure to pure equity and book your profits”.  

Well considering that, I don’t make or sell investment products (or advice for that matter) and I don’t have AuM targets to meet in order to make a bonus, I can afford to be plain speaking – Something tells me that, the its time to stop being ashamed of being cautious and stop being greedy because when ( not if ) the slide down begins there may not be enough time for exits, only for blood and tears.

Individual investors should bring down their allocations to equity as an asset class (keep an eye out for income tax). I would say not more than 25% at best. 

Please don’t get me wrong – its not as though I have lost faith in the India long term growth story – its only what may happen in between that has been bothering me off late!


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