Nature and Behaviour of Equity Markets

Since January 2008 when SENSEX made a high of 21300, Markets have not been able to capture that level till date. It’s been almost 4 years that we have been hovering in this range and market has failed to give any meaningful returns to investors.

This all started with Sub-prime crisis in the U.S which was one of the worst crisis in last 100 years. Lehman Brothers which was a 125 year old bank, filed bankruptcy followed by many more banks and financial institutions. Investors lost money ranging from 30% to 70% across the world in Equity markets. As it is known that if US sneezes than the world catches cold and so across economies, Equity market fell.

Capitalism came under threat and investors shifted their money to safe haven like Gold, Silver and Property. Equities which are known as a risky asset went out of flavor. However one silver lining is that in spite of market not doing much, earnings of companies have gone up. So underlying asset i.e. businesses have become cheap on valuation parameters. Our historical average Price Earning Multiple for SENSEX is 16-17 times which is currently 13-14 times. Many companies are available at par or below replacement costs.

Now the question is that if we believe in Capitalism then definitely Equity is the place to be in as it is available cheap. Price Earning Multiple is a function of sentiment. If confidence increases then Price Earning will catch up within no time and returns will come up very fast. Remember that Equity markets never go up in a linear fashion. They tend to be volatile in nature. So some year returns may be negative and some year it will be positive. Given the growth prospects & demographics which India has, one can expect a return of 15-20% CAGR post tax from equity markets over a period of next 5 years. But this return will not be linear. It should never be compared with fixed Deposits. Similarly since market has not given return in last 5 years it has a lot catching up to do. In the last 10 years, India’s per capita income has crossed $1,600, but is still 60 percent lower than China’s. India shall be the 3^rd largest GDP in next decade and even # 1 by 2050. In another 15 years India and China will account for 30 percent of the market capitalization and 40 percent of the world population. Middle-class in India is going to go up from 5 cr. to 45 cr. in next 15 years and when that happens we can expect the market to go up by four times from its present position.

Good returns materialise over time on investments made at cheap valuations (meaning low PEs) and PEs is more likely to be low when the news flow is adverse. However in due course valuations do catch up and equity markets eventually generate a return of 15-20% CAGR over a 5 year time horizon.

Equities should be bought when cheap be held for longer period to derive the best advantage.