As Sir John Templeton said ‘Bull markets are known to be born on pessimism, grown on skepticism, mature on optimism and die on euphoria.’
Markets are trading at levels they have not seen before. Both broad indices BSE Sensex and NSE Nifty are at their lifetime highs. Generally analysts are cautious whenever markets touch new highs as the fall from these rarefied altitudes can be as sudden as it is steep.
As Sir John Templeton said ‘Bull markets are known to be born on pessimism, grown on skepticism, mature on optimism and die on euphoria.’ The question to ask is are we in the ‘euphoric territory’ and so should be cautious, or should we take our foot off the brake pedal and go for it?
Let’s look at the issue from various parameters to get an idea of where the market and evaluate the possibility of being stranded at these high levels.
Valuations: Even as broad market indices have touched a new high their valuations are nowhere close to the peak levels. There may be individual stocks that are trading at record valuations but on the whole the indices have some way to go before they replicate the euphoria of 2000 or 2007. BSE Sensex presently trades on a trailing PE of 22.68 which is above the long term average of around 19 but is nowhere close to euphoric levels of between 28-30 which was seen in 2000 and 2007. Strictly on valuation of broad index there is still enough room for the market to move.
Stock participation: An indicator of euphoria is when most of the stocks are touching new highs along with the market. Among the 30 Sensex stocks only 6 stocks are trading at their lifetime highs. In the case of NSE Nifty the number is only 6 out of 50 stocks.
Market Breadth: Another indicator is the breadth of the market. During a euphoric bull run, most of the stocks are advancing. Peak levels of advance decline ratio (ADR) of stocks traded shows that at both the instances (2000 and 2007) nearly 7 out of ten stocks were advancing, or a ratio of 2.33. Currently ADR is at a modest 1.7.
Fund raising: When markets go ballistic, small companies approach the market with fund-raising proposals. The ones already listed tend to announce fund-raising plans through the secondary market as money is easily available at high valuations. This does not seem to be the case presently. Those companies that are approaching the market are all-high quality companies; though valuations may be high in some cases they are still not at record levels.
Environment: It is said that when the cab driver or your barber gives you a stock tip it is time to be wary. In the present scenario there are more cases of people missing out on the rally than tales of those making tons of money from the market. We still have ‘experts’ advising caution and analysts basing their recommendations on reasonable valuations. In earlier rallies five-year forward profit numbers were used by analysts to justify the market prices.There may be a case for a short-term correction, especially on account of external factors and the year-end results season. However, nothing in the air smells of a top. There is still a lot of money to be made before we reach there.