There are several reasons why investors should keep their expectations tempered from 2015 and why the likelihood of the market topping 2014‘s returns next year is low.
Equities have risen close to 30 percent year-to-date this year, capping a momentous rally that saw the Indian stock market become one of the world’s best-performing ones.
The rally this year has attracted plenty of retail investors back into the market fold after many had fled the asset class following the tumultuous 2008 experience.
But there are several reasons why investors should keep their expectations tempered from 2015 and why the likelihood of the market topping 2014’s returns next year is low.
Here are the three key ones.
‘Be fearful when others are greedy and greedy when others are careful’ is perhaps the most-repeated and least-practised advice in the stock market.
It must be remembered that the market is on track for the third straight year of gains having clocked 8.5 percent in 2013 (for the Sensex) and 25 percent in 2012.
Ultimately, over the long run, prices of shares are closely linked to the earnings that companies make.
So while stocks started this bull run in 2012 being extremely undervalued (at 15,000, the Sensex stood at 12.5 times FY13 forward earnings of Rs 1,200), they have now gone above the historical average of 16 times (at 27,500, the Sensex is trading at 17.7 times expected FY15 earnings of Rs 1,550).
For stocks to rally further, they will need to either corporate earnings to grow more than the 15 percent the market currently expects, the price-to-earnings ratio to increase further (a possibility during bull markets), but investors must remember that markets usually revert to historical PE averages over time.
Also, as earnings multiple expand further, it is a signal markets are pricing in ever greater expectations and the market becomes more vulnerable to negative shocks (of which, read more below).
Global economic slowdown
Barring US and India, pretty much all important pockets of the world are undergoing an acute slowdown. While the Eurozone and Japan have been an ongoing problem, China’s debt-fuelled boom post the 2008 crisis too appears to be unwinding at the moment.
With the slowdown in growth in the world’s three largest economic blocs barring the US, it will become increasingly difficult for Indian companies, which have over the years become increasingly global in nature, to thrive.
Given that the Federal Reserve has more or less pledged it would increase rates next year, economists say it is almost inevitable the US dollar, which has already risen by 10 percent this year, to strengthen further.
A strong US dollar has almost never been good news for equities worldwide (remember 2008?). Further, weakness in the rupee, which even though experts reckon could cope better with the dollar strength than peers, would worsen India’s trade balances, exacerbate inflation and increase foreign borrowing costs for companies.