In order to answer the question we need to first define what a high level for the market is. This can be done both by using technical analysis as well as fundamentals.
It would be an understatement if we say that there is a left out feeling in the market. With BSE Sensex touching the 30,000 mark for the second time in two years many investors have been caught sitting on the sidelines. Having reduced their position ahead of the five state elections, retail investors were waiting for an opportunity to re-enter. But markets caught them on the wrong foot and did not give them the moment to re-enter as it zoomed past them without any meaningful correction.
Like the proverbial ‘sour grapes’ for the fox, investors are now talking of the market being overpriced and valuations not justifying investing at current levels. There are also talks of market topping out after a new high is made and rising mutual funds folios indicating that a bubble is in the making. On the other hand there are those who are fully invested who talk of a start of the bull market. They cite examples of 2004 when there was complete disbelief in the market which kept on moving higher for the next three years.
Here is a little bit of detail of how long a bull market can last. The average bull market in the US has run for nine years. Imagine if an investor who does not like buying on highs would have not purchased the market high in the first year, he would have had to wait for eight more years to get an opportunity to reinvest. Similarly all those investors who like to cherry pick their investment at a deep discount to its intrinsic value would have a long waiting period to give them the opportunity. Bear market are short and sharp. Average bear market in the US has lasted for 1.3 years.
So what does one do when a market is like a runaway train? In order to answer the question we need to first define what a high level for the market is. This can be done both by using technical analysis as well as fundamentals. In technical analysis the definition is very clear according to the Dow Theory. If the market pushes through the low of recent highs then the bullish trend is considered to be over. This gives the trader enough room to buy on shallow corrections in the market. As far as the bullish trend is intact various technical strategies can be adopted to participate in the rally.
Markets tend to move in a step formation. Investors and traders can take the help of basic technical analysis tools in taking entries. Oversold levels through stochastic indicators or Relative Strength Index (RSI) have been successfully used for entering strong trending stocks.
In fundamentals however, the definition is not so easy. Many investors use the price to earnings (PE) ratio to determine if a market is in bubble valuation territory or discounted cash flows of future earning streams. While this is a good indicator, it lacks to capture key traits. Markets always discount the future. Little purpose is served in arriving at conclusions by looking at past fundamentals since market would have already discounted it. What really matters for the market is how the economy and companies are expected to do in the future. Thus what matters more is the Price to Earnings Growth ratio (PEG) which discounts future valuation. If the growth trajectory is intact then market will continue to move higher. Markets will correct only if there is a visibility of a slowdown or the event that was discounted has not come true.That’s precisely the reason that when Narendra Modi and Donald Trump were elected leaders of their respective countries markets discounted the future as both had spoken of spurring domestic growth during their election campaign. But as reality struck that turning an economy is not an on-off switch and will take some time for it to move, markets corrected. Indian markets have taken over two years to reach the level it had after Modi’s electoral victory. US markets still are living on the hope of a fast recovery. As far as companies continue to maintain a positive guidance and show quarterly as well as annual growth markets will continue to move higher.
However, there will be times when markets move much ahead of valuations. We see analysts recommending stocks based on 3-4 years forward numbers. That’s the time when one should be worried about as the foreseeable future has already been discounted and now market is discounting prices much ahead of the bend. The current market scenario is now where close to such euphoric levels.
For investors who have missed the bus, they need to remember that they will not be able to buy stocks at 2009 valuations. That period is over and might take a lot of time to reappear. They will have to live with the current market and current valuations.
For the fundamental investors, a strategy of nibbling the market can be adopted, just as retail investors do while investing through systematic investment plan (SIP). But stocks with strong fundamentals and clear future visibility of growth have to be only considered. The most important point to note before investing is the quality of management. At high valuations, despite future growth prospects, one needs to stay invested in good quality stocks. Even if the market falls the investor will still be holding quality stocks.
Timing the market is one skill no one in the world has mastered. Regularly buying the bottom and selling at the top is possible only in textbooks. As far as the investor is betting for the long run timing the entry or exit is not that important. Quality of stock plays a more important part. For traders, as far as they follow a stop loss strategy there is nothing to fear from where the market is trading.
A market expert had once commented ‘All past market crashes are viewed as opportunities, but all future market crashes are viewed as risks.’ This holds true for all markets across the globe. As mentioned earlier, markets spend a long time to move up and need money power and new investors to lift it. Rather than worrying about the short period of times when the market falls investors can spend more time in studying to participate in the up move. Keeping emotions out of equation and risk low investors can ride any wave.The writer is Executive Director of Trade Smart Online