Why you should be fearful when others are greedy

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The equity markets continue to power on, on the bout of abundant liquidity in the system. While many investors who have missed part of the market rally are waiting for a correction to buy, even the most minor correction looks elusive. The legendary investor Warren Buffett once put it succinctly when he said: "Be fearful when others are greedy and greedy when others are fearful" Has the time arrived to be cautious while the rally keeps continuing or is there more juice left in this market?

In a discussion on CNBC-TV18's show Taking Stock, Udayan Mukherjee spoke to veteran market men Advent Advisors' Managing Director KR Bharat and Nomura India's Managing Director and Head - Equities Pankaj Vaish who feel those invested in the market can enjoy the rally till it lasts but they advise that one should watch over his shoulder when the first signs of trouble emerge.

"The market may rally till the year end," said Bharat. "The next year, as inflation creeps up, interest rates may be hiked across the globe, which may lead to liquidity being ploughed out of equity and put into other asset classes like money market," he added. "So the liquidity reversal is what is going to create a correction in my opinion."

Even as the markets continue to head higher, the echo on valuations exceeding actual earnings potential of companies keeps getting more resonated. "Beyond 5,300 Nifty, it just starts putting the bar very high in terms of earnings to be delivered," said Vaish.

"Our house has been on the high end of the spectrum talking about 30% earnings per share growth this year. But it's just that to follow up with that for next year, I think it just sets the bar a little bit high. I would rather see the market consolidate those gains," added said.

Bharat said that investors could either start booking profits as when the markets continue to head up or risk being a little more adventurous by keeping a strict stop-loss and continuing to ride the rally. "It again means that if you are managing large sums of money, you have got to be in very liquid stocks and you cannot afford to get stuck in a stock where you cannot get out. So I would say those who are managing large liquid funds are adopting the second strategy. Some of the smaller players who are more long-term and who don't trade the market so much are adopting the former strategy."

Here is a verbatim transcript of the KR Bharat and Pankaj Vaish's exclusive interview on CNBC-TV18. Also watch the video.

Q: Are you bullish or bearish from hereon?

Vaish: From hereon, I think we still go a little bit higher, perhaps 5,300 Nifty or something like that. I think the sentiment is still overall positive. Over Diwali, everybody was in a great mood, inflows are still decent and even the Chinese market after a severe correction looks like it's well supported now. So, I think it will be a little bit higher. My one concern - which I see more people increasingly talk about - is interest rates. If bond yields are within shouting distance of 7.5% and if those break, I would be concerned. That is the one worry I have even sector-wise in terms of financials, but first I think the market goes a little bit higher.

Q: You have been a bit circumspect, you continue to hold that view or has anything changed since we last spoke?

Bharat: I don't think anything has changed. In fact, the last time we spoke I had said that you should be scared but the party will continue for some more time before the correction happens and I stick to that view. I think you have got another two to two and a half months left for this party to continue. I certainly don't see any great danger to this rally until the end of the year for variety of reasons which I will get into. But for the next year, I would be very circumspect - I would probably be tempted to pull some money out of the market. I would be bearish and then long-term of course, I am very bullish Indian equities, global equities also but certainly Indian equities.

So I would say immediate term bullish, and then if medium-term - if one can call next year that - I think there will be time for correction and consolidation, then you will see a resumption of the bull market.

Q: If your view is that there is this last 5-6% left to this rally, what could prick the bubble? Do you think it is going to be interest rates or it could be something which turns globally?

Vaish: I don't know honestly. I was actually expecting RBI to be even more hawkish in their statements but I think the political pressure is very strong on them to take it easy.

If anything, [they may] err on the side of being too late rather than too early.

So my mind was: we would get towards 5,300, bond yields will break 7.5% and then the action starts with maybe a CRR rate hike, which would prick it.

But it looks like that has receded a bit and I think it would be a mistake. So what else would do it, bring the market down, I am not sure. It is possible that some of the earnings globally and not just in India disappoint. I know the technology sector globally is doing well. Financials are a mixed bag and frankly the epicenter of this whole thing [is the US], so for if every Goldman Sachs or JP Morgan, you get Citigroup that has not done so well. If that sort of becomes a bigger proportion of the overall pie, then maybe that is the one that pulls us back, I am not so sure.

Q: Your call too is that we have got couple of months left in this party and then things start souring. What do you think will lead to things souring or is that just a gut feeling. You can't put a finger on it but you believe that there is not much juice left in this rally?

Bharat: In terms of timing, I am not able to put a finger on it, I have said that for two and a half months - there is nothing sacrosanct about that. But in terms of what could trigger it, if you look at the whole genesis of this rally, I think everybody will agree with you that it's been lead purely by liquidity. I think any talk of fundamental at this stage is ludicrous because people are not buying equities today because of valuations, people are buying because of momentum; people are buying because they think that more money will come into the equity markets.

Just as something if you want to chew on: I am told that in the last three months the total redemptions in the US in money market mutual funds were at the order of USD 320 billion because money market mutual funds are earning pretty close to zero. Where do you think this money is gone? I don't need to be a genius to say that it's gone into equities and commodities. So the liquidity story continues unabated, there is huge amount of money being thrown at financial assets, which is why this market has gone up. So any correction therefore the trigger will have to be a reversal of this liquidity.

What could lead to a reversal of liquidity? The most logical answer that comes to mind - and let me prefix that by saying that logic doesn't work for a long time in these markets - is to do with global interest rates and the US dollar. I mean the rate at which the US dollar is depreciating, two-three things are happening, one is you are having imported inflation, supply-side inflation across the globe. The average American is getting poorer, which is politically not the savviest thing an American politician can do and, at some point in time, either to shore up the falling dollar or to prevent the spectre of inflation from getting out of hand, you are going to see some kind of interest rate hike in the developed world.

The reason I said two, two and a half months is one, I don't think anyone wants the party to end and [smiles] by December-end, most people would like markets to be high because of net asset value (NAV) and other things. But on a more serious note, I would not assume any major changes to interest rates happening in this calendar year. I would see it happening more likely in the first quarter of next year. Therefore that is probably more likely to be a trigger of the reversal of liquidity from equity markets into other asset classes whether they be money market or whether they be an overall reversal liquidity because you had the worst tsunami that financial markets have ever seen and the crisis is over because governments have printed money.

Logically, that doesn't make sense to me so the liquidity reversal is what is going to create a correction in my opinion and I would say the first trigger will come due to inflation concerns, the concerns of the falling dollar because of which interest rates may go up in the US.

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