Understanding stock market vagaries
- our 3m performance review

Everytime when the markets tanked badly, I would be confused - understanding stock market was too fuzzy - too many spoils at attractive valuations. So where's the best bang for my buck??

This time round I thought of following a sector approach - and reasoned the financial/banking sector had been beaten down the most. Was all of that deserved or was much of it overdone??

I did my fair bit of research on this sector - 3 articles got published at Seeking Alpha. Came to the conclusion that much of it - fears over NPLs, derivatives exposure, off-balance sheet contingent liabilities,etc. - were overdone. Have a look and refresh your memory.

Private Banks Peer Comparison
Private Banks India Contingent Liabilities

Performance Record

The recent rallies - before the election results, and the huge jump post the results - have ensured that many of these reccos have crossed 100% from the recco lows. So, we are getting better at understanding stock market game. And some of my friends have made a killing on Yes Bank and Axis Bank. I made decent gains, and my wife would have made a killing too, but she prevented me from averaging down much more- saying she wanted to conserve cash:)

So going forward, what do we see?

Let's assume this rally sustains on the hope of what this stable government (without the baggage of the Left) can deliver. Financial sector reform, PSU disinvestment, infrastructure spending, rural sector spending. Certainly the risk/reward situation about investing in India has changed dramatically with this massive mandate. Foreign money flowing in through FII, FDI and even ECB and FCCB will be easier. The foreign investors sitting on the sidelines had already started testing the waters (pre-results) will start pouring in perhaps. MFs are sitting on huge piles of cash, they will need to get in on the act or risk missing out - they have already missed the first 40-50% of the rally.

Let's also assume this government will move fast on reforms. The Pension Reforms Bill will probably be the first bill to be passed - that will bring huge additional money into the market. PSU disinvestment should also follow soon - given that much of the work has been done earlier. It will become easier for companies to raise money again at easier rates, even sectors like Real estate - we have seen what DLF could raise selling 25% stake. Easier access to money will mean investments in growth will start kicking in.

On the flip side, much of this is based on the expectations of what can be! The problems that India Inc. is facing like demand slowdown, leveraged balance sheets, a poor exports scenario, etc. do not get washed away with the election results. It carries big execution risks - on the part of the government for executing on the reforms, setting the enabling platform for growth and making amends quickly on the huge fiscal deficits it has run up.

1. Corporate Earnings are not seeing big growths in a hurry - not improving significantly before 2 qrs and will take much of FY 10 and FY 11 to recover

2. What can happen though is PE multiple expansion. Will it go up significantly from current 16x (16x earnings for the market)? In a bear market no one can see beyond the next 3 months, but in a bull market investors are willing to price in the future. As this euphoria dies down, the market may correct from here and consolidate in a range for quite some time for all we know. It may also continue the journey and provide PE multiple of 20x in FY 09, who knows.

How do we navigate the course ahead?

Its important in either case, to keep our homework done to take advantage of, understanding stock market vagaries. You may like to read what Benjamin Graham describes so aptly as Mr. Market.

The prevalent advise (and a pragmatic one too) will be to take some gains off the table and stay away from the markets till the next big correction. While I am doing that, if you ask me, there are enough pickings still to be made, such as in

- PSU Banks - given that this government is likely to move on the proposals for allowing Bank consolidation/mergers in 2009
- Profitable PSUs -given the disinvestment angle
- Quality midcaps and quality smallcaps

I am looking to turn my attention next -towards understanding stock market vagaries - in the search for quality mid and small caps. They have been buthchered the most and unlike the biggies, many haven't reached fair valuations.

And again this is a call for volunteers to help with data collection and analysis towards understanding stock market vaagries better.

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