Rise and the fall of the Sensex

What a swing of the Sensex from its peak of around 21000 on 08-Jan-2008 to low of 7600 today (27-Oct-2008)!. There are questions and answers flowing everywhere whether we have reached a bottom. Many people forget the tops and bottoms were only recognized hindsight. You will only be able to confirm whether this is a peak or not only after an year or later. Never the less both tops and bottoms are associated with some characteristics which somewhat give an idea if we are nearing that. However these could well mislead many a times, so you never know if this is a real bottom.

Characteristics of Tops (Sensex or Nifty peak):

• P/E is high. On 08-Jan-2008 the Nifty P/E is about 28. Which is very high but not dangerously high. If two more quarters of good results flown-in, then the PE would have become somewhat lesser may be about 22 or 24.

• P/B is high. On 08-Jan-2008 the Nifty P/B is about 6. Which is dangerously high.
• Dividend Yield. It was less than 1% meaning we are in for a fall some time in future if not today.
• Market cap/GDP ratio. Another bubble indicator was excessively high at 1.8 (anything above 1.3 is a bubble region)
• All the analysts started talking about 1-year silly forwards PEs or even 2-year fully forward PEs. They go to any extent in justifying the price and target of a stock (in fact they are always paid for this).
• Market hype: Very high market hype. Every Tom, Dick and Harry started buying into IPOs, Secondary stocks, Mutual funds and ULIPs. People started looking at Reliance Power as something produces Gold out of nothing starting from tomorrow instead of thinking it produces electricity from fuel in 2012-2020. The valuations were equal to what were commanded by Infosys in their bubble days (2000).

So the crash had to happen. If not in Jan-2008 some few months later or an year later. The credit crisis has actually made it come faster.

Let us look at Bottoms (Sensex or Nifty Bottoms):

• P/E is very low (trailing 4 Qtr PE of 10-12). Nifty PE was 10.38 On 27-Oct-2008.
• P/B of around 2. Nifty P/B is 2.12 o 27-Oct-2008.
• Dividend Yield of > 2%. It is 2.24% on 27-Oct-2008.
• 4. Market Cap/GDP ratio of 0.6 saying we are very reasonable. This can become high only if India is heading into GDP contraction (recession) which is very low probable event. The worst you can assume is 5-6% GDP growth for next 2-3 years.
• Analysts only talk of trailing 4 Qtr PE. No one has guts to say are going to be this year’s earnings for any company, forget about silly-forward-PEs.
• Absolute fear in the market. All the Tom, Dick and Harry are just waiting to dump their stocks into market at the slightest increase in prices.

Probably the last one i still incomplete it takes some time before every Tom, Dick and Harry realizes it easier to earn money in selling peanuts, or growing Vegetables or running a auto-rickshaw rather than by inverting into stock markets. Over the next 2 years these people are going to leave. That process is not going to be smooth, but painful with dips at every rise. That reminds of a some quotes: Stock markets are going to be irrational longer than you can stay solvent. Or They are going test the patience of the even the most patient investor. Key is to stay solvent, keep investing only excess money that you probably not need in next 3 or 5 or 7 years, after keeping an emergency funds of 6-12 months of expenses.

I am loving it. This is right time to start executing the plans. We may still go down a bit from here and stay there for quite a while, but great over all opportunity to collect value.