Why market rallies are deceiving...

Tue, 1 Apr Pre-Open

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The Indian stock markets are at an all time high of about 22,300. There is a general level of optimism on street. Brokerages are coming out with new BSE-Sensex targets as macro-economic indicators are showing signs of improvement. In short, the environment is full of greed.

However, those who have missed the current rally are repenting. But for not having to repent more, most investors are contemplating to invest in the markets now. This is a peculiar situation which unfolds after a prolonged bear market. A relief rally creates a feeling of repentance. As a result, greed money makes way into the markets. And then as expected, investors incur losses as markets subsequently crash for the lack of fundamental support.

And Indian markets are perhaps in this peculiar situation now. While stock markets may have rallied to an all time high the fundamental situation has hardly improved. Banks are saddled with problems of NPAs. The ground framework of engineering, real estate and infrastructure sectors has not improved. Yet, markets have reached an all time high, as they are discounting a forward event. And it pertains to elections. There is a belief that the opposition party may come to power and change the fortunes of India Inc.

We feel this is a classic case of greed taking over sanity. One may agree that corruption, delays in decision making and poor governance has hurt India's growth prospects. However, believing that the new government is panacea to such ills is a wishful thinking. While a change of government may ease the way business can be done in India, for it is deemed as business friendly, coalition compulsions cannot be ignored. Thus, all decisions may not be pro-growth. Hence, basing buying decisions on election verdict and trying to ride the current rally could be a grave mistake.

In fact, trying to ride any rally is amateur as most rallies are deceitful. That's because rallies are an effect of the cause which has already been priced in. While election may be the current theme there are various themes/theories that float into markets over time leading to rallies. For instance, when sectors like infrastructure and engineering whose fortunes were based on policy decisions were suffering, FMCG and pharma sectors saw unprecedented rise. In fact, some FMCG stocks traded at sky high valuations. And this was just because excess liquidity was chasing them and nothing else. This was a case of liquidity rally. And the current one is a case of pre-election rally.

The bottomline is that any decision to buy or sell should be a function of fundamentals and valuations and not short term events. In the near term, factors like elections can play a role in garnering returns but over the long term earnings drive stock prices. Hence, investors should focus on those aspects and then make the investment decision. While sometimes such decisions may be against the popular voice on the street they more often than not prove to be right in the long run.