IS THIS THE TOP OF THIS BULL MARKET?

 

We finally had a meaningful correction in the Nifty last week. The inevitable correction which most investors have been waiting for has thus begun. Since many investors had been left out of  a rising market, I presume there must be a sense of relief at the onset of a correction.  When the market goes up everybody wants a correction. When it goes down there is the usual post-mortem of the ‘why’. What surprises me is that when a market is going up investors want it to correct so that they can buy and when it corrects nobody ends up buying, in fact they sell on the rise!! Why?  Because everyone is convinced that it will crash. The question in the minds of most investors is whether this is the top of the current bull market. I think not. Even though we are in a bull market, it does not mean that the market isn’t prone to sharp corrections. Investors must get used to the volatility. The index hit an intra day and all time high of 7808.85 on 08th July 2014 and reversed course to close the week at 7459.6. Since the market close on the 08th of July was a good 132 points below the low on 07th of July, hence one can safely assume that we at least have a ‘intermediate top’ in place. In the last week, we did see some vicious corrections in the benchmark and sectoral indices as can be seen from the table below:

 

INDEX	11/07/2014	04/07/2014	%
CNX NIFTY	7549.60	7751.60	-2.61
CNX BANK	14447.20	15556.15	-7.13
CNX AUTO	6722.50	7153.20	-6.02
CNX ENERGY	9443.20	10062.55	-6.16
CNX FINANCE	6019.60	6388.65	-5.78
CNX FMCG	18100.25	17846.45	1.42
CNX IT	9933.55	9866.95	0.67
CNX MEDIA	2058.90	2129.00	-3.29
CNX METAL	3135.00	3392.15	-7.58
CNS PHARMA	8819.05	8796.45	0.26
CNX PSU BANK	3406.20	3864.40	-11.86
CNX REALITY	241.65	267.70	-9.73

What does all this volatility and noise mean for the long-term investor? In one word, nothing. In market’s volatility is opportunity spelt differently. The long-term investor does not need to bother about tops and bottoms. Turning points are exceptionally difficult to identify, but when we are trading at all time highs the temptation is irresistible. The punditry is  always trying to call the top so to say, but as I have been saying incessantly, it is impossible to predict market movements let alone call tops and bottoms. Some learned person has rightly said that “Tops are a process and bottoms are an event”. In fact it is far more difficult to call market tops than it is to call market bottoms. When the market bottoms out the dominant emotion is fear, whereas when a market tops out we generally see a combination of greed, euphoria and complacency. In the situation that we are in today, I find that fear of an impending market crash is a dominant theme among most investors. This does not mean that we are at the bottom, but it definitely means that we are not at the top. Where are we then? In the middle (obviously), and middles are tricky. Why? Because the market is likely to be devoid of any discernible direction. This is popularly referred to as a sideways market. It effectively means a period where there is no major movement in the benchmark indices and stocks gyrate on both sides. In a sideways market, when markets go near the top of the trading range you can expect profit booking and when they move towards the bottom of the trading range you can expect dip buying.  The media prefer to call it “consolidation”. Investors will be well advised not to zig-zag with the market, rather they should zig when the market zags and vice-versa.

 

 

INVESTING AT THE TOP

 

In the current scenario the percentage allocation to equities within the average Indian household is abysmally low. There is a perennial fear among most investors of committing money to equity as an asset class.   There is a joke which defines a correction as the next day after one buys stocks.  Since the investing public is so afraid of buying into stocks I did an empirical study of the two asset classes, viz, the most hated one (Equity) and the most loved one (Gold). For the sake of comparison I have used the NIFTYBEES and GOLDBEES (both are ETF’s). The basic assumptions are as follows :

• I invested an amount of Rs. 10,000 in both these asset classes.

• The starting date is 08th January 2008. I have picked this deliberately since that was the date the Nifty made its last all time high. So, since everybody is convinced that a correction starts from the next day that they buy stocks I have chosen to accept this as the truth.

• An amount of Rs. 10000 is assumed as being invested on the 8th of every month beginning with 08th January, 2008 and ending on 31st March 2014. By way of example, on 8th Jan 2008 the Niftybees closed at 632.61, so Rs. 10000 invested at the close would fetch 10000 / 632.61 = 15.81 units which is shown in the QTY column. The returns look something like this:

 

NIFTYBEES

 

DATE	2008	QTY	2009	QTY	2010	QTY	2011	QTY	2012	QTY	2013	QTY	2014	QTY
JAN	632.61	15.81	288.55	34.66	525.85	19.02	585.01	17.09	482.57	20.72	604.23	16.55	624.34	16.02
FEB	521.01	19.19	293.28	34.10	478.89	20.88	539.74	18.53	542.11	18.45	592.77	16.87	614.79	16.27
MAR	482.82	20.71	262.40	38.11	512.89	19.50	558.47	17.91	535.72	18.67	599.78	16.67	657.38	15.21
APR	477.24	20.95	335.41	29.81	530.76	18.84	588.94	16.98	527.25	18.97	558.29	17.91
MAY	510.85	19.58	362.65	27.57	519.32	19.26	564.16	17.73	504.85	19.81	604.23	16.55
JUN	454.99	21.98	444.92	22.48	501.54	19.94	559.88	17.86	509.82	19.61	590.59	16.93
JUL	403.45	24.79	409.73	24.41	534.52	18.71	574.38	17.41	528.56	18.92	587.47	17.02
AUG	459.08	21.78	444.05	22.52	550.18	18.18	523.86	19.09	536.06	18.65	564.05	17.73
SEP	457.28	21.87	477.87	20.93	560.84	17.83	522.92	19.12	539.03	18.55	594.01	16.83
OCT	355.53	28.13	498.71	20.05	612.75	16.32	506.00	19.76	571.40	17.50	603.86	16.56
NOV	317.43	31.50	493.09	20.28	634.26	15.77	537.01	18.62	576.87	17.33	621.55	16.09
DEC	283.15	35.32	515.12	19.41	596.50	16.76	501.93	19.92	594.67	16.82	642.16	15.57

 

 

TOTAL   AMOUNT    INVESTED	750000.00
LESS DIVIDEND RECEIVED	38234.25
NET INVESTMENT	711765.75
TOTAL NUMBER OF UNITS ACQUIRED	1509.74
MARKET VALUE ON 31ST MARCH 2014	1011526.05
NET PROFIT	299760.31
% RETURN	42.12
ANNUALISED RETURN	10.25 %

 

GOLDBEES

DATE	2008	QTY	2009	QTY	2010	QTY	2011	QTY	2012	QTY	2013	QTY	2014	QTY
JAN	1092.17	9.16	1314.62	7.61	1650.62	6.06	1973.90	5.07	2654.30	3.77	2890.30	3.46	2740.05	3.65
FEB	1170.17	8.55	1389.65	7.20	1607.08	6.22	1958.40	5.11	2699.70	3.70	2882.80	3.47	2791.20	3.58
MAR	1286.78	7.77	1524.59	6.56	1664.42	6.01	2043.25	4.89	2659.95	3.76	2777.25	3.60	2805.25	3.56
APR	1198.86	8.34	1434.98	6.97	1642.92	6.09	2057.85	4.86	2687.80	3.72	2784.80	3.59
MAY	1178.09	8.49	1443.52	6.93	1708.20	5.85	2137.15	4.68	2766.90	3.61	2558.10	3.91
JUN	1257.67	7.95	1444.15	6.92	1878.90	5.32	2171.80	4.60	2789.10	3.59	2608.50	3.83
JUL	1303.99	7.67	1443.22	6.93	1809.25	5.53	2140.70	4.67	2821.65	3.54	2471.25	4.05
AUG	1206.32	8.29	1473.35	6.79	1783.10	5.61	2417.65	4.14	2823.45	3.54	2631.70	3.80
SEP	1162.73	8.60	1576.04	6.35	1878.70	5.32	2634.55	3.80	3051.65	3.28	2824.65	3.54
OCT	1334.70	7.49	1576.93	6.34	1887.05	5.30	2543.45	3.93	2954.15	3.39	2872.15	3.48
NOV	1157.28	8.64	1652.86	6.05	1958.85	5.11	2746.90	3.64	2983.05	3.35	2871.00	3.48
DEC	1231.18	8.12	1735.67	5.76	2004.60	4.99	2798.80	3.57	2961.80	3.38	2815.55	3.55

 

TOTAL   AMOUNT    INVESTED	750000.00
LESS DIVIDEND RECEIVED	0.00
NET INVESTMENT	750000.00
MARKET VALUE ON 31ST MARCH 2014	1074824.42
NET PROFIT	324824.42
% RETURN	43.31
ANNUALISED RETURN	10.50 %

 

The key takeaways are

• The fear that equity as an asset class is doomed are misplaced since the annualized  returns on both are basically the same. I have taken 31st March, 2014 as the cut off date.  If one considered 30th June as the cut off date, then Equity would be the clear winner for obvious reasons.

• There is an argument that individual stocks would tend to outperform both the ETF’s chosen above. This is factually correct but the trillion-dollar question is selecting the correct set of stocks. The ideal scenario is when one allocates an equal amount to both i.e. individual stocks and the Niftybees. However one should avoid buying individual stock names which are already part of the ETF composition to avoid an overlap.

• The very obvious advantage that a graded plan has is that one tends to buy more units when the market is in  correction phase and this improves the buying average. This is also the primary reason why the returns on both work out to more or less the same. In the last 2 years Gold has stagnated or moved down. Effectively, one ends up buying the same number of units each month. In the case of the Nifty this is not true.

• The Niftybees gave a total dividend of Rs. 34 in the period whereas the Goldbees gave Nil. The reason for this is that in case of the Niftybees the underlying assets are dividend paying stocks. In the case of the  Goldbees the underlying asset is Gold, which is a non dividend paying asset. In the above case, if dividends were to be excluded from the calculation, the comparative return for the Niftybees would be 35 % translating into an annualized return of 9.25 %.

• This effectively proves that even if one were to invest at the top, for the long-term investor it is not a doomsday scenario. Even though I have assumed that I am entering the equity market at the top and the commodity market at the bottom, the returns don’t pan out as badly as is widely perceived. Investment in stocks, even if badly timed does not work out to be a bad idea, after all.  This will work for individual stock names as well, in fact, the results are likely to be superior. The assumption is that one has  invested in fundamentally sound stocks.

 

HOW DOES AN ETF (EXCHANGE TRADED FUND) WORK

Since I have been talking about ETF’s in almost all my post’s I thought it might be a good idea to shed some clarity on how they work.  An ETF is basically an index fund that is traded on stock exchanges like a stock. ETF’s generally track an index. In case any one wants to study how an ETF works click here.  The following are the salient features:

• ETF’s like traditional mutual funds, can create or redeem shares on a daily basis. In traditional mutual funds, the mutual fund company facilitates the creation and redemption of shares. In an ETF, Authorized Participants (AP) are brokerage firms that create and redeem ETF shares by delivering or receiving the ETF’s underlying basket of securities.

• Every night ETF providers send out a portfolio composition file. In the case of a purchase, when a buyer’s share amount exceeds the shares available in the market, Authorized Participants will buy the underlying securities that comprise the ETF and deliver those shares to the ETF provider. In return, the Authorized Participant receives ETF shares that are passed along to the buyer.  It can pictorially be seen below

 

 

 

CONCLUSION

The fact remains that calling a top or a bottom is not a consistent way to make money. If someone is telling you that he or she has bought at the top and sold at the bottom then remember that it is a blatant lie. This cannot be done. In the investment world there is a popular adage which says  ‘When in doubt get out’ . This is however, to be interpreted on the basis of whether one is under invested or fully invested. In reality, doubt is a more resilient emotion than hope. The under invested cling to doubt in bull markets. On the contrary the fully invested quickly abandon hope in bear markets. Are you fully invested in the Indian equity market?

 

 

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