Is the Bull run over for equity markets?

Continuing from my last post on behavioral finance, the recent fall in the equity markets confirms the fickleness of human mind, when it comes to taking decision about our finances. Retail investors who were all gung-ho on the markets around Diwali, are now panicking and asking the question whether bull run is over on the markets? To answer this question I shall rely on the three different approaches to analyse the future of the markets:

• Fundamental Analysis: We all knew around Diwali that the markets were over stretched on fundamentals, and excess liquidity was driving the momentum stocks. So once the liquidity crunch was observed, after the unearthing of a series of scams, the momentum stocks in the realty and infra sectors were the worst performers. These stocks were beaten down to such ridiculous levels that quite a few of them are looking attractive at current levels. The positive GDP numbers announced today are pointing to the fact that the worst is over for the markets from the fundamental point of view, at least for now. The markets can expect some positive news flow from the international markets also in the days to come.
• Technical Analysis: The unabated run of our equity markets from the Nifty level of 4800 to 6300 did call for a technical correction. The markets have retraced around 40% of the above rise, which is close to the 38.2% retracement level held sacred by technical analysts. The bounce back on the markets was widely anticipated from the 5700 levels on the Nifty, and the markets have obliged. Given the oversold position of the markets the bounce back could be ferocious. The beaten down sectors shall be at the fore front of the rally. The technical correction seen by the markets is good for the long term health of the markets. 
• Astro Analysis: While analysing the markets I would like to give equal weight age to the astrological angle as the other two factors. Human behaviour is determined by the confluence of planetary configurations, and stock market behavior is no exception. As I am no expert in this area I would like to quote what the famous astrologer Lachman Das Madan had said in October: "Within a period of about one month from 6th November 2010 financial institutions, members of security forces, business people, diplomats, youth, sports people etc. are likely to be accused of corruption and illegal activities and actions are likely to be initiated against them". You can analyse the correctness of this astro prediction. The unearthing of scams one after another was influenced by the planetary configurations. The malefic affect of the planets now seems to be diminishing, hence we can soon expect business as usual in the markets.

In view of the above I would like to conclude that the Nifty and Sensex are likely to surpass their previous highs of 6300 and 21000 respectively by the year end. How much beyond these levels can the markets rise will largely depend on the liquidity flows. It seems that Christmas festivities have begun with the positive flow of economic data, India reporting 8.9% GDP growth in 2nd quarter. But this does not mean that the bad news is fully discounted by the markets. Behavioral finance tells us that human beings are in a state of denial to bad news when it first strikes, but gradually tend to accept it over a period of time. The bad news like the follow up on 2G scam and the Bank bribery scam will again come to haunt the markets around Budget time in February 2011. Coupled with bad news on economic recovery, or the lack of it, from European markets may spell doom for the markets again. The downward movement at that time could take the markets back to the sub 5500 levels on the Nifty again. This does not mean that the bull market is over, it only is a pointer to the fact that investors should keep booking partial profits whenever markets provide that opportunity.

Behavioural Finance: Investors do react to newsflow

The recent correction in the stock market has send shock waves down the spine of retail investors. Many of them who have entered the markets at higher levels are frantically calling their brokers/ advisers on the future course of action. This behaviour can be explained by understanding the concept of 'Behavioral Finance'. Behavioral Finance, is a study of investor market behavior that derives from psychological principles of decision making to explain why people buy or sell the stocks they do. Behavioral finance places an emphasis upon investor behaviour leading to various market anomalies.

Contrary to popular belief, studies reveal that  investors perceive bad news as less credible (i.e., are more optimistically biased) than good-news management forecasts and discount bad news accordingly. For this particular reason, investors remain in a denial mode in discounting the bad news in respect of the stocks that they hold. Behavioral finance tells us that most investors are most vulnerable to losing their principal investment, and thus continue to hold onto a particular stock, more so when adverse conditions have pushed the stock price below their purchase price. They are always hopeful that the market would reverse sooner than later, and they will recover their original cost. This behavior is also the stepping stone of 'Technical analysis', taking into account the support zones of stock prices.

But the bad news is discounted by the investors/ markets, albeit with a time lag. What we are witnessing now is the reaction of the investors to all the accumulated bad news. In the recent bull run that continued till Diwali, investors continued to ignore both international and national bad news when it unfolded initially. The Greek debt crisis and the slowdown of industrial production in India, were initially shrugged aside and the markets continued their upward march unabated. It took the unfolding of the political scams in India to put brakes on the markets. It is fortunate for the investors that the much awaited correction has started, which gives an opportunity for investors to re-enter the markets at lower levels. Await some more bad news to get discounted, before committing large funds into the equity markets. A 10-12% correction from the recent highs will be good for the long term health of equity markets.

Samvat 2067: The charge of the 'Bull'

We are in Samvat 2067 of the Indian calender which commenced on 16th March 2010. However, stock market traders view Diwali as the start of the new Samvat. Diwali is the time to review the performance of the stock market for the past one year. The year gone by has been an eventful year for the stock markets, and the new Samvat 2067 has commenced on a positive note with the BSE Sensex scaling a new closing high of 21004 at the close of the 'Muhurat' trading on 5th November. Before we proceed to analyse the year ahead, I would like to recall my observations on Samvat 2066, put up on my blog on October 18 2009, under the caption: 'Samvat 2066: Return of the Bull Run!'. I had written: 

• Markets are poised to retest the earlier top of 21000 on the Sensex by Diwali next year. We have to keep our fingers crossed to see whether it happens or not.
• The growth in profits during 2010-11 will ensure that valuations become attractive in the second half of FY 2010-11
• Specific sectors that are likely to outshine are those which focus on the domestic growth story: Retail, Pharma & Healthcare, FMCG, Media, PSU Banks, Hotels & Tourism.
• There is no doubt in my mind that the 'Mother of all Bull Runs' has arrived. Stay invested, add on declines to profit from the India growth story for the next 3-5 years.

However, I must admit that I was hopeful of a 5-10% correction during the middle of the year which never occurred, leading to a sustained bull run to the previous highs of 21000 on the Sensex (6300 on Nifty), achieved on Diwali day. Now for the crystal gazing for 'Samvat 2067':

• I would like to re-iterate that the 'Mother of Bull Runs' is on. 
• Technically, supported by the massive liquidity overhang, the markets are still in an uptrend. A strong base seems to have been created around the 5600 levels on the Nifty, which should hold as the base in the next correction, whenever it occurs.
• Fundamentally, the performance of companies has been reasonably good. The stretched valuations at this juncture would seem justified if inflation is tamed by the end of FY 10-11.
• Astrologically, according to eminent astrologer Bejan Daruwalla, Samvat 2067 will be excellent for the Indian economy and our markets. Barring a downturn from January 2011- May 2011, markets will be in the grip of bulls.

Considering the above facts, most market analysts are hopeful of Nifty scaling 7000 levels by next Diwali, which is a reasonable expectation. I am sanguine that this target is likely to be achieved by next Diwali. But given the risk-reward ratio for equity investment, a 10-11% yearly return is not the risk worth taking. Therefore, new investments should be undertaken only after a 5-10% correction from the current levels. The second important factor for taking advantage of the next up move in the markets would be the identification of right sectors. My sector bets for Samvat 2067 would be: Tourism & Hotels, Aviation, Auto motives, Paper products, Media & Entertainment, Health care.

Wishing you all a Happy Diwali and Happy Samvat 2067.

The return of the 'Bond'

The retail bond/ debenture market was flourishing in the 90's with several top companies coming out with debentures in the form of Non convertible debentures (NCDs), Fully convertible debentures (FCDs) or Partly convertible debentures (PCDs). The non convertible portion was separately listed on the stock exchanges and there was a fair amount of trading in these debentures. But with the opening up of the economy, the companies had more options to raise debt in overseas market, leading to a virtual stagnation in the retail bond market.

 In Budget 2010, the government introduced a new section 80CCF under the income tax act to provide for income tax deductions for subscription in long-term Infrastructure Bonds. These bonds offer an additional window of tax deduction of investments up to Rs. 20,000 for the financial year 2010-11. This deduction is over and above the Rs 1 lakh deduction available under sections 80C, 80CCC and 80CCD read with section 80CCE. Infrastructure bonds help in inter mediating the retail investor's savings into infrastructure sector directly.

Two issues of infrastructure bonds were recently launched to tap the retail segment: IDFC and L&T infrastructure bonds. These bonds offer an attractive option to fixed income investors looking for safety and tax saving. These bonds are expected to generate higher returns as compared to bank deposits and post office schemes. These bonds offer 7.5-8% annual returns, alogwith tax saving. These bonds may not appeal to investors in the lower tax bracket as they would be saving only 10.3% in taxes. However, investors in the highest tax bracket will be saving 30.9% on taxes which amounts to a decent Rs.6,180 savings on an investment of Rs.20,000. those with a long term perspective can choose to invest in these 10 year bonds, which have a lock in period of 5 years.The IDFC issue has closed while the L&T bond issue is open till 2nd November 2010. Even if you miss out on the issue this time there is no need to bother, there will be a spate of such issues towards the close of the financial year.

The salient features of the infrastructure bonds are listed below:

1.The bonds don't attract any TDS, however the interest receivable is subject to tax.

2.The interest accrued on the bonds will be credited to the respective bank registered with the demat account through ECS on the due date for interest payment.

3.The bonds will be listed on NSE and BSE and can be traded after the 5 year lock-in period.

4.Investors can mortgage or pledge these bonds to avail loans after the lock-in period.

5.An investor would need a demat account and pan card to invest in these bonds.(physical form is also allowed).

6.The bonds will be issued only to Resident Indian individuals (major) and HUF.

The Micro Finance Muddle

A spate of suicides in Andhra Pradesh, which accounts for over a third of the micro finance business in India, has seen the state government pass stringent regulations to control these institutions. The micro finance institutions (MFIs) have played an important role in fulfilling the credit requirements of the rural folk, who have limited access to organised bank finance even today. Most MFIs started as service oriented NGOs but have assumed a commercial role over a period of time.

While the Reserve Bank of India is eager to get credit to the poor and encourages banks to lend to microfinance institutions, it has not permitted them to raise deposits. Indian microfinance lenders generally charge between 24 percent and 36 percent annual interest. It is more or less on the lines of the interest rates charged by unorganised money lenders or the more sophisticated credit card companies. Banks have their own interest in extending credit to MFIs, to fulfill their agricultural lending targets.

Questions are now being raised about the functioning of MFIs. Some analysts also compare the MFI story to the sub prime crises in the US. RBI has also started an enquiry into the affairs of MFIs on a selective basis. There is definitely a need to regulate the MFIs, without killing the model that they adopt. The problem area could be multiple financing in certain pockets which could escalate into a bubble. But we must not forget that these institutions by and large enjoy an excellent recovery rate of 95-100%. The regulators will have to segregate the hay from the chef, rather than cast a shadow on the functioning of the entire MFI sector.

Looking at insurance beyond Tax saving

The underlying concept of insurance is "Insurance is a subject matter of the solicitation", which means that the client or the person proposed to be covered by the insurance cover should seek insurance from the insurance company. But the irony is that insurance is not solicited in our country, but it is sold or rather 'mis sold' in the garb of certain benefits which are sometimes beyond the basic purpose of insurance, that is to safe guard the interest of the survivors or in other words the near and dear ones of the person seeking insurance. The advent of ULIPs had unleashed the beast of rampant mis-selling by the insurance advisers. Thankfully, better sense has prevailed of late and the regulators have come out with stringent norms of disclosure for ULIPs effective September 1, 2010.

Many people still buy insurance primarily to take advantage of the tax gains associated with it. There is no harm in saving a little of your taxes, but the primary purpose of insurance should not be missed. The tax breaks available on an insurance product should merely be seen as add-ons or sweeteners. With the application of the new direct Tax code from 01.04.2012, there are going to be some significant changes on the tax implications of insurance products. Here are the important changes proposed:

• Under DTC the deductions applicable to insurance products (currently defined under section 80C) will be over and above the limit of Rs. 1,00,000, to the extent of Rs.50,000. However, the deduction shall be available only to those insurance policies where the premium does not exceed 5% of the capital sum assured in any year.
• Insurance proceeds shall continue to be governed by EEE (Exempt-Exempt-Exempt) system of taxation, as contributions, accretions and withdrawals under a life insurance policy continue to be tax exempt.
• The maturity proceeds of life insurance policies become taxable, other than in case of death of the policy holder, if the premium paid exceeds 5% of the sum assured. In other cases the insurer company will be subject to dividend distribution tax, which will be deducted from the proceeds of the policy.
• Insurance companies will be subject to normal rates of corporate tax stipulated at 30%, instead of the 12.5% concessional tax paid by them currently. this is likely to increase the cost of insurance for the clients.

All said and done, insurance cover should be seen in the context of the need for insurance, which is based on the security and safety of the dependents in the event of pre mature demise of the individual, rather than the tax breaks associated with the insurance policy.

Ganesha Smiles: It's time to bid farewell!

Ganesha is smiling on the equity markets, but sadly it's also the time to bid farewell. The BSE Sensex is on the threshold of Mt.21000 again after a gap of 32 months. Bulls have been on the rampage for the last couple of sessions, but just like all festivities must come to an end one day, the dream run on the markets is also nearing an end for this season. Retail investors are advised to exercise extreme caution at this juncture, and refrain from putting fresh funds in the markets. It may not be a bad idea to book some profits. However, long term investors should continue to invest in Mutual funds through the SIP route.

The question nagging the market pundits is whether we have moved into a bubble zone? Let us try to find an answer to it. A bubble is defined as "Something that lacks firmness, solidity or reality." The bubble isn’t bad at all, that’s when prices inflate and living is good. As most economists will tell you, it’s the bursting of the bubble that markets should worry about. Forming of 'bubble zones' is not new to the markets,  as markets are not expected to trade on fair valuations all the times. “When people start using phrases like ‘this time it’s different, or we have a new paradigm, or I better buy now or I won’t be able to afford it,’ then you know you’re in trouble,” says economist Will Dunning. Investors should be able to see the writing on the wall.

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  There is a clear disconnect with the fundamentals. The PE multiple for the markets at 23-24 has moved into troubled zone. What is worrying about the current rally is that the PE of small cap index has also inched towards the 20 mark.
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  The rally is fuelled by FII money, sometimes called hot money. Unfortunately, there are no means to identify the origin of this money. How much of this is speculative investment by hedge funds, is any body's guess.
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  There is also the derivative bubble which threatens to destroy not only the US economy, but has serious repercussions for the developing world.
  The derivatives market is almost entirely unregulated and in recent years it has ballooned to such enormous proportions that it is almost hard to believe. Today, the worldwide derivatives market is approximately 20 times the size of the entire global economy. 
• "It's always better to be safe rather than sorry".

The intention of this piece is not to scare the investors but make them appreciate the impending scenario.