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Stock market: Beware of the bubble

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Indian equities have been rallying since 2017, and the momentum has continued in the new year, notching new highs. The accelerated gains in Nifty and Sensex proudly scale past 11,000 and 36,000 respectively, the peaking indices high enough to cheer the investors and rapid enough to drive a speculative rush.

So, what’s propelling the market? Is world economy in better shape? Is India shining? Are corporate profits strong? Are there any major economic reforms in the offing? Have the Foreign Institutional Investors (FIIs) confirmed increased investment presence in India? Or, is it due to low interest rates that investors park their money in stocks seeking better returns?

Whatever, will this record-breaking run continue, or a market bubble waiting in the side line? While the bears argue that the market is overvalued, the bulls believe valuations are justified to stretch more, some even eyeing a “Nifty at 13,000”. The stories produce unrestrained ebullience, fomented by higher prices and ambitious optimism.

The bullish triggers

Most Central banks have pumped substantial amount of funds in global markets, the abundance causing mispricing across asset classes. The current valuations may sustain, even expand if FIIs participate more in equity markets rather than in debt funds. Domestic mutual funds have been robust and likely to increase their share. RBI data reportedly shows that the household savings jumped to a historical high of Rs 1,825 b in 2016-17, compared to Rs 226 b in 2000-01. Even bank deposits witnessed a big jump into equity/mutual fund space.

Having said that the Price-Earnings ratio is a widely used tool for stock selection, it indicates that the market is on an overvalued range. Surely, it is puzzling when market players use technical arguments (a function of momentum?), to justify fancy targets.

Exercise caution

If your asset allocation is in line with your risk appetite and you are consistently reviewing, then it’s beside the point.  Else, the bigger the bubble, bigger will be the burst and messier the explosion. So, how on earth do investors respond?

Remember, the Indian stock market is too reliant on the magnanimity of FIIs for liquidity, though there is a perceptible increase in domestic inflow.

Countless fortunes have been made and lost during stock market bubbles.  Both ordinary individuals and seasoned investors can be caught unaware. A shock bubble emerges when the price for an asset becomes unreasonably high simply because so many people are buying it. Or, a bubble is formed when an asset’s price has increased to well above its intrinsic value. You can’t time when the bubble bursts, so turn your paper profits into realised gains.

Beware that the so-called pundits and analysts, who have sold their clients on their “ability” to know when to pull out, are playing a lethal game of chance.  You might get lucky, but the odds are not in your favour that your luck will hold out very long. If you are following the herd in your financial decisions, consider the cost of making mistakes.

If there are no recessionary signals this year, the US might raise interest rates, which could trigger the outflow in to safer havens of US bonds. Such trends will not be good news for the Indian stock market. Crude oil prices crossed $70 a barrel, and with the Gulf unrest, every uptick will hurt market sentiments.

Greed and fear

It is tough to distinguish a healthy bull market from a market bubble.  There are various types of investors, traders, speculators, and fund managers.  Each one has his own agenda, perspective, and goal and thought process. No one is perpetually right or wrong.

Greed and fear, the two demons of market euphoria, are on investors’ shoulders. Neither is an angel. There is more to a financial market: Corporate results, sudden shifts in economic variables, global political decisions. Lastly, irrational and emotional decisions of every market decision. It’s a lot to track.

You enter the market with optimism, and en-route enthusiasm and exuberance reach euphoria, the highest level of financial risk. You can’t ride euphoria for long. Hence, you encounter anxiety, which is followed by the consequent fear and despair that push you to panic mode, ultimately losing the game.

Put aside the “fear of missing out” (FOMO) syndrome. Ignore spammed, unsolicited stock tips, rampant these days. Adopt an enhanced diversification. The best way to play a bull market is to be long. Adequately hedge your portfolios.

Many people today acquire speculative habits in the error that they are investing.  A premonition is due so that investors are not overexposed. Make a “correction” plan when time and a clear head are in your side. That doesn’t mean you should store all your money under the mattress, or deposit in a low-yielding savings account. As you track your account balances grow, you will use each high as your new bar for success. Well, it’s time for a reality check.

(The views expressed by the author in the article are his/her own.)

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