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Valuations, not levels, should be your guide

Be a little more careful if markets are at higher levels or have run up too much too quickly.
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First Published: Tue, Feb 05 2013. 08 02 PM IST
Hemant Mishra/Mint
Hemant Mishra/Mint
Stock markets once again surprised analysts and investors globally in 2012. Though most analysts and investors expected a rough ride for stocks in 2012, most markets closed the year with smart gains.
The Indian stock market, gauged by the benchmark BSE Sensex, gained over 25% during the year. While stocks added weight in 2012, bulk of the gain came in during the second half of the year as Sensex moved at least 21% between June and December. Since majority of the gains came in the second half due to a combination of factors—both domestic and international—and was not widely anticipated, you too, like many others, may have missed the rally. If yes, should you enter the market at this stage? Or will it be wise to wait for a correction and buy at lower levels?
The background
The rally of 2012 in the Indian markets can be attributed to the significant reduction in risk in the global financial system, and the renewed efforts by the government of India to address the deteriorating fundamentals of the Indian economy and to boost investments. The risk in the global financial system declined significantly in 2012 due to direct intervention by the large central banks such as the US Federal Reserve and the European Central Bank.
This helped the Indian market attract foreign institutional investors (FIIs) who have collectively put in $24.4 billion (Rs.1.28 trillion) in 2012 and $4 billion in January 2013. Meanwhile, the markets are also willing to buy into the intent shown by the government of India in areas such as containing expenditure and clearing large projects which are currently stalled due to various factors.
However, despite reduction in financial risk in the global markets, it must be noted that fundamental reality has not changed significantly. While the developed world is still struggling to push output, analysts are still waiting to see signs of revival in growth in the Indian economy.
The expectation
It is widely expected that large central banks will keep the world afloat on cheap cash, but will that be sufficient for stocks to rise beyond a point is the question. Says Dhananjay Sinha, co-head, institutional research, Emkay Global Financial Services Ltd: “The global liquidity has helped the market, but earnings will have to catch up and drive the market.” A Mint report on Monday (http://goo.gl/tljQX ), based on data from 958 listed companies that have declared results for the December quarter, noted that Indian companies have witnessed the fastest net profit growth in 11 quarters, an indication that earnings could have bottomed out. However, analysts are still willing to wait before betting on earnings growth revival. Says Daljeet Kohli, head of research, IndiaNivesh Securities Pvt. Ltd: “Earnings may have bottomed out, but it also has to revive. It is also important to see the quality of revival.”
What to do
Despite the run up in 2012, markets are not looking excessively valued compared with its own pricing in the past, though it is not cheap either. The Sensex is currently available at about 17.60 times earnings compared with an average of 18.22 since 2002.
Therefore, if the markets have to move up significantly from the current levels, as analysts argue, earnings will have to improve.
Even though it is not clear when the revival will come in, numbers suggest the risk of deterioration seems to be ebbing. Says Gaurav Dua, head of research, Sharekhan Ltd: “The risk of earnings downgrade is minimal from here on.” Since it is always difficult to time the market, analysts advice that investors should not give too much weight to the index levels and focus on individual stocks.
Says Kohli, “As an investor, you do not buy the index, you buy stocks and there are stocks available at reasonable valuations.”
Mint Money take
Markets may move up from these levels due to continued supply of liquidity from global investors, simply due to lack of choice from their point of view, but sustainability at higher levels could be an issue. However, waiting for a correction to enter the market may not be a good idea as well. There are chances that market consolidates at present levels and races ahead on the first sign of revival of earnings, as any sharp correction at this stage would need a dramatic shift in expectations on risk in the global financial system or a big event domestically. For investors, it is important that they do not get carried away by index movements or be afraid of entering at the current high levels.
When the markets are at higher levels or have run up too much too quickly, you should be little more careful while picking stocks. It is important that you do not lose focus on valuations, irrespective of the level the index settles at the end of day.
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First Published: Tue, Feb 05 2013. 08 02 PM IST
More Topics: Markets | stocks | Sensex | FIIs | valuations |