Prashant Jain | Mar 7, 2014, 12.30AM IST | Times of India
The sensex closed at 21,514—an all-time high—on Thursday. This news will be met with optimism by some, who will think that things are improving, confusion by some who will wonder why is the market rallying when the economy is not doing so well and when elections are just round the corner and denial by the rest who will take it as an opportunity to sell whatever little equity ownership is left with them.
The majority, in my opinion will judge this as unsustainable, will look to sell and will be wrong, yet again, at least in the medium- to long-term. Why is the majority seldom right in equities? It is so because the majority guesses the future by looking at the past. When the returns of the past few years are high as was the case in 1992, 1999 and in 2007, most simply extrapolate and invest large amounts. On the other hand, when the returns over the past few years are poor as is the case today (the sensex is where it was 6 years ago), the same is also extrapolated and the majority either does not invest or sell at every rally as is being observed nowadays.
The simple, sensible and profitable approach to participate in equities is to do the just the opposite of what the past suggests. When the past returns of equities are high, one should be cautious and when the past returns are low as is the case today, one should be greedy, one should be optimistic about the future and one should invest more in equities.
The reason for recommending this approach to investing is simple. Equities over long periods give returns in line with the growth rates of the economy. That’s why, when the past returns are high, the future returns tend to be low and vice versa. It needs to be realized, that despite the slower growth periods once in a while like present, India is a basically a high growth economy and its economy has been growing at nearly 15% in nominal GDP terms for several decades. Is it a surprise then that the sensex has compounded at nearly 15% over long periods?
Compound interest is the eighth wonder in this world, said Einstein. The sensex has grown from 100 in 1979 to 21,000 in 2014, an astounding 210 times, simply by compounding at nearly 16%, in line with the nominal GDP growth of India. This suggests that despite being at historic highs, markets are not overvalued. In fact, given the nearly nil returns of the sensex over last 6 years, a period in which economy has nearly doubled in rupee terms, given the below average P/E multiples that the markets are trading at and given the improving economic outlook as suggested by improving current account, inflation and GDP growth numbers etc, this is a time to look at equities favourably and not otherwise. Finally, given the volatility in equities in the short run, it is recommended to participate in equities in a phased manner, ideally though SIPs in mutual funds.
Source : http://goo.gl/bQWJkk