The global financial panic has led to a sell off in the world markets. The emerging markets have fallen in fact much more than their counterparts in the US and European countries.
The most logical reason is that they had risen too fast and too much and hence its correction too would logically be fast and deep.
Should we, the investors, then be surprised by the speed and extent of the fall?
But beneath the gloom and doom and talks of 5000 and 6000 Sensex levels, I thought we should visit the long term charts to check whether we are over-reacting (as usual).
The Fundamental view
Fundamentally speaking, we expect a growth rate of GDP of more than 6.5-7%. We are therefore not at all in a recession. (A recession is when an economy has negative growth in two consecutive quarters). So what we are witnessing is a ‘slowdown’- that we cannot deny.
But, as investors, we are supposed to look ahead not behind. In situations as today, the recent-past events like the Lehman collapse, the bailouts etc will have a high amount of weight in the investors’ minds. But it is necessary and crucial now to look ahead. Past history tells us that such major financial or social crises have sown the seeds for next bull market and thus as investors, instead of shying away from it, we need to prepare ourselves for it.
The markets have fallen more than 60% from their peak and the current Price to Earnings multiple (P/E) of the Sensex is about 11 x. As a thumb rule, investors are normally ready to pay a premium of about 2 to 2.5 times the growth rate – this means that assuming a GDP growth of even 6.5% , the P/E multiples should be about 13 to 16 times. This itself indicates the undervaluation of the Sensex at current sub-10000 levels by about 30%!
The Technical View
The monthly chart of the Sensex suggests that we are in a long term bull market, though in the short term we are witnessing bearishness.
On the monthly chart given below (from 1979 till date), you would observe that the rising trend line joining the highs from 1992 to 2002, is now ready to give the Sensex support. In fact the Sensex tested this support level in the recent panic sell off when it touched 7700 level.
A technical analyst would view this as good support and our view is that the possibility of the recent low being broken is very less.
It must be remembered that peaks are generally made during ‘euphoria’ and troughs are made in ‘panics’. And, in all probabilities, the panic sell off seems to be over.
It is therefore a good time for the investors to look ahead, rather than behind, and try to overcome the daily mood swings of a volatile market.
It did not take much time (only six months) for investors world over to turn from bullish to bearish and the probability is high that in similar time, we will find ourselves scrambling to buy stocks again!
The following is the monthly chart of the Sensex right from 1979 base year.
This report is prepared by CA Rajiv D Khatlawala, Head – Research and Training, Jhaveri Securities Ltd. Please give credits in case you want to reproduce it on your blog / elsewhere. Thank You!
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