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Cautious bull, optimistic bull, fearful bear are some of the terms thrown at equity investors in the past several weeks. Most investors are waiting on the sidelines, mulling whether to enter the market or not. Some question if this rally is sustainable.
Remember two things. One, there is no way for anyone to predict what the markets can do in the next few days. Two, and a key point: equity markets recover much before the actual economy does. There are no easy answers but, yes, there are certain signals one should look at.
FII flows
Let's start with this, an easy one for most people.
India is a very shallow equity market and, in global market parlance, is like a village when compared to developed equity markets where there is a lot of participation, not just from institutional investors but also from retail investors, through retirement and education plans.
The point is that Indian markets are highly dependent on flows from foreign institutional investors. A few billion dollars have the propensity to take the market in either direction. Hence, FII inflows and outflows must be tracked carefully to see if delivery-based buying has been taking place consistently.
If markets move up consistently on rising volumes and increasing FII flows, it's a signal that buying interest has come back and its time to scale up equity exposure. Of course, it is important to take stock of valuations but these can remain stretched for an extended period of time.
Credit situation
Then there is credit, the lifeline of any economy.
It's important that companies and individuals have access to credit at reasonable rates. High inflation is followed by higher interest rates and this often has a dent on corporate and consumer balance sheets. At the same time, if banks are unwilling to lend, the short-term outcome will not be rosy.
On the other hand, low inflation, low interest rates and easy credit flow are good signs for corporations and individuals. When this happens, take a look at the loans disbursed by banks and financial institutions. The question to ask is: Have banks started to lend and are corporations and individuals borrowing?
A healthy credit situation and easy liquidity situation, beside good future corporate performance, also means equity markets could see decent inflows and less outflows.
General sentiment/ Consumer spending
This is, again, an important signal a lay person can see around him.
Are people buying homes, cars, taking vacations, buying electronic items, queuing at restaurants and so on? If you see most of these things happening around you, it means people have disposable income and access to credit. If this is so, corporate profits are likely to improve or increase in the future.
Also ask yourself: 'Are people more optimistic about the future now than they were six months before? What about businesses? Have they started hiring again?' Recruitment activity picking up is again a very important signal and one to be watched closely.
Though there is no employment or unemployment data that is released in India every month, talking to people from different sectors and companies could give you a good indication. Look within your own firm or business. Has the business scenario changed for the better or worse?
Improvement in macro numbers
That means corporate earnings, inflation, GDP growth, agriculture output, IIP numbers, export numbers, oil prices -- being some of the macro numbers one should look at. Their interpretation should be viewed in the context of what has happened in the immediate past and whether there are any improvements in these numbers.
Most analysts were expecting a GDP growth of below 5 per cent last year, but this prediction was short-lived, as the numbers were a strong 6.3 per cent.
If in one of the worst years the economy has the potential to grow at 6.3, does it mean we could grow at much higher rates if the economic and investment environment were favourable?
There are several such questions to review on every parameter. At the same time, do not overanalyse, as it may lead to inaction.
Equity market moves
Then again, are equity market moves more broad-based across sectors or restricted to one or a few sectors?
During the technology boom of 1999 and the power sector boom of 2007, any company that had technology and power written on it would go up by leaps and bounds, defying logic and common sense.
At the same time, there are times when the market moves are broader-based, like the ones we saw during a substantial part of the bull run.
If the market moves are broad in nature and mid-caps also start to catch up, then there is a strong likelihood that a much stronger upward move will happen in the future.
Finally, remember two cardinal rules.
Do not put any short-term money, required in the next one to two years, in equity.
Second, the best time to invest is when the markets stink, so ignore the noise around you and invest if you get to do so between PEs of 8 to 12 of the market.
Rational and courageous investors who did buy between October 2008 and March 2009 are now laughing all their way to the bank.
The writer is director, My Financial Advisor.
