Date:10/09/2005 URL: http://www.thehindubusinessline.com/2005/09/10/stories/2005091000990300.htm
Back Stocks: `Have moderate expectations for medium-term'

Pratap Ravindran

Pune , Sept. 9

THE behaviour of share prices has been so volatile in recent weeks that market mavens have become uncharacteristically ambivalent in making a call about the future direction.

According to Mr Prashant Jain, CIO of HDFC Asset Management Co Ltd, while the speed and the extent of the movement of the BSE Sensex from 6,000 levels to about 8,000 in about three months has surprised many investors/market observers, it has once again proved the futility of trying to predict the short-term movements of the markets.

However, in a paper titled "Index at 7600: A Comment on the Markets," he points out: "Surprising though it may seem, it is relatively less hazardous to predict the longer-term movements of the markets. This makes equities a unique asset class wherein the uncertainty of returns reduces with time unlike many other asset classes where uncertainty tends to increase with time."

Before taking up the medium to long-term prospects of the markets, Mr Jain provides an interesting insight into their behaviour. He observes that although it is a virtual certainty that, over long periods, returns from equity will be almost equal to the growth rate of profits, the returns do not occur in a linear fashion.

"On the contrary, whereas profit growth rates are more stable, the bulk of the returns tend to come over very short periods of time. One may hold shares in a company for four years and the price may not move much even if the profits grow. It is likely that in the fifth year, the stock goes up a 100 per cent. Similarly, it is also possible that in the first year of investment, the stock may go up a 100 per cent - and then not do anything for the next four years."

According to Mr Jain, equity markets are capable of large moves in relatively short periods of time.

He gives the following examples:

  • The BSE Sensex moved from 272 in December 1984 to 657 in February 1986 - a change of 143 per cent in 13 months;

  • From 411 in February 1988, the Sensex went up to 780 in April 1989 - a change of 90 per cent in 14 months;

  • From 850 in June 1990, the Sensex went to 1420 in September 1990 - a change of 67 per cent in four months;

  • From 1220 in February 1991, the Sensex rose to 4,285 in March 1992 - a change of 250 per cent in 14 months;

  • From March 1992 to April 1993, the Sensex fell to 2122 - a fall of 50 per cent in 13 months;

  • From 3,055 in December 1998, it went to 5,447 in February 2000 - a change of 78 per cent in 15 months;

  • And the current rally started in June 2004, moving up from 4,800 to 7,800 - about 60 per cent.

    "Seen in this context a move of nearly 60 per cent in last 14 months is not unprecedented because the PEs are still quite reasonable unlike in the past."

    In sum, Mr Jain's view is that the index had been lagging economic growth rates and profit growth rates for quite sometime and that the current movement should be seen as "a catching up of the index with the economic growth rates."

    What, then, is a good investment strategy in the current context?

    According to him, the markets are thus currently neither under-valued nor over-valued and returns are likely to track the earnings growth rates over the medium to long term. However, there is always uncertainty about the timing of the returns.

    Given this consideration, investors should have moderate return expectations for the medium-term as the returns of the last three years are unlikely to be sustained.

    And then again, as PEs will come down only over time as profits grow, there is a need for investors to increase the time horizon of their equity holdings. "Three years or longer is a reasonable time frame, in my opinion," says Mr Jain.

    Further, as PEs are reasonable and there are always risks linked to local and/or international events, equity investors should be prepared for volatility, particularly over shorter time frames.

    Finally, the risks to earnings are not so much across the board as sectoral in nature.

    To illustrate:

    * a cyclical downturn in commodities is negative for commodity stocks;

    * a sharp hardening of interest rates is more negative for smaller-sized companies, capital spending etc; and

    * an appreciating currency is negative for exporters (including IT companies) along with commodities, etc;

    In such an environment, effective diversification is of greater value and carries lower risk.

    In summary, "investors must assess what is that portion of their wealth which is not required for three years or more and in relation to which they can tolerate volatility and invest accordingly.

    He emphasises that equity investments continue to have merit because they are likely to yield higher returns than most other asset classes - even though future returns may be less compared to the past.

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