As the markets hit all time highs the refrain from most investors is to say, “markets are too expensive, wait for a correction to enter”. The quote for this newsletter from no less than Peter Lynch himself, a respected fund manager who ran one of the most successful mutual funds for along period of time highlights the risk of waiting for one. However, all such prognostication misses the point. It is well known to all that markets are random and that investors have a hard time predicting the direction at any given time. The reason for that is that markets are as much a function of sentiment and collective human behavior as much as economic and corporate fundamentals. At what time will any one aspect rule the valuation at any given time is anyone’s guess. In periods of extreme gloom, corporate fundamentals are ignored and in periods of euphoria valuation and corporate fundamentals are ignored.

The way to look at a market at any time will be use a valuation framework, work out if it is trading at a premium or discount to such a framework and then understand the sentiment. This may only allow an investor to assess the sentiment but does not guide him to conclude about the immediate direction. Nevertheless, it is helpful to understand the scenario prior to investing or divesting and apply some longstanding rules that govern investment success in the longer term and such a framework help in this endeavor.

What is equity investing?

Most investors are attracted by stories of quick gains
Often investors are attracted by the gains perceived “easy money” and rush to cash in on the boom. However, such investors will have a sorry tale to recount as markets are cyclical. They are also unpredictable, and the gains seen in the short term are driven by sentiments and not exactly by corporate fundamentals. This requires a bit of explanation: Stock prices over long periods of time are a slave to earnings. Earnings are disclosed every calendar quarter and can be compared on a year-on-year basis. But markets are trading these earnings on a day-to-day basis. This is the gap between sentiment and reality. If an investor understands the longer-term potential of equities, allocates a reasonable amount of capital to it and allows it to run for a fair period, market crashes, and bull runs should have no fear or greediness for such an investor

But investors are human beings

And as a result, given to emotions such as avariciousness and trepidation. And hence investing is all about the investor and not about the markets at all. Paradoxical but true!

Mr. Tushar Pradhan
Chief mentor, Investment Strategy

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