The Indian equity market is proving to be a shining star on the global stage with the BSE Sensex and Nifty 50 continuing to hit record highs in 2021. So far in 2021, the Indian frontline indices are turning out to be world-beating indices with Nifty 50 up by more than 25 per cent and BSE Sensex trading higher by more than 23 per cent. Amongst the major emerging markets, Vietnam is the only country beating the Indian benchmark indices, soaring by more than 35 per cent. The outperformance is there for everyone to see; however, what is not clear to a majority of investors is whether this outperformance will continue in 2021 and beyond.
While no one argues about the strong structural story in India at play which promises to create wealth for entrepreneurs and companies that can get their act together, the practical question that every investor today is asking is: Haven’t the markets run up a lot and aren’t they trading way ahead of the fundamentals? Going by the textbook definition and every theory in finance that talks about valuations and extremes in the equity markets, in all probability the Indian equity markets are very close to being in an extreme situation where we can say that the markets are a little more than overvalued and could be close to a bubble-like situation.
Now, the curiosity is how long can the markets stay like this? And further, how long can the markets stay overvalued and yet not be in a bubble zone? Unfortunately, there is no device or an indicator designed to calculate and quantify the answer for us. However, we can at best, make an educated guess on such contradictory and yet meaningful aspects of the market. Experts who have been tracking the markets can confirm that they do have a tendency to remain overvalued for a frustrating long period of time, so much so that people start accepting the new ‘high valuation’ as ‘normal valuation’.
We also hear from several experts that you cannot compare the valuation of a high-growth company equipped with the latest gadgets that can be used to reach out to millions of customers within a matter of seconds and which also can borrow money at nominal interest rates to the age-old company toothless without the advantage of today’s technology and that used to borrow money at astronomical interest rates. This argument is often used by several analysts and bulls in the market to justify high equity valuations in today’s world.
Says Chandrakant Munot, an investor in equity markets, “I don’t have to explain how strong the market momentum is right now. It’s been almost a month that I have liquidated my portfolio and parked my monies into gold and some of it in fixed income securities. My thesis was that the equity markets will correct if not crash. With an intention to preserve my capital and to retain by huge profits, percentage-wise, that I made in the equity markets over the past 18 odd months I thought I should switch to a different asset class. Obviously I was wrong and after I sold my portfolio it is up by over 10 odd percent in just 23+ trading sessions. Ever since I liquidated my portfolio, I have been hunting to find an expert view or an opinion to confirm my logic and expectation on market correction or even better a crash.”
“I did find some experts who think there might be a correction and that the current market is highly overvalued but the prices are not falling as per my expectation. There must be some way to identify when the markets are going to change the trend. There must be some way to identify if the markets have peaked or have topped out. Over so many years in the market, I have overlooked the importance of identifying trend reversals. Not anymore, because I have realised that it is crucial to identify a market peak as it is to identify a market bottom,” he adds.
Indeed, identifying a market peak can be a profitable exercise. However, it is not always possible to identify the market tops accurately. That said, one can always be cautious when the markets are overvalued or overbought or both. One gets a fairly good idea when the markets are overbought and overvalued at the same time. When it comes to identifying a market peak, support of technical analysis is required. Technical analysis helps us identify the early warning signs of a market peak.
The Red Flags
It is said that certain clothes are associated with certain types of weather, as for example, if it’s the summer season, cotton clothes are more preferable. In the same way, certain chart formations are often associated with certain market phases. Generally, we assess the movement of the security in four phases:
Since we are talking about identifying the market peaks, the third stage i.e. the distribution phase would be of our point of discussion. As is well-known, the markets spend most of their time in a trading range and these ranges which develop over a period of time may have three main interests behind them: it is accumulating and creating a foundation for an upward movement or it is distributing in developing a foundation for a downward movement or it is fluctuating up and down randomly without any distinct intent. So, when this range develops, how would one distinguish which of the interests out of the three is at play?
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