Is it time to fearful in equities, when everyone is greedy?

Updated: Wednesday, August 22, 2012, 9:45 [IST]

Indian indices have gained more than 16% since the start of the year, even while Indian economic fundamentals have deteriorated. Here are a few reasons why it maybe prudent to apply Warren Buffet's theory which says, "be fearful when everyone is greedy".

Indices have rallied over 16% since the start of the year

Benchmark indices have rallied 16% since the beginning of the year, leaving very limited room for upside. This means that the risk to reward ratio has come down significantly. Investors are now likely to take a greater risk for lower returns, since markets have already climbed substantially.

Indian Sensex p/e multiples are the most expensive

Indian Sensex companies are trading at 14 times forward earnings. This makes it very expensive, at a time when there are countries whose indices are trading in single digit multiples. In fact, China trades at just 11 times forward earnings, making it a cheaper market.

A downgrade could see FII exodus

A likely sovereign downgrade from international rating agencies would surely see a flight of fund flows from foreign institutional investors. This is likely to see a significant drop in equities and a severe damage to investor wealth. The way the government is managing the twin deficits and reforms, a downgrade is looming.

Earnings likely to falter

With a series of GDP revisions, its clear that earnings are going to falter. Investors are not going to accord higher p/e multiples to Indian equities, when growth is slowing down.

No reforms in sight

Reforms including fuel de-regulation, GST, DTC, pension reforms and FDI in retail have been stuck and are likely to remain so. There seems little inclination from the government to push through reforms.

Everybody is saying "buy"

A sharp rally in small cap stocks (as is happening) is almost a sure sign that speculation is back and with it plenty of risk. When every analyst says "buy", its a sure sign to sell. In 2008, when the Sensex was at 20,000 investors were told by analysts that it would reach 40,000. However, the Sensex collapsed to 8000 points, following the Lehman Brothers crisis. Clearly, analysts might have their own interests in mind. As for investors, they should exercise caution. "Prudence is the better part of valour".

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