The current market meltdown has left investors shocked and stunned. The important question in everyone’s mind today is does the market have further downside left or has it bottomed out? Nearly everyone is offering some or the other opinion on this question. The economy has posted a growth of 9% in FY08 and the future growth, although slower, is expected to remain around 7%.

Earnings Approach..

We expect earnings per share of Sensex companies to remain in the range of Rs 900-950 levels in FY09. FY 10 is likely to post a negative return of around 20%, though the picture will become clearer after the Q3 results come out in January.

The current level of Sensex implies 10.0 x – 9.4 x P/E of FY09 earnings and probably around 12.5x – 11.3x of FY10 earnings. Historically, since 1991, Sensex has traded in the range of 10-30 times one year forward earnings. So, currently the Sensex is certainly at the lower range of the historical P/E band. Even if things are likely to be different this time due to a worldwide recession, we do not expect more than 20% downside from these levels.

Book Value Approach

Also, if we consider the book value of companies, many bluechip companies are trading below their net worth. Moreover, the current P/BV (Price to Book Value) of Sensex is hovering around 2.3 which is in the range of historic lows of 2-2.4. In last 18 years, whenever the P/BV ratio had drifted to around 2, it has been followed by a smart pull back. For example, in November 1998 when Sensex fell to around 2800 levels (P/BV of 2), the next six months witnessed a strong pullback rally of more than 40% pushing the index to 4000 levels.

Conversely during last 15 years, markets have fallen sharply every time the P/BV ratio has crossed 6.5. January 2008 was no exception to this rule.

Falling Yield in Equity

Historically, it has been observed that whenever Equity yield has crossed the G-Sec yield, it makes sense to invest in equities. On the other hand, whenever G-Sec yield has reached higher than equity by 4% or more, it has been a good opportunity to sell out of equities. In January 2008, the G-Sec yield was higher than equity by this threshold margin. Since this indicator was very accurate in predicting the peak of the bull market, it may be used as a good sign to determine the trough of this bear market. Since Equity yield has already crossed the G-Sec yield, we may conclude that we are near the bottom of the cycle as far as equity markets are concerned.
Conclusion

All the above signals point out that equity as an asset class has certainly become attractive from a long term point of view. Yet we need to keep in mind that bull markets end quickly after peaking out and bear markets spend a lot of time near the bottom before reversing and forming a bull market.

Hence though valuations may be attractive, it makes sense to buy in small increments as the markets will take a long time start moving up in a sustained trend. All dips from these levels should be used for long term investors to buy into equities. The encouraging trend from the previous bear markets is that though it takes a long time for the negative trend to completely go away, there are bear market rallies which give decent returns going along.

To conclude, while it is fair to say that investments done at this stage are likely to generate great profits only in the long run, decent returns due to short bear market rallies are the positive surprises which investors getting into the market at this stage can look forward too.

(These are the author’s personal views. Readers are advised to view the pros and cons of their decision before going in for any stock pick. The author is CEO, Invest Shoppe India Ltd. )

source: Economictimes

Tags: calls, daytrading, free calls, intraday, tips

Similar Posts:

• It is time to take money off the table: Jim Walker
• NSE TECHNICALS : Are markets back on track?
• Open interest – What it is, how is it calculated and how to make best use of it
• Stock market to remain range bound in 2009: Crisil
• Markets heading for smart recovery?