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Long term, it’s red for equities

This article was posted on Dec 15, 2008 and is filed under Market Outlook

MUMBAI: Stocks have barely managed to beat bond yields over the past 10 years, an analysis of the earnings of indices such as Sensex, the BSE 100 and the BSE 500 show. And if things get worse from here, which seems a distinct possibility, yesterday’s rock stars might end up delivering much less than risk-free bonds.

In the past ten years, the BSE 500 and the BSE 100 have given returns of 13% each, while the Sensex managed a compounded annual growth rate (CAGR) of 12.2%.

The ten-year bond yields in 1998 were at 12.2%.

In terms of returns over a three-year timeframe, the BSE 500 and BSE 100 are in the red already, while the Sensex has given a compounded annual return of just 1% in the last three years.

Ridham Desai and Sheela Rathi of Morgan Stanley, in an analysis of ten-year returns, said the crash this year has compressed the CAGR by over 400 basis points.

“The median 10-year return for a sample of 978 stocks that were listed and traded in 1998 is 10.5%, while the average return is 11.4%. This compares with the 10-year bond yield of 12.2% in December 1998, implying a negative realised equity risk premium of 1.7% on median returns,” Sheela and Rathi wrote in their India strategy report last week.

Mahesh Bhagwat, head of equities, MAPE Admisi Securities, brushes off the story of equity outperforming in the long-term as a myth. “Surely, that’s not the case. Even Dow Jones has made zero returns in the last ten years. In fact, there have been extended periods of markets going nowhere between the late 60s and the early 80s. In those days, the prevalent wisdom was that bonds were better than stocks and stocks were for the ‘risk takers’. This kept the P/E (valuation) of stocks really low.”

This period of low valuations ultimately led to a turnaround when the stocks started performing well in the 90s. People who got in at low valuations got handsome returns and the new prevalent wisdom was stocks were better than bonds.

Bhagwat says this brought more money into stocks, leading to high P/E ratios.

“The prevalent wisdom is still that stocks will outperform in the long term. So, the prices are going to stay high. Until the prevalent wisdom shifts to a stage where everyone feels stocks are risky, this cycle won’t turn,” he concludes.

Amar Ambani, vice-president – research, India Infoline says, “The strategy of buy and forget might have helped in the olden days. People buy the share certificates and then wake up after a generation and find that they have made a fortune. These days, things are so dynamic, it’s better to monitor your investment’s performance continuously. If you cannot do it yourself, get someone who can to do it for you.”

Ambani says one should be clear of one’s objectives. For example, if one is getting into a stock at Rs 1,000 with the objective of it reaching Rs 1,600 in two years. Due to some reason or other, if the stock reaches Rs 1,500 in three months, one should be ready to take these profits. There is no point in waiting another 20 months for the sake of the extra Rs 100.

“Typically, if you are in a ten-year cycle, the market will offer you two or three opportunities for a profitable exit, provided you have bought at reasonable levels. If you miss that and are forced to sell at the bottom of the bear market due to some personal exigency, one should not conclude that stock market doesn’t make sense in the long term,” says Ambani.

Or is it too early to say?

source: DNAIndia

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