It’s unfashionable to talk about things like valuations now. The latest Howard Marks’ memo is a brilliant read (click here). Specifically this part:
We concluded that some or all of the following are necessary conditions. A few will give us a bull market. All of them together will deliver a boom or bubble:
• A benign environment – good results lull investors into complacency, as they get used to having their positive expectations rewarded.Gains in the recent past encourage the heated pursuit of further gains in the future (rather than suggest that past gains might have borrowed from future gains).
• A grain of truth – the story supporting a boom isn’t created out of whole cloth; it generally coalesces around something real.The seed usually isn’t imaginary, just eventually overblown.
• Early success – the gains enjoyed by the “wise man in the beginning” – the first to seize upon the grain of truth – tends to attract “the fool in the end” who jumps in too late.
• More money than ideas – when capital is in oversupply, it is inevitable that risk aversion dries up, gullibility expands, and investment standards are relaxed.
• Willing suspension of disbelief – the quest for gain overcomes prudence and deference to history.Everyone concludes “this time it’s different.”No story is too good to be true.
• Rejection of valuation norms – all we hear is, “the asset is so great: there’s no price too high.”Buying into a fad regardless of price is the absolute hallmark of a bubble.
• The pursuit of the new – old timers fare worst in a boom, with the gains going disproportionately to those who are untrammeled by knowledge of the past and thus able to buy into an entirely new future.
• The virtuous circle – no one can see any end to the potential of the underlying truth or how high it can push the prices of related assets.It’s broadly accepted that trees can grow to the sky: “It can only go up.Nothing can stop it.”Certainly no one can picture things taking a turn for the worse.
• Fear of missing out – when all the above becomes widespread, optimism prevails and no one can imagine a glitch.That causes most people to conclude that the greatest potential error lies in failing to participate in the current market darling.
The key part: India is in all of the above, we think. But probably not in insane quantities. There is an environment that feels you can’t lose money in stocks. There’s an India story, strongly believable but not much supported by data. There’s early success and a lot more money than ideas that deserves them. We ignore any bad news. We love the “new” – like housing finance companies and such. And then, there’s the fear of missing out.
Indian markets have been bubbly, and in recent times we have come to reject the very valuation norms that have worked for us. One thing we at Capitalmind track is the P/E ratio of the Nifty. That, at extremes is a kind-of signal. People ignore it now (a “rejection of valuation norm”) but the metric is useful to look at.
(In context, a high P/E can be justified by extremely high earnings growth. But very low single-digit earnings growth, with a near-all-time high P/E is veering on the extreme. See the Nifty’s ratio now:
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