How Do We Know When the Market Has Troughed?
Capitulation upon us: The steep fall in the Nifty raises the question whether this is the time to buy. Fundamentals will likely trail share prices, as they usually do. Valuation and sentiment indicators are the key. No doubt, some of the sentiment indicators we track appear to be reaching oversold territory and at some point in the next few Nifty points and few days, the market is likely to rally. However, until the fundamental construct remains the way it is - we think this is will be a rally to sell, not buy. We remain cautious on banks and overweight US$ hedges from a portfolio perspective.
What are the indicators saying? The indicators are not universally in buy territory. While our market-timing indicator is in buy zone, one of its key components - our proprietary composite sentiment indicator - still has some distance to cover to reach oversold zone. Of this indicator's constituents - namely, flows, momentum, breadth, volatility, and positioning - only breadth and positioning suggest market capitulation. Flows, momentum and volatility portend further downside.
What to track for a fundamental turn: The key valuation metric, as we have argued since the RBI lifted the short rates, is the modified earnings yield gap (trailing earnings yield minus short-term yields). This metric tells us that the market is not cheap, yet. The P/B is 5% from its bottom decile, from where losing money is a rarity but it does not mean that the market does not remain there for an extended period. The most positive indicator for the market is the state of downward earnings revisions - this has reached a buy level. From a macro perspective, it is all about when short rates retract, which is hinged to US yields - not a pleasant situation for equity investors. Policy makers can trigger rallies from time to time by either resorting to subsidy reduction (steep hike in diesel prices) and/or raising foreign capital. The markets could also respond to better growth trends in China or stabilization in EM - however, these are unlikely to create a new bull run.
Capitulation upon us: The steep fall in the Nifty raises the question whether this is the time to buy. Fundamentals will likely trail share prices, as they usually do. Valuation and sentiment indicators are the key. No doubt, some of the sentiment indicators we track appear to be reaching oversold territory and at some point in the next few Nifty points and few days, the market is likely to rally. However, until the fundamental construct remains the way it is - we think this is will be a rally to sell, not buy. We remain cautious on banks and overweight US$ hedges from a portfolio perspective.
What are the indicators saying? The indicators are not universally in buy territory. While our market-timing indicator is in buy zone, one of its key components - our proprietary composite sentiment indicator - still has some distance to cover to reach oversold zone. Of this indicator's constituents - namely, flows, momentum, breadth, volatility, and positioning - only breadth and positioning suggest market capitulation. Flows, momentum and volatility portend further downside.
What to track for a fundamental turn: The key valuation metric, as we have argued since the RBI lifted the short rates, is the modified earnings yield gap (trailing earnings yield minus short-term yields). This metric tells us that the market is not cheap, yet. The P/B is 5% from its bottom decile, from where losing money is a rarity but it does not mean that the market does not remain there for an extended period. The most positive indicator for the market is the state of downward earnings revisions - this has reached a buy level. From a macro perspective, it is all about when short rates retract, which is hinged to US yields - not a pleasant situation for equity investors. Policy makers can trigger rallies from time to time by either resorting to subsidy reduction (steep hike in diesel prices) and/or raising foreign capital. The markets could also respond to better growth trends in China or stabilization in EM - however, these are unlikely to create a new bull run.
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