Are Indian stocks in bubble territory? An interview given by Uday Kotak to The Indian Express (you can read it here) asks this question. Kotak is making valid points when he says that there is a wall of money coming at the market which does not have enough stocks to absorb the cash. A strong institutional flow is bringing Indian household money to the stock market through mutual funds, unit-linked insurance plans (Ulips), National Pension System (NPS) and the Employees’ Provident Fund Organisation (EPFO). This money is going into a few hundred stocks because the Indian market lacks depth. The market cap of the top stock is Rs6 trillion and that of the 100th stock is just Rs32,000 crore. The market looks overvalued on metrics of the current price-to-earnings (PE) ratio, which is much higher than the 10-year average. Valuations can go back down in two ways—markets can crash, bringing prices down or the earnings can grow; both bring the PE down. The wait for earnings has kept the market buoyant in the past few years and the wait is still on. Which will come first, the market crash or the earnings bump? As retail investors, we have no option but to give our money an equity exposure; see Table 1. But we will never have the relevant insight to time the market. We also know that markets go up and down, get overvalued, crash and then recover. See Table 2. So, is there a way in which we can ride out the bubble, if indeed there is one?
ICICI Prudential Mutual Fund’s new fund offer (NFO) of Bharat 22 exchange traded fund (ETF) is in the market this week seeking investor money for the government’s disinvestment programme. Looking through the document, I was struck with the expense ratio of this fund. At 0.0095% per year, this is the cheapest ETF in the market today. Understand what this cost means first. The expense ratio describes the price you pay for the facility of handing your money over to a fund manager and it is charged on your funds under management. For example, a Rs10 lakh corpus, with an expense ratio of 1%, will cost you Rs10,000 a year. You don’t have to cut a cheque for this cost since it is taken by the fund house out of your corpus—that’s why it is called net asset value, it is ‘net’ of costs. Expense ratios have a big impact on investor returns over a lifetime of investing. At 0.0095%, Bharat 22 will cost you Rs95 a year. Reliance AMC’s CPSE ETF (the first government disinvestment fund) costs 0.07% or Rs700 a year. A 2% managed fund expense ratio costs you Rs20,000 a year.
How do we know when a market is overvalued? The equity market looks at price: earning (P-E) ratios, book value, price earning to growth (PEG) ratios and valuations to see if stocks, or entire markets, are overpriced or underpriced. Is there a similar metric for real estate, a rule of thumb that tells you when a property, or the whole real estate market, is overpriced or underpriced? Mature markets use some rough rules of thumb to decide over- or under-pricing in real estate. The first is the ‘gross rent ratio’. Divide the sale price of a property with the gross annual rent it will get. Gross rent does not account for costs of the loan, maintenance or society fees. If a flat sells for Rs1 crore and can be rented for Rs50,000 a month, or Rs6 lakh a year, the gross rent ratio is 16.6. Real estate investors use a rough rule of thumb that says: buy at 10 and sell at 20. Buy when the rent ratio is 10 and sell when it touches 20 because the property is overvalued. The second metric is the yield which just switches the two numbers. Divide the gross annual rent by the sale value of the property. The annual rent of Rs6 lakh divided by a capital value of Rs1 crore gives a yield of 6%. Mature market thumb rules say buy at a yield of 5% and sell at 10%.
Markets are too high, I will wait for them to cool down before I invest. Nifty broke 10,000 and Sensex is at 32,000, is it too high? We’re in bubble territory for sure. Markets are in an overdrive—this ends badly. Markets are looking ahead and pricing in the structural reform the government is doing. Goods and services tax (GST) will cause markets to drop in the next 2 months—we’re just a few days away from a crash. Market is pricing in the long-term benefits of more taxpayers, less black money and better compliance due to GST.
Listen to the voices about the market and you’d imagine people are talking about two very different things. There are two voices that we hear today—one believes that we are already in a stock market bubble. The other believes that small corrections will happen, but we are in a long-term bull run.
Getting those real estate itchy fingers? Stock markets have been on a roll and the upswing in markets is usually a precursor of a jump in real estate prices as investors book profits and sink their money in land. The breathless expectations from a new real estate regulator, combined with an overall upswing in the mood of the economy, is making people begin sniffing the air for real estate deals one more time. One more time I write to caution real estate aspirants, specially those who cannot deal with the clunkyness of the asset, against jumping in. Of course, it still remains a really bad investment at current prices when you compare it to alternatives.
The middle-India push-back (http://bit.ly/1Udgm4P) on the government’s plan to tax the Employees’ Provident Fund and reduce rates on small savings products tells us that despite frothing at the mouth against the government during the day, finally, when the dust settles, we love the role of the government as an asset manager. What do we want? Ideally, government-guaranteed returns with no risk. So why don’t we buy government securities (G-Secs) directly? Because of the way the intermediation (link between savers and investors) market is constructed. Maybe it is time for this to change. We’re ready for G-Secs going direct to the public. But first, the background.
Ask any group of people what gives the highest return and nine out of 10 will say: real estate. The 10th will name gold as the next best investment. Mention stocks or equity and the response is either hostile due to the stock market related scams (including the unpunished scam of unit-linked insurance plans) or fearful. Every time I’ve spoken to a group, I get the same response: a sure-thing with real estate and gold, and an overall feeling of mistrust with equity. Let’s unpack this a bit. Let’s look at return rates. I will do this in two parts. One, historical returns. If we begin with the Sensex at 100 in 1979 as a starting point for a meaningful comparison and look at returns across the market, real estate and gold, we get a positive return for all three. Investment in gold from 1980 to 2014 (I got gold prices in Indian rupees off gold.org) returned 11%. Investment in the Sensex returned 17% over the same period. Tracking real estate is tougher due to lack of data series and due to location issues. So I picked the village where buffaloes bathed turned boomtown of Gurgaon to see what the price change has been. Speaking to original inhabitants from the 1980s of what is now DLF City, I get rough rates of Rs.2 lakh investment turning into Rs.2 crore over 34 years, or an average annual rate of growth of 15%. Just to put it in context, I looked at Reserve Bank of India data and got an average annual return of 9% on a five-year fixed deposit (FD) across the same time period.