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A Liquid Market

So what is pushing the Indian stock markets to what may be called obscenely high levels. It just cant be something as lame as the India story which we get to hear from every one, yes India has vast potential for growth and the market is huge but then the market is higly overvalued and is most expensive of the new emerging markets. The PE ratio of sensex is more than 17. Yes, it is lower than the avg PE of 20 somethin in 90s but compared with other markets at such high levels the market is overvalued.

It is the liquidity of the market which is driving it even at such high level. The liquidity in Indian market is powered by a certain class of traders for whom we have a very derogatory term "speculator". These speculators are day traders who buy and sell stocks without taking any delivery ie. buy a stock and sell it on the same day which enables them to have ready cash everytime.

So, how does the liquidity drives the flow of money into an overvalued market? This could be explained by a simple example : Say Mr.Smith had invested some money in real estate, now he is in real need of the money so he wants to sell his property but since the market is illiquid( i hope the term is correct) he wont find a buyer easily so he has to lower the price to create some buyers or to attract the prospective buyers had he invested in the indian stock market, he would have found buyers ready to buy the stocks at current levels anytime, so he need not suffer loss while exiting any investment option. It is this feeling of security which forces the FIIs to direct their money to India even though the market is costlier than others in Asia.

Life at 8000

The Sensex has been behaving just as I predicted in my earlier post, but for how long. Well we have seen a short term correction a week or so back and sensex had no problem in jumping back(again just as I predicted) but can it repeat the feat at 8000, the fall this time could be steep and for extended period when the institutional investors will try to book some profits( which they will at these levels) so how should the small investor play his game, I think the small investors should book their profits now(before FIIs) and then buy back when the markets fall say 200 - 300 points as the market will again jump to a new high.
What makes me so confident of the revival? well, its a belief that FIIs dont think like the day traders, they invest in a market only when the fundamentals are correct and there is large scope of growth, and none of the two factors have changed, even at 8000 the BSE sensex is more attractive than the stable(or stagnant) American or European markets., so the FIIs will again come back and this time in more numbers pushing the markets to a level of 8750by the year end.

What the hell is Arbitrage??

The practice of making money by taking advantage of the imbalance between two or more markets is known as arbitrage. Dictionary.com defines it as :

The purchase of securities on one market for immediate resale on another market in order to profit from a price discrepancy.

for example - A share X is trading on NSE at a price of 65.17 Rs while at the same time it is trading at 65.21 Rs on the BSE so if someone buys 100 shares on NSE and sell it on BSE at the same time he will make Rs4 without any investment this practice is known as arbitrage and those who practice this are known as arbitrageures .
Arbitrage can be practiced when any one of the following three principles is not met :

1. Same commodity must have same price in all markets.
2. Two commodity with identical cash flow must trade at same price
3. An asset with a known price in the future, must today trade at its future price discounted at the risk free rate.

Another example could be found in money markets, lets say you start with 100 rupees and buy dollars worth 100 rupees now you buy pound sterling with that dollar , buy euro with pound............... now buy back the rupee you wont have 100 rupees but you will end up with say +/- 1-2 rupee(some times you can make obscene profits if you chain through large number of currencies), if correctly monitored this can yield great returns.

In this age of short term transaction tax arbitrage may not seem an attractive option but buying in national commodity exchange and selling in international markets do provide operating margins enough to make huge profits with well absolutely no investment at all.

Sensex at 7750!!!

If I am correct then it wasn't long ago when sensex's crossing of 5000 created euphoria not only in the market but throughout the business circles in the country. Questions were raised if the SENSEX could maintain these levels and experts recommended to go for cash rather than equity, well they seemed correct for once as the sensex came crashing down from 5500 levels to 4500 level in may 2004 but then it was not due to any natural corrections but the fall was news triggered as the markets feared left parties entering the government .
This was about an year ago and now the sensex stands at above 7500 and the same questions are being asked, but this time the experts seemed very confident about a fall, infact they are repeating the same statement since SENSEX reached 6000, even a single point fall is seen as the indication of up coming correction. Well it seems our experts forgot what happened at Dow Jones when an index bound by 1000 pt limit crossed 10000 in virtually no time at all.
This rise in the index is here to stay and markets holding up even after not so interesting numbers from Infosys and other tech giant is a very good indicator of this fact. What I'm saying doesnt rule out the possibility of corrections, we may see a 2-3% correction in a day but the SENSEX would bounce back in no time at all, corrections may also be stock specific and the index can remain unaffected even if the stock is an Infosys or Reliance.
So what about the future, well in 1999 the combined EPS of all the companies on SENSEX was 167 and the index was at 4200 levels ie 25 times overvaluation was there, now the EPS is 485 and the index is at 7600 level ie. 15.5 times overvaluation, the EPS of companies on SENSEX is expected to be around 547 by end of this FY. Estimating a modest PE of 16 times the markets should be around 8752 by end of year, considering the overvaluation of 25 times in 99 this should be a modest estimate.
Estimating the behaviour of stock markets is a dangerous business as the markets always tries the best to prove you wrong but still this is a good time to invest, so come out of the shell and take some risk.