December often sets the tone for the next year’s market trend. The early birds move ahead of the market to capture vantage positions. Last December saw the markets bottom out. Throughout 2012, FII’s have taken full advantage of the absence of the domestic retail investor from equities. They have been able to buy at will as demand for equities have remained weak and domestic investors have only tried to exit equities on every rise. This lack of confidence among domestic investors is hardly unusual and history is replete with similar behavior. Domestic investors need to learn to take a more objective view of equities. Valuations should drive their thinking rather than sentiment which is the predominant influence at the moment. At lower valuations the smarter investors lock themselves into equities and December will see strong evidence of this trend.
When prices of an asset class are peaking, the potential is fully priced in.
The valuations of a company tend to constantly readjust in alignment with the market expectations of the company’s earnings. Earnings expectations in 2012 actually showed slowing growth and this caused the valuations to remain range bound through the last two quarters. The transition to a new year will see the markets realigning the valuations keeping in mind the earnings expectations of the next financial year viz 2013-14. The current mood seems to be muted and markets expect frontline companies to grow steadily next year and nothing out of the ordinary is expected. Valuations are therefore unlikely to run up on the basis of the fundamentals of the companies. Yet, that is exactly the surprise awaiting the markets. How could this happen? Sentiment is likely to only get better and that in turn should expand valuations of companies. Investors will start thinking that the worst may well be behind them. This should see earnings expectations improve progressively with every quarter. Watch the interest rates, exchange rates, commodity prices and oil prices. Together, the play of these four factors will play the positive catalyst to earnings.
Under-ownership of equity needs to be corrected quickly.