In the long term, fundamentals still rule the market

Published: May 16, 2018 2:02 AM

The National Stock Exchange (NSE) index has witnessed uninterrupted rally from the lows of 9,950 till 10,700.

money, fundamental, market, money newsThere are many stocks whose prices were sky high during the peak in 2007 and prices were not justifying their valuation back then.

The National Stock Exchange (NSE) index has witnessed uninterrupted rally from the lows of 9,950 till 10,700. There are many individuals who are clearly looking for a rationale behind this considering that the market has faced a long list of negatives, namely, deteriorating bank financials and banking scandals, trade wars, weaker rupee, elevated crude oil prices and because of that risk of fiscal slippage and risk in borrowing rates in the secondary market.

Markets driven by logic

Bears clearly had ample ammunition to trigger a correction in the market looking at all these reasons but the market defied logic and rationale and digested all this bad news. The logic and rationale behind this is that the market is pointing clearly towards growth and therefore ignoring all the noise about near term challenges. One of the difficult lessons to learn and certainly to practice is that irrespective of what the majority of the market thinks, the market in the long term is perfect and driven by logic and rationale.

Let us say you invested in a certain script based on your rationale. You tell it to your friend who buys and spreads the word. Now collectively many investors have bought those scripts. All those buying would have pushed the prices up but what next? Sure, we could see short term movement in the script because of herd mentality but in the long term, the script will trade according to its fundamentals. Further participation in that script after a certain point needs a reason. I would say for short term, market is driven by sentiment but for the long term, fundamentals still rule. There is no question about it.

Market is acting rationally

The current concern in the market is that the economy is passing through challenging times—GDP growth is slow, earnings growth still has to pick up, etc. We don’t deny that there is slower GDP growth and weak earnings growth in the last two quarters mainly because of GST and after-effects of demonetisation.

Once again we are the fastest growing economy. GDP growth has taken off. Manufacturing PMI and service PMI is growing. So clearly the market is acting rationally when it is ignoring all the short term noise. There are ample examples of stocks where we have seen massive volatility and price reaction in the short term but if we stretch it to the long term, the real value according to its fundamentals will be seen.

There are many stocks whose prices were sky high during the peak in 2007 and prices were not justifying their valuation back then. But can you find after 4-5 years the same thing? No, because in the long term, the market corrects the mispricing. Irrational investors are replaced by rational investors.

In the long term, significant deviations from intrinsic value are rare. Markets usually revert back to share prices commensurate with economic fundamentals. Remember the quote from Benjamin Graham, “You’re neither right nor wrong because other people agree with you. You are right because your facts are right and your reasoning is right .”

By Dhruv Desai

The writer is director & COO, Tradebulls Securities

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