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Suresh Krishnamurthy

ANALYSTS who exhorted investors to put money in stocks in October this year have been vindicated. Stocks are up and do not appear set to look back in the near term. The analysts' recommendation this time around was based on two factors — the documented November effect and the fundamentals that justified a share price rise. But investors need to view this trend cautiously.

The November effect refers to the phenomenon of a rise in stock prices from November to February each year. Since 1996, the markets have gone up in this period on five out of six occasions. If this rally persists, it will be six out of seven. Gains have been of the order of around 20 per cent on three of these occasions. Only in 1997 was the November effect missing.

The fundamental factors that justified a price rise this time were the prevailing low valuations in the backdrop of rising corporate profitability and fall in interest rates. The yield for savers is 6-7 per cent in the case of debt. In equities, the yield in terms of earnings divided by price is, in quite a few cases, more than this. In fewer cases, the sustainable dividend yield alone is higher than the yield on debt. Inevitably, investor interest has increased and led to the rise in equity prices.

Caution needed: However, investors need to be equally cautious. Having experienced the November effect investors need not now look for alternative explanations for the rise in prices. It may be tempting to view this rally as led by the improved economic scenario, though it may not be prudent to do so. In other words, the price rise may not be sustainable beyond March.

This is because the market have also fallen sharply between March and October each year on four of the last six occasions. Only in 1999 did the markets rise 18 per cent between March and October. And even that year, the market fell sharply in April before starting to rise. Besides, the rally that year was influenced by an unprecedented bull run in technology and healthcare stocks, the likes of which we are not likely to see.

Positive factors: There are definitely positive factors. For one, interest rates are at an all-time low for savers. Importantly, the low interest rate regime appears set to stay for quite a while. Second, the balance of payments situation and the forex reserves position are quite comfortable. These factors do support an increase in stock prices.

However, the other risk factors involved do not appear to have changed for the better. The economic scenario has not improved. Neither has the fiscal deficit situation. In addition, improving the fiscal deficit situation requires decisions that may have adverse implications for corporate profits and economic growth.

For example, an increase in the incidence of corporate taxation can hurt profits. In fact, if the recommendations of the Kelkar Committee report are implemented, they could lead to rising incidence of taxes. So, there are enough reasons for the investor to be cautious.

Use momentum judiciously: For the investor these factors suggest the need to use the momentum in stock prices judiciously.

If you have already invested in index funds or plan to invest now, then the period after the Budget may be a good time to exit.

If, however, you have long-term funds, then staying invested in diversified equity funds or balanced funds may be a much better idea. For such investors, timing the market may not be a good idea.

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