Beware, the stock market is in a bubbly territory

We eventually met a week later at the same spot on the Worli Seaface. The Sportsfield building was behind us and it was threatening to rain.

The Monsoon was ready to hit the city and it was humid as hell.

“Why did you leave me?” I asked her, as we sat on the bench.

“You were not the marrying type,” she replied.

“Neither were you.”

“Let’s say, I changed my mind.”

“Oh!”

“Now that we have got the emotional bit out of the way, can we go back to discussing what we were last week?” she asked.

“For sure,” I replied, having been caught in a corner.

“So, go on.”

“Well, last week we were discussing about foreign investors leaving India, but despite that the stock market has continued to remain strong.”

“Yes.”

“Between April and now, foreign investors have sold stocks worth Rs 16,643 crore. During the same period, the BSE Sensex, India’s premier stock market index, has gone up by a little more than 7%.”

“Yes. What is happening here? If foreign investors are selling out, shouldn’t the Sensex be falling?”

“Well, not really. It depends on how other investors in the stock market are behaving.”

“As in?” she asked.

“Domestic institutional investors have bought stocks worth Rs 30,202 crore since April, which is significantly more than the total stocks sold by foreign investors.”

“Ah, that way.”

“Domestic institutional investors are basically mutual funds and insurance companies operating in India.”

“So, what does that tell us?” she said, while taking out her mobile phone, starting the camera and trying to reapply her lipstick.

At that moment, I wondered, how women can multi-task so well, and men can’t.

“The money that insurance companies and mutual funds invest in the stock market is essentially the money that retail investors hand over to them.”

“Yes. I mean that much I understand.”

“When it comes to the stock market, the law of demand does not seem to apply, at least for the retail investors,” I said.

“Now you are talking like a jargon spewing economist V. You know, I loved you, because you kept things simple,” she said.

“The law of demand basically states that the demand for something goes up as prices fall. In case of the stock market, many retail investors start getting into the stock market, after it has already rallied,” I replied, not falling for her bluff.

“Hmmm.”

“So, in the last three months, as foreign investors have been getting out of the stock market, Indian retail investors operating through domestic institutional investors, have been more than happy to buy.”

“Hmmm.”

“If you look at the price to earnings ratio of the BSE Sensex, it is currently higher than 23. This basically means that an investor is willing to pay Rs 23 for every one rupee of earning for the stocks that make up the Sensex.”

“So?” she asked.

“Since 1998-1999, if we look at annual data, the price to earnings ratio of the Sensex has been higher than 23, only in two years. In 2017-2018, it averaged at 23.78 and since April 2018, it has averaged at 23.36.”

“So, the stock market is in bubbly territory.”

“Yes, it sure is. And retail investors are caught up in the bubble,” I replied.

“Thanks for today’s lesson,” she said, as she got up. “Does that mean I should stop my SIPs?”

“Oh, not at all, the entire idea behind SIPs is to keep investing and not to time the market,” I explained.

“When do we meet next?” she asked.

“You tell me.”

“Why don’t you come home next week and let me introduce you to S,” she said. She always liked to have the last laugh.

Somethings never change.

(The example is hypothetical).(Vivek Kaul is the author of the Easy Money trilogy).