Ask not how the market is doing

By Vivek Reddy

"How's the market doing" or "what's happening in the market"! People ask these questions all the time, and expect short answers. The problem is whatever the answer, it usually leads to faulty understanding and wrong conclusions.

Let's take all three market scenarios — it has been rising, it has been flat or it has fallen. If the market has gone up, one has to answer, "the market is doing well". However, once these words register, the person hearing it usually becomes emboldened to put money into stocks. If the market has been flat or falling, the answer of the market not doing well is instantly interpreted as a signal to avoid investing. Clearly, such conclusions may be wrong and may not even have been intended by the person answering the question. If one were to analyze the causes of such miscommunications, they would be, one, an undue focus on the recent past and, two, a short attention span.

The way out is to communicate clearly that the past behavior of the stock market has little bearing on its future, and that a more reflective and studied approach should replace relying on sound bytes and one-liners on the market.

The more appropriate question, of course, would have been to ask, "what factors will influence the market" over whatever timeframe the investor is considering an investment/exit decision. And a sensible discussion will focus on the future and include:

expected future growth in corporate profits in relation to price-earnings multiples;

trends in liquidity and capital flows; and

impact of various economic and political events on corporate profitability. Thereafter, there has to be a view on how India's market compare on these factors to other developed and emerging markets. This analysis should give investors a basic idea on how much of their financial assets can be allocated to India's market.

It must be remembered that this broad understanding of the market will serve only those investors looking for a diversified equity portfolio or mutual fund. Those seeking to invest in individual stocks will need to study that company in depth before taking an exposure.

While deciding on an investment plan, there is always a multitude of expert opinions available in various forms. A sound approach is to ignore those analyses which dwell on the past and give a rear-mirror perspective on why the market behaved in a particular way. Also, distrust brokers who motivate you to transact often as they may be looking to profit at your expense.

So next time you feel like asking or have just been asked how the market is doing... pause, rephrase the question and take time to engage in a meaningful discussion. If there is a shortage of time, the best response is "only God knows".

(The author is former CEO, Kothari Pioneer Mutual Fund, which is now part of Franklin Templeton, this article appeared in 2006, however its relevance is timeless!)