Predicting market returns? Not so fast!

“Be careful – you are using the same data to predict as the model itself. You used past data to determine how stocks have behaved 1 year in the future based on the P/E that the index had (average ranges). Then you plot the “prediction” of that past data as a backcasted chart. Obviously it will show the same curve, because you used the very same data to determine the ranges in the first place :)” – Deepak Shenoy Excellent comment on my last post: Predicting stock market returns, by one of the most prolific analytical finance practitioners in India. (If you

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Predicting stock market returns

At a glance While predicting market performance is nearly impossible, there are lessons to be learnt from looking at past performance We take the predictive power of three popular valuation metrics; Price-to-Earnings, Price-to-Book and Dividend Yield P/E as a valuation metric performs better than P/B and yield as a lead indicator of annual returns As of early Jan 2015, the Nifty is trading at 21.2x earnings, more expensive than 80% of all trading days in the last 16 years Higher the P/E at the time of purchase, lower the returns achieved for the Nifty Current P/E levels indicate marginally negative

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3 charts that sum up Indian equities in 2014

1. An “exuberant” 2014 Both key benchmark indices up by 30% December so far has seen the only significant correction in 2014 2. A “can’t go wrong” 2014 Every sub-index provided positive returns, some more than others with returns ranging between 10% and 70% Metals, Oil & Gas, IT, FMCG and Power under-performed the broader index Small caps, Consumer Durables, Mid caps, Auto & Capital Goods offered 50%+ returns 3. An “Expectations ahead of Earnings” 2014 Indian markets currently trade just above 21x earnings (For every ₹1 in earnings, you pay ₹21) Unless earnings show significant growth in the next quarter or two, historical data over 15 years suggests you’re more

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Why do stock prices move (Part I – Short Term)

At a glance Stock exchanges like the BSE and NSE facilitate stock trading by providing the platform to match buyers with sellers The key price-setting mechanisms buyers and sellers follow are “at limit” (setting a pre-defined price) and “at market” (taking whatever is the prevailing price) When more buyers look to buy “at market” the price trends upwards and when more sellers do the same the price declines An investor’s ability to deal with short-term price movements has a huge impact on her success or failure Imagine you walk into a street market in a large city… You’re thinking of

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