Will Sensex Highs Trip You Up?

Nothing indicates an exciting time on the equity markets than headlines of the Sensex touching an all time high. There’s a lot of such excitement nowadays. On Friday, 31st, October, the BSE Sensex hit an all time high of 27,865.83. Since the beginning of June this year, the Sensex has hit new all time highs 22 times in barely 100 trading days. Over its 35-year history, the index has hit new highs on 499 out of a total of 8,110 trading days. Thus, on an average, about on 1 in 20 trading days, the index closes at an all time high. Going by that, this does not appear to be a particularly rare event.

However, the distribution of these highs is hardly uniform. They tend to come in clusters when the markets are rising rapidly and then don’t come around for a long time when the equities retreat. One such cluster was during 1981 when the Sensex registered 30 all-time highs in a matter of 60 trading days, rising from 152 to 186 over the period. Still, this couldn’t have caused any excitement then because the Sensex did not actually exist at the time. The index was launched only in 1986 but calculated back to 1979 to give it a history.

The biggest cluster of all-time highs was much closer home, from a time we all remember well. In the 60 trading days from 10 February, 2006 to 10 May 2006, the Sensex closed at an all time high on 32 days, rising 25.5 per cent from 10,045 to 12,612. The dry stretches are all much, much longer. No all-time high was recorded over the five years from August 1994 to July 1999, or for the four years to January 2004, nor for three years ending in Oct 2013, when the current cycle started.

This pattern is not just of academic interest to those who like crunching numbers. The skewed manner in which the markets generate excitement plays a large role in how people think about equity investments. There are long periods when there is nothing in particular to encourage new investors to start thinking of equities, or indeed, to encourage all but the most committed ones to invest. Then come the boom times, when the near-daily news of new records being set create the impression in investors that every rupee not invested in equities is an opportunity missed.

That’s exactly the situation that we find ourselves in now. It’s always said that the many more bad investment decisions are taken in good times than bad. The reason is self-evident. These are times when it’s easy to mistake a monkey for a goat. Or, to ignore the goats because the monkeys look so much more promising. I refer to the investing parable of the two villages that I have written about elsewhere. It’s about two villages that are fooled into buying very expensive animals buy a clever salesman who gets them excited about the future value of the animals. One village buys monkeys and the other goats. They are all over-priced but the goats at least provide milk, meat and produce more goats that do the same. The monkeys are just a nuisance and prove to be worthless.

And that story really holds the most important thing that investors need to keep in mind about investing in these heady times. We could be heading for a time when the practically every stock looks overpriced. However, as past history shows, such estimations have a way of falling by the wayside. As long as one take care to buy an overpriced goat, instead of an overpriced monkey, it will eventually work out.