I read a thread on a possible melt up & subsequent crash. I with due permission want to copy & share the post in this thread as its quite relevant to this thread. @ kashif_1461…Hope you don’t mind sharing your post
Author has analysed previous bubbles and noticed that an acceleration of index by approx 60% in 21 months prevails before a hard crash landing. Which in sensex terms means approx 41000 by later half of 2018.
I have borrowed the title of this article from a recent commentary by Jeremy Grantham. Read it first here - https://www.gmo.com/docs/default-source/research-and-commentary/strategies/asset-allocation/viewpoints---bracing-yourself-for-a-possible-near-term-melt-up.pdf?sfvrsn=438
In this article, Mr. Grantham first starts by pointing out the elevated levels of US stock markets. Whatever parameters you use, there is no denying the fact that markets are exceptionally high at this stage and have been for some time now. In fact Jeremy Grantham is not the first investor to warn about the exceptionally high levels of the stock indexes. Many other equally distinguished investors have been sounding the alarm as well. Howard Marks also sounded the alarm about the elevated risk levels and gave his advice to be cautious going ahead in his quarterly memo – There they go again… again9. Some other very distinguished investors like Seth Klarman, Paul Singer, John Hussman, Bill Gross etc. have been quite outspoken about the risks in todays economy including the policies of central bankers around the world, China, Trump, etc.
But does the high levels of the stock market suggests that we are in a bubble which is going to burst? In the article referred to above, Jeremy Grantham explains that – “Price alone seems to me now to be by no means a sufficient sign of an impending bubble break.” Stock market bubbles are characterized by exceptionally high prices alongside signs of excesses and euphoria among the market participants. Many experts including Howard Marks, Jeremy Granthan and Robert Shiller agree that although while the current prices are high but the current stock market rally lacks the psychological, touchy feely elements of euphoria. Hence, we are not yet in the bubble territory although there are early signs that the bubble is beginning to form. One of the most important indicator of the euphoria and the resulting formation of bubble apart from price is “acceleration of price.” This has been observed in each of the previous bubbles wherein there is a final acceleration of price which takes the index to levels of ~60% higher within an average time of 21 months. And we can see early signs of this acceleration of price and hence formation of the bubble.
Other than acceleration, there are two other historically reliable indicators of the formation of the bubble. These are: - Concentration and Outperformance of quality and low beta stocks. These are related – concentration refers to the obsession of the investors with a few stocks such as Nifty50 in the 1960s, and Cisco and Microsoft in 1999 and FANGs in the current period. The second factor is pretty much self-explanatory.
The current rally in stock markets in India has been going on for a long time now. As a result, the valuations have become stretched and most of the stocks of quality companies are trading at exceptionally high valuations. The retail investors have poured back into stocks after getting hurt and staying out of the markets after the 2008 crash. All this has made the value investors very nervous and rightfully so. But as we have seen overvaluation is not the only trigger for a crash. For a bubble to burst, it has to form first. And in India as well, the bubble has not fully formed yet because we have yet not seen the second most reliable indicator of the bubble – acceleration. The Sensex has gone up by ~28% during calendar year 2017. While it increased by 16% during the first half, the growth decelerated to 10% during the second half of the year.
The current rally started in December 2016 and has been going on more or less uninterrupted for the whole of last year. Just to get a flavor of where we can go from here. As we saw, historically the price has increased by an average of 60% over the last 21 months in the previous bubbles. We already had an increase of 28% during the last 12 months in Sensex. Which means that the price should increase by another 25% during the next 9 months. This will take the Sensex to 41,600 by September 2018. We can construct various scenarios but the bottom line is this – we should see a final acceleration starting soon for a bubble to form.