How to analyze stock market?

Stock markets are barometers of the economy. It is expected that the markets and their indicators, in the form of indices, reflect the potential of the corporate listed on them and, in the process, the direction and health of the economy. If a countrys economy is performing well and expected to grow at a healthy rate, the market is usually expected to reflect that. Indian economy is increasingly exposed to global markets post liberalization in the early 90s. So before analyzing domestic markets one needs to analyze the Global economy. According to us, to analyze the domestic market, one needs to: Analyze Global Economy, then how it affects the Indian Economy and then comes Sector Wise assessment and then finally analyzing the Company or the Stock.

GLOBAL ECONOMY

INDIAN ECONOMY

SECTOR WISE

COMPANY/STOCK

GLOBAL ECONOMY:Markets across the world are seeing a lot of short term volatility mainly driven by news and events in the global markets. The countrys capital market is increasingly influenced by global developments because of the active participation by FIIs and big corporate growing appetite for global borrowings. For example, news/rumors related to economic recession in USA, soft/hard landing and estimation of losses due to sub-prime crisis in USA, speculation over interest rates cut by FED, rise in global commodities prices, fluctuation in global crude oil prices etc. These are some fundamental reasons why global markets, especially the Indian stock market behave in a volatile manner based on developments in global markets. Indian companies are getting involved in exporting their products to global markets, raising funds by listing on foreign stock exchange. The percentage revenue of Indian companies coming from foreign markets is growing year over year. Therefore, share price movements of these companies are more likely to be affected by the development in world economy. So analyzing global economy is something vital.

INDIAN ECONOMY:India is the second fastest growing economy in the world. It is one of the most attractive destinations for business and investment opportunities due to huge manpower base, diversified natural resources and strong macro-economic fundamentals. Also, the process of economic reforms initiated since 1991 has been providing an investor-friendly environment through a liberalized policy framework spanning the whole economy. Though the global financial crisis have affected the Indian equity and foreign exchange markets at present, the macroeconomic brunt of the meltdown is not much, due to the overall strength of the domestic demand and the largely domestic nature of its investment financing. Also 60% of Indias GDP is dependent upon domestic market. There are some economic parameters which affect the Indian Economy and there by the stock markets such as monetary policies, fiscal policies, governmental expenditure towards infrastructure & lastly confidence among consumers to spend more and generate demand for the goods & services for stimulated growth. All such economic indicators not only measure/analyze the present performance of an economy but also help in predicting and forecasting its future growth prospects.

We can broadly classify the above said parameters in to two:A) Monetary Parameters B) Fiscal Parameters The Monetary Policies regulates the supply of money and the cost and availability of credit in the economy. The Monetary Policy aims to maintain price stability, full employment and economic growth. The Reserve Bank of India is responsible for formulating and implementing Monetary Policy. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements. Lets take a look into the Monetary parameters:A) CALL MONEY MARKET:

The money market is a market for short-term financial assets that are close substitutes of money. The most important feature of a money market instrument is that it is liquid and can be turned over quickly at low cost and provides an avenue for equilibrating the short-term surplus funds of lenders and the requirements of borrowers. The call/notice money market forms an important segment of the Indian money market. The funds located through the money market can be utilized to provide financing for the purchase of securities that can be added to the portfolio of the investment firm, or as a resource that will cover the margin accounts of the firms clients.
B) CRR & SLR CASH RESERVE RATIO & STATUTORY LIQUIDITY RATIO:-

CRR, or Cash Reserve Ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation. Besides the CRR, banks are required to invest a portion of their deposits in government securities as a part of their Statutory Liquidity Ratio (SLR) requirements. The government securities (also known as gilt-edged securities or gilts) are bonds issued by the Central government to meet its revenue requirements. Although the bonds are long-term in nature, they are liquid as they can be traded in the secondary market.
C) OPEN MARKET OPERATIONS:-

An open market operation is the principal tool of implementing monetary policy by which a central bank controls its national money supply by buying and selling government securities, or other financial instruments in order to expand or contract the amount of money in the banking system. When the Government sells securities to the public, it absorbs money from the economy. There is, thus, a reduction in money supply. Later, when it spends, the money flows back to the system, resulting in a net nil effect. When the RBI enters the secondary market for the purchase or sale of securities, it does so to implement its monetary policy. Thus, if it wants to have an expansionary policy, it may buy securities, injecting money into the system.

D) REPO AND REVERSE REPO:-

Simply the operations whereby RBI injects liquidity in the system are termed as Repo, and whereby the Central Bank absorbs liquidity are termed as Reverse Repo. REPO or repurchase agreement or ready forward deal is a secured short-term (usually 15 days) loan by one bank to another against government securities. Legally, the borrower sells the securities to the lending bank for cash, with the stipulation that at the end of the borrowing term, it will buy back the securities at a slightly higher price, the difference in price representing the interest. It allows a borrower to use a financial security as collateral for a cash loan at a fixed rate of interest. In a repo, the borrower agrees to immediately sell a security to a lender and also agrees to buy the same security from the lender at a fixed price at some later date. Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. Banks are always happy to lend money to RBI since their money are in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to these attractive interest rates. It can cause the money to be drawn out of the banking system. Now lets move on to governments fiscal parameters:Fiscal policies may be defined as a deliberate change in government revenue and expenditure to influence the level of national output and prices. For instance, at the time of recession the government can increase expenditures or cut taxes in order to generate demand. On the other hand, the government can reduce its expenditures or raise taxes during inflationary times. Fiscal policy aims at changing aggregate demand by suitable changes in government spending and taxes. The Fiscal Policy can be used to overcome recession and control inflation. Fiscal policies that need to be looked upon to analyze the stock market include:A) INFLATION AND DEFLATION Simply put, inflation is a rise in prices of several items over a period of time. It is measured through various indices and each provides specific information about the prices of items that it represents. The index could be the Wholesale Price Index (WPI) or the Consumer Price Index (CPI) for specified categories of people like agricultural workers or urban non-manual employees. Each of the indices is created in a specific manner with a certain year as the base year and they consider the price change over a year. An index used for measuring inflation comprises several items having different weight age and hence the index moves according to the price changes in these items. To tame inflation, the government usually hikes interest rates. High inflation is not always bad and low inflation need not always be good for equity markets, as the impact will differ for companies and sectors across different time horizons. Inflation is caused by a combination of four factors: 1. 2. 3. 4. The supply of money goes up. The supply of other goods goes down. Demand for money goes down. Demand for other goods goes up.

Deflation occurs "when prices are declining over time. This is the opposite of inflation; when the inflation rate is negative, the economy is in a deflationary period." The stock market normally reacts when there is a significant change in inflation and deflation, either ways, over a period of time. B) GDP GROWTH The Gross Domestic Product (GDP) or Gross Domestic Income (GDI) is one of the measures of national income and output for a given country's economy. It is the total value of all final goods and services produced in a particular economy. GDP is widely used by economists to gauge the health of an economy. The growth in nominal GDP matches that of the corporate performance year after year and hence there is a fair degree of co-relation between Stock market & GDP. This may be due to the fact that the GDP of the economy is the collective output of the agriculture, industrial, and services sectors. It can, therefore, be asserted that corporate performance tends to trace GDP growth over the long-term, and it is assumed that the stock market follows suit. In the long-run, the economy goes through cycles of recovery, peak, slowdown, and depression. Stock markets also exhibit similar cycles. Hence, if India's GDP grows at 10 per cent in one year, the Sensex may not gain a similar percentage during that year. However, the relationship may hold true over the longer-term. It may be stated that the state of the economy has a bearing on the share prices but the health of the stock market in the sense of a rising share price index is not reflective of an improvement in the health of the economy. C) FDIs & FIIs FDI is defined as investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. Foreign direct investment has become the major economic driver of globalization, accounting for over half of all cross border investments. Companies are rapidly globalizing through FDI to serve new markets and customers, map out their value chains in the most efficient locations globally, and to access technological and natural resources On the other hand, FII is used to denote an investor, who invests money in the financial markets of a country different from the one in which that investor is incorporated. So, if you as an Indian decide to invest in the US stock markets, it is an out-bound foreign institutional investment. Similarly, suppose a rich American millionaire invests in the Indian stock markets, it would be termed as in-ward FII. FIIs are supplementing volatility in Indian market. This is what is happening in current scenario. The Indian market is interdependent on global markets like U.S., Europe and other Asian markets. This was the same that happened in current scenario, U.S. and other market meltdown slotted in direct impact on Indian market. The FII are taking out the money and the impact is shown on current Indian markets. It is because of the volatile nature of investors sentiments that FIIs are tracked so closely. It would not be prudent to drive away foreign investors from investing in our country because for a developing country like us, its very important to drive foreign investors to our country.

D) FOREX RESERVES Foreign Exchange Reserves (also called FOREX reserves) in a strict sense are only the foreign currency deposits and bonds held by central banks and monetary authorities. Foreign exchange reserves are important indicators of ability to repay foreign debt and for currency defense, and are used to determine credit ratings of nations. Coming to the economics of forex reserves, they are basically held to achieve a balance between demand for and supply of foreign currencies, for intervention, and to preserve confidence in the country's ability to carry out external transactions. While analyzing the potential cost or benefit of holding such reserves it is pertinent to always keep in view the objective of holding reserves which include maintaining confidence in monetary and exchange rate policies, enhancing the capacity of the central bank to intervene in forex markets, capacity to absorb shocks in times of crisis and, above all, provide market confidence to indicate that the economy is well-placed to meet all external obligations and, of course, the security of backing domestic currency by external assets. The country also benefits by using the excess forex reserves to repay its liabilities and also use a part of its reserves to finance the import of capital and intermediate goods and to boost domestic production. The stock exchange and the foreign exchange markets are interlinked. The returns of one market are affected by the volatility of other market. Particularly the returns of the stock market are sensitive to the returns as well as the volatility of foreign exchange market. On the other hand returns in the foreign exchange market are mean reverting and they are affected by the volatility of stock market returns. There is strong relationship between the volatility of foreign exchange market and the volatility of returns in stock market. E) RUPEE DOLLAR RELATION The appreciation and depreciation of dollar against rupees will have huge impact on Indian economy. It will have direct impact on the export sector, as little appreciation would give huge income on the contrary a slide would count huge loss. A rise in the Rupees value against the Dollar would mean that our goods would be more expensive in Dollar terms, which may reduce our sales abroad. Alternatively, if the Dollar price of our goods is kept fixed, the corresponding Rupee realization would be less. Either way, our export earnings may suffer. This has already affected the bottom lines and share prices of some of our software companies. The same may happen to other export industries, especially in the US market. On the import side, however, the Rupee cost of oil and other goods (whose prices may be fixed in dollars) would fall, which may help keep the inflation rate down.

What happens if the rupee keeps on falling?

As the rupee falls, foreign investors will want bigger returns for their money to compensate for the higher risk. This means that the Indian government, companies and individuals will have to pay more for the money they borrow: in other words, higher interest rates. A major problem with a falling rupee is that it will increase the Indian government's burden of repaying and servicing foreign debt. Another problem is that it might discourage foreign institutional investment from pouring funds into the Indian markets.

Indian companies which could borrow from the overseas markets at cheaper rates to finance their import and export needs will also be badly affected.

F) IIP DATA IIP number or data is a measurement which represents the status of production in the industrial sector for a given period of time compared to a reference period of time. IIP number is one of the best statistical data, which helps us to measure the level of Industrial activity in Indian Economy. IIP data is a simple index which provides information about the growth of different sectors of our economy like mining, electricity, Manufacturing & General. The IIP index reflects the growth in Indias industrial activity and excludes all kinds of services. Index of Industrial Production (IIP) is an abstract number, the magnitude of which represents the status of production in the industrial sector for a given period of time as compared to a reference period of time. Indian stock markets are very sensitive to IIP Numbers. A better IIP number would show a positive growth on our Industrial production and share markets would possibly cheer.

SECTOR:Investors tend to underestimate the importance of sector before investing in a stock. They generally concentrate on stocks but forget about the importance of sector. Stocks sectors are helpful sorting and comparison tools. This is extremely helpful, since one of the ways to use sector information is to compare how your stock or a stock you may want to buy, is doing relative to other companies in the same sector. If all the other stocks are up 11% and your stock is down 8%, you need to find out why. Likewise, if the numbers are reversed, you need to know why your stock is doing so much better than others in the same sector maybe its business model has changed and it shouldnt be in that sector any longer.

Lets look why sector analysis is important in stock market?

Firstly, to start with, a long-term portfolio needs to be well-diversified in terms of Sector Allocation. Why such Sector diversification is needed in LONG-TERM investment?? Sector wise Diversification is needed in long-term investment as the investor is willing to wait & hold the portfolio for a longer-duration of time or until his pre-set targets are achieved. This long-term investment can span across few years or even more. During such times, in this constantly changing environment, various sector of the economy come into bullish trend & diminish from the sight time-n-again. The trend keeps changing among various sectors depending upon various internal and/or external conditions elated to the economy in general.

Like, for example, currently in the bearish situation, FMCG and Pharmaceuticals sectors has shown better resilience due to their operation in the space of inevitable consumption of goods/services. Even in bearish times, people wont stop consuming Medicines or People wont stop bathing with soaps. At the most, they may downgrade using expensive soaps with less expensive ones. But, they wont stop absolutely using it .Similarly, before this bull run, we saw how liquidity made a rush towards Commodity stocks, including Metal stocks. Now, that bullishness has disappeared for the time being, due to concerns of slowdown in world economy. So, meaning to say... Commodity trend came & went by. It may come back once global economy stabilizes & shows some recovery over next few years. Similarly, every portfolio should have 10-20% investment in defensive sectors to over-come the overaggressiveness of remaining sectors. This would provide cushion of safety when the tide turns in opposite direction, as we witnessing right now - bear phase. No investment is a sure thing. Any company, howsoever strong in any & every way it may be, can have serious problems that are hidden from investors. Even the most financially sound company with the best management could be struck by an uncontrollable disaster or a major change in the marketplace, such as a new competitor or a change in technology. The same thing applies to SECTOR specifics also & most of them are also governed by the LAW OF SEASONALITY. The trend keeps changing.

COMPANY:Finally comes analyzing the Company. To analyze a company one need to do both fundamental analysis and technical analysis. Fundamental Analysis:This type of analysis of a business/company involves analyzing its financial statements and health, its management and competitive advantages, and its competitors and markets. The analysis is performed on historical and present data, but with the goal to make financial projections. There are several possible objectives: to calculate a companys credit risk, to make projection on its business performance, to evaluate its management and make internal business decisions, to make the companys stock valuation and predict its probable price evolution. Prediction of how the company/stock will move, normally for the longer term, is based on its fundamentals and valuation. Fundamental analysis is the process of looking at a business at the basic or fundamental financial level. This type of analysis examines key ratios of a business to determine its financial health and gives you an idea of the value its stock. Many investors use fundamental analysis alone or in combination with other tools to evaluate stocks/company for investment purposes. The goal is to determine the current worth and, more importantly, how the market values the stock/company. The tools of fundamental analysis are:Earnings per share Price to earnings ratio

Price to book ratio Return on equity/investment Debt/equity ratio Dividend yield ratio

Technical Analysis:This manner of playing the market assumes that non-random price patterns and trends exist in markets, and that these patterns can be identified and exploited. While many different methods and tools are used, the study of charts of past price and trading action is primary. It maintains that all information is reflected already in the stock price, so fundamental analysis is a waste of time. Trends are your friend and sentiment changes predate and predict trend changes. Investors emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does not care what the value of a stock is. Their price predictions are only extrapolations from historical price patterns.