Forget the S&P 500, watch the NASDAQ Composite

S&P 500 Watch

Three days ago the S&P 500 set a new record. But what about the other closely followed index on the U.S. stock market - the NASDAQ Composite index?

The NASDAQ index is a benchmark that closely follows the fortunes of US listed technology companies. The information technology companies in the limelight – Apple, Google, Facebook, and Amazon – are all listed on the NASDAQ stock exchange. The S&P 500 is more representative of all sectors of the U.S. economy – both traditional and the new.

During the height of the dot com boom, shares of technology companies soared – the benchmark setting an all-time high on March 6, 2000 of 5048.6 on a closing basis. Now the NASDAQ is within a touching distance of that all-time high – it closed at 4924.7 yesterday.

Fifteen years to come close to setting a new high is a brutally long time for any investor! Note after the dot com bust in 2000, the S&P 500 took just seven years to once again set a new high.

The point is that when it comes to investments, valuation – the price one pays for the asset - is just as important as the growth prospects of the asset (a company or a group of companies in an index). 

On March 6, 2000 when the NASDAQ closed at 5048.6, it traded reportedly on a trailing P/E (Price earnings ratio) of 175! Such extreme valuation punishes investors for an unacceptably long time. Today the NASDAQ trades at a somewhat modest valuation of 31.

Sixth, February 3, 2015, Bi-Monthly Monetary Policy Statement by Governor Rajan: RBI determined to keep the real policy rate in the 1.5 - 2% range

RBI Watch                                                                                    Monetary Policy 2014-15

In my last note on Dec 31, 2014, I had indicated that the new paradigm of monetary policy is the RBI’s determination to keep the real interest rate – the repo policy rate – in the region of 1.5 - 2%. In my note on monetary policy of April 14, 2014, I had discussed this issue under a section titled “Will the RBI follow a real policy (interest rate) rule?”, as a major weakness of RBI’s policy in the past, when inflation was stubbornly high, was that the real rate was negative.

It is abundantly clear now from the RBI’s conference call with analysts and media that RBI is determined, under Governor Rajan, to keep the policy repo rate in real terms at 1-5-2%. This is the key to understanding future changes in the interest rate policy of the RBI.

What is the real rate? The real rate is the rate of interest less the rate of inflation. So, if RBI expects inflation to reach its targeted level of 6% by January 2016, a repo rate in the region of 8% is appropriate, implying a real rate of about 2%. Why should the real rate be positive? To my mind, in the absence of a positive rate an individual or economic entity simply needs inflation to repay his borrowings.

On February 3, no change in the repo rate was announced. On January 15, the RBI reduced the repo rate to 7.75% from 8% - this was an unscheduled announcement. One wonders why the RBI could not have waited till February 3 to give the same signal – a loosening in monetary policy after over a year of tightening.

The RBI did make one change: it reduced the SLR to 21.5% from 22%, thereby giving more funds to banks to lend. I expect this trend to continue if government continues on its path of fiscal consolidation.

On the development of markets, RBI continues to take small steps that will make the Indian bond market robust and investor friendly, particularly to long term investors. The decision to allow foreign investors to reinvest the coupons in government bonds even when the overall limits have been fully utilized make sense, although perhaps administratively difficult to monitor. So does the decision to allow fresh investment by foreign investors in corporate bonds only in maturities in excess of three years.

Monitoring the NaMo Bull Market in Stocks: Update as of January 2015

Indian Stock Market Watch

Please refer to my blog of July 9, 2014 for the original note on using TMV/GNP ratio to gauge whether market is cheap or expensive.