At this juncture, the markets are poised on a tightrope. Here are three possible future scenarios—and the probable outcomes 

We have come to a point where the markets seem to be on a razor's edge. Given the current volatility and the prevailing mood, one can predict three possibilities as far as the possible market's move is concerned. These have been given as Case I, Case II and Case III (See table). Case III, the best case, is an upside of around 22% from here, and my view is that it could take between 18 and 24 months to get there. If we factor in a 15% earnings growth in this year and the next, 6,300 should take around two years. It would then be trading at nearly 17 times earnings. I am assuming inflation to be around 7% to 8% and GDP (gross domestic product) growth to be around 8%.



(The table is a useful reference point. The market tends to correct when it reaches around 20X earnings and becomes investment worthy at levels close to or below 15X earnings)

So, if we get in today, we have a potential upside of around 22% and a downside (I assume that the markets could hit either 4,800 or 4,600) of around 11%. Clearly, the risk reward seems at very textbook odds of 2 to 1.

So, do we invest or not? My call is that we could wait this out. In two years, a bond could give you a return of 11% p.a. This would be taxable and we could avail of indexation benefit. In which case, the return would drop by around two percentage points, or around 9% per annum. The markets could give us 11% p.a, but it would be tax free! So, the market gives us a two percentage point extra, if things pan out as expected. Yes, it is likely that we could hit 6,300 sooner, in which case our returns would be higher (provided we sell out at 6,300). This point is also around the previous high on the Nifty.

One other thought that strikes me is whether the stress of the markets is worth taking on, for a mere two percentage or so extra returns. The world is going from one crisis to another and my positive outcome is dependent on the assumption that India is immune to most of the troubles going on in the world, since our economy is domestic-demand driven, among other factors. Being the worrier that I am, I think that it may so happen that our economic growth could slip. Our exports could slow down. Inflation may still be high. So many worries cannot vanish easily. The corporate earnings growth story is intact, but not a runaway factor.

So, does it not make sense to wait for some time for the markets to come down to 4,600 or 4,800? If I invest there, then I get a better return on the ride to 6,300.  What if the markets do not come down to 4,800? Then, there is also a possibility that our markets will remain in limbo or a range from 5,000 to 5,400 for some months to come. I can always keep my money in liquid assets (which gives me a decent 8% plus) or buy some bonds. Assuming that things go well, I can sell the bond later at a good gain (for the markets to resume an upward momentum, I think that interest rates have to come down) and put the money into equities.

I also hear voices on global markets telling us that there is a slowdown. I think if that happens, our growth is certainly impacted. We will fall below 8%. If we fall, then it becomes a vicious cycle. All the freebies that the government doles out today, thanks to buoyant revenues, will take a heavy toll when the buoyancy dips. This will worsen the fiscal position and take us on a downward spin even faster. So, this is one more reason to be cautious about the markets.

If you are into a Systematic Investment Plan (SIP) in equities, do continue. Do not let some disturbances come in the way of your savings. SIPs are good if you have the patience and the persistence. What I discuss is perhaps more relevant if you are not of the SIP type.

What is the other possibility? Well, markets being markets, none of the above may happen in the manner that I foresee. It could simply run away to a new high, if there are sufficient funds from the FIIs (foreign institutional investors) into the markets. India may attract more money on the factor that "India is one of the two or three markets that are growing" theory and becomes a 'must own' market. In such a case, markets would get to an overvalued level quickly and can continue to defeat all my expectations. And I would not have been wrong on the markets for the first time.

(R Balakrishnan is a regular contributor to Moneylife. His email address is [email protected].)