Rothschild’s most worn out phrase, “to invest when there is blood on the streets” is being turned on its head. Ever since the recent elections, Rakesh Jhunjhunwala (the primary arouser of animal spirits in the Indian stock market) has called  the next few years the “mother of all bull markets”. Before you call your neighborhood mutual fund sales guy or start punching in buy orders to your favorite online stock broker, it would pay to keep in mind Warren Buffett’s advice. “Be fearful when others are greedy and be greedy when others are fearful.”

The “market” (as it is called by most people) refers to either the Sensex or the NSE Nifty. While the Sensex gets most of the headlines, the NSE Nifty is the one which has the most trading volume – actual trading volume watched most closely by market professionals. The Nifty is an index made of 50 stocks which makes up 70% of all free float market capitalization of all companies. Further, just 10 stocks make up nearly 56% of the Index (see table below).

So, when people talk about the “market” going up, what they are really talking about are 2 software companies, 4 banks, a cigarette company, Reliance, Larsen & Toubro and Tata Motors. You could form a bottom up view and analyse the risks and rewards of each of these companies, but I’m pretty sure neither you nor anybody investing in the “market” will have the patience to do so.

It seems like a decent enough time to invest in the NSE. It is at about 30% higher than it was in October 2007 (nearly 7 years ago). The price to earnings, price to book and dividend yields of the NSE all seem within broad historical ranges, although they are slowly creeping toward the higher side.

Despite the decent valuation of the “market”, we should consider two factors that may cause natural constraints for abnormally high growth.

The first factor is the yin and yang of the dollar. There is a downward pressure on the dollar (given the euphoria of the new government) which may cause issues for export-led companies such as TCS and Infosys. However, the flip side to this question is that the rupee may fall further driven by macroeconomic US monetary policies. The US has kept treasury rates at a 220 year low as a part of their QE 1/2/3 program in order to spur new home buying, making investment decisions and trying to get people to take more risks. As a result, US mortgage rates are at an all-time low and you could finance a home in, say, Cincinnati for 3.14% today.

However, once the QE program stops, interest rates are expected to go up, and investors’ money will flow back to the US chasing better returns from the US treasury, which exerts pressure on the rupee and on the broader Indian market. So, you have the domestic economic improvement which causes the dollar to fall, and then you have global macroeconomics that may cause the rupee to fall. Who will win? Who knows? Just use that as a tempering factor before you go all out and invest in some of those “markets”.

The second factor is size. Ultimately, all companies reach a size that makes it difficult to outperform the market on a regular basis. Call it the Apple effect, which is one of the world’s most innovative companies but also the world’s largest market cap at $528 billion. To double your money in Apple in 5 years (~15% compounded rate of return), Apple needs to be worth $1 trillion dollars. Now, take TCS whose market cap is $70 billion and has to get to $140 billion (80% of IBM’s size) to generate a 15% return in 5 years. Similarly, SBI has to go from $35 billion to $70 billion (50% of Citigroup’s size) for the same 15% return.

Given all the on-the-one-hand-and-on-the-other-hand analysis, the Nifty Index may still be the best place to invest for most passive investors. Index investing is what Warren Buffett did for his wife. It will make for a decent investment and will probably leave something for your retirement. Just don’t expect to retire anytime soon.