13 September 2016

Nifty PE above 24 - Historical Trends

If you read our posts over the last few quarters you would be just reading one theme - Nifty valuations are stretched and that it is not a good time to invest for the long term. We waited for a correction in valuation levels or a growth in earnings but they never came! Now as we speak, the Nifty valuations have crossed PE levels of 24! And at the same time, the earnings growth has stagnated to 0% (+/- 1%). This means that the investors are now paying 24x earnings with no growth yet and expecting that growth in earnings will come.

Stats don't lie

Added to this is the fact that interest rates and yields on bonds are at historical lows all across the globe. Take the case of India where a 91 day T-Bill is yielding around 6.56% which means that a post tax return from these bonds is 4.6% for the investors. Across the world, the borrowing rates have managed to stay at extremely low levels and that has caused the returns from fixed income instruments to fall dramatically low. The bond prices have rallied to new highs and the institutional investors are flushed with a lot of funds at cheap interest rates and they are looking at investment opportunities across the globe. When the Government bonds are giving a return of 4.6% post tax, investors won't mind getting a yield of 6% from equities, so how much returns are equities offering?

Central Bankers across the globe have kept rates LOW

At a PE of 24.3, the yield is close to 4.11% - Lower than the safest assets class. But there is another catch! The expectations of these investors over the next 12 months are:

1. Interest rates will be cut by the RBI over the next 12 months by around 0.75% and thus the yield on the government bonds will also fall down to about 4% after tax

2. Earnings will grow at 12% and the Nifty's forward PE at an expected EPS of Rs 408 and current level of 8,800 (Approx.) is 21.56. This means the yield works out to 4.63%

This we have seen from the point of view of an Indian Investor. The FII's see India as a market which is offering a 4.6% expected yield on equities and 4% on the safest asset class! Also, if they invest in bonds now the price of bonds is expected to go up as interest rates come down. All these points have caused a tsunami of inflows across all the asset classes. When will this party end? Noone can predict. Everyone is expecting it to end when FED hikes the rates or USA presidential elections, but we know that everyone is ALWAYS wrong on the street. If you are invested for the long run then it is time to be cautious. If you are trader then it is the best time to be with the trend and make use of the momentum. If you swear by FD's, then it is the last good time to invest and get in that 7% p.a. return  as this is expected to fall over the next 12 months.

No stopping this BEAST!

In the past, there have been 4 instances when the PE of the Nifty crossed the 24x mark and the duration for which the index managed to stay above these levels is:

1. 70+ trading sessions ( 3 Months )
2. 70+ trading sessions ( 3 Months)
3. 50+ trading sessions ( 2.5 Months)
4. 1 session

There is a very high probability that the index will for the next 2-3 months trade above the 8650-8700 levels and in the mean time go on to make new highs and touch PE levels of 25-26, maybe even 28! But what are the hazards of investing at such stretched valuation levels? You can read our previous articles to understand this:

1. July 2015 article
2. January 2016 article
3. May 2016 article

To sum up our views: We were right in the past as Nifty corrected to 6800 levels in Jan and Feb but we have been fuming at times as we continue our equity light and debt heavy portfolio just to see equities rally and give mind boggling returns! However, we have performed at PAR with the Nifty, thanks to the 10%+ returns we are getting from bonds and the equity exposure of our portfolio has managed to give the balance required to be at par with the index, if not out-perform. We are cautious, we believe that this is NOT the time to INVEST for the long term in equities but we also believe that predicting WHEN the rally will end is out of anyone's reach. This is a traders market with a second thought - Thanks to the momentum. And yes:

Tezi mein sabka bol bala, mandi mein sabka moo kala

When in a bull run all are right, when the bear strikes - Everyone's face is BLACK. 

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