“You've got to know when to hold 'em. Know when to fold 'em. Know when to walk away.” - Kenny Rogers.
Last week, we had looked at the strategy calculator in Part 3 of our investor series, and quickly realized that market valuation today is extreme historically and due for a correction. If you have large funds parked in market instruments, it’s time to move and wait out the incoming correction.
The Nifty50 is Overheating
Earnings have been negative over the past 2 years, with the exception of some recent good quarters for anchor companies in infrastructure and auto. Nifty is now trading at a PE of 23 (see chart above of Nifty PE versus Nifty movement: Jan 2006 - till date).
A 23 PE is a crucial number for the Nifty50:
- Between Jan 2006 and Sep 2007, the Nifty never breached a PE of 23. Once the exuberance began at the start of October 2007, the PE stayed above 23 for just 3 months. It breached a high of 28 in the beginning of 2008, followed by a correction that lasted nine months.
- Nifty again breached a PE of 23 in Oct 2010 and in Mar 2015. Each time this occurred, Nifty corrected by 20-25%.
Earnings potential for stocks needs to be higher than it is now for the climb to be justified
Bulls will be quick to point out that earnings and results are catching up on the back of a good monsoon and festival spending. However during the above mentioned periods Nifty earnings growth was:
- Jan 2006 - Jan 2008: 35% ie ~17% pa
- Jul 2010 - Dec 2011: 15% ie ~10% pa
- Jan 2015- Jun 2016: -7%
The Nifty mean PE for the last 10 years has been 20. Nifty PE Mean is where we feel there is money to be made. Even if Nifty earnings go up at the heyday of 2006-2007 levels ie ~17%, it will still take Nifty PE 9 months from now to reach its mean.
The Nifty50, the largecaps index, is not the only area where there is a valuation glut. The Nifty100 PE is currently at 24.8, and has a mean of 19.62. The current mean is above previous periods of exuberance - in Sep 2007 the PE was 23, in Oct 2010 and March 2015 the the PE was 24 and 23.5 respectively
Chart 2: NSE Primary Indices: Historical Highs versus Mean
Similarly the Nifty200 PE is currently at 26, above the 10 year mean of 19.6. Previous periods of exuberance had it rising to 23 (Sep 2007), 24.5 (Oct 2010) and 24.6 (Mar 2015).
A few sector-specific indices are below their two year averages - Nifty Auto, Nifty Pharma and Nifty FMCG (See Charts 3 and 4 for the PE values of all individual indices).
Overall, the Nifty is showing some clear over-exuberance, and it’s time to put a cushion around your money for the next few months - after all, why risk your hard-earned earnings in the market in the short term for small incremental gains?
For now, the data says that your money is safer out of the market.
Chart 3: PE of major NSE indices today
Chart 4: PE of NSE sectoral indices today
For more details about earnings you can look at following pages Nifty 50 EPS, Nifty 100 EPS and Nifty 200 EPS.
