I regularly monitor index ratios like price-to-earnings, price-to-book values to gauge overall market sentiments. I know it’s a very crude way of doing it. But still it provides a decent picture of what is happening in markets.
Now here is something interesting what happened on July 7th, 2014.
Nifty 50’s P/E multiple crossed 21 after almost 3 years. Surprisingly, last it stood past 21 was also on July 7th (2011). That’s exactly 3 years back!
Long term analysis (starting end of 1998) of Nifty’s P/E ratio tells the following story...
We all know its common sense to buy low (Low PEs) and sell high (High PEs). And we also know that its difficult to do it. So if you go out and buy the index as whole when P/E multiples are less than 12 (quite low), then on an average, your probable 3 year and 5 year returns will be 39.5% and 29% respectively.
Similarly for index-buying during P/E multiples being in between 12 and 16, the 3 and 5 year returns are 28% and 25% respectively.
But we are currently in the band of 20-24. And this is not a cheap market at all. As per past data, your 3 year returns and 5 years returns look bleak at 4% and 7%.
So does it mean that we sell all our stocks and put money in bank deposits?
The answer is I don’t know.
The above numbers are based on data of past 15 years. And there is no guarantee that past performance may be repeated. Or whether this time it might be different.
The last instance of PE21, for which 3 year returns data is available (May 02, 2011), the market gave a return of 5.3%.
Similarly for last instance of PE21, for which 5 year returns data is available (June 11, 2009), the returns were 10.3%. Not bad considering the superiority over returns given by safer ones, but also not eye-popping considering the optimism we have for next 5 years.
Now we are all quite hopeful that the new Indian government, if permitted by external uncontrollable like oil-shocks, natural-disasters, wars, etc… would be able to provide a conducive environment for India’s return to high growth days.
But having said that, I also beg to differ with those who believe that this would be achieved overnight and Sensex will hit 40000 by end of 2015.
As for the current markets which are rising everyday, it seems that they are now running ahead of the actual ground realities. But it is this over-optimism that gives us, the long term investors a chance. Isn’t it? :-)