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Over the last 3-4 months the nifty has given a good run up by 30% from 15K levels to 19970 levels.
Most of this rally has been in the last 3 months where the nifty has risen by about 18% from March-July 2023, which is a sharp rally given the macroeconomic conditions the world is facing.
There has been a fuss around social media where some influencers advocate for profit-booking, suggesting that it might be prudent to lock in gains given the substantial rally. On the contrary, others believe that this rally is only the beginning, and there could be further upside potential.
But what is it that we retailers should do? Should we book our profits from the stocks and our Mutual Funds? Or should we continue to hold them?
In this article let us make a detailed study about the current situation of the markets and do both fundamental and technical analysis as to where exactly our markets are and what the course of action should be.
Let’s begin.
Table of Contents:
Fundamental Checks
1. The PE Check.
2. The Forward PE Check.
3. The Buffet Indicator Check.
- Scenario 1:
- Scenario 1:
4. The FII Impact
5. Where are we now?
6. What is the BEER ratio?
7. Inflation Check:
Technical Check:
8. What’s our action plan?
9. Conclusion
Fundamental Checks
Let us now assess our market’s current position by analyzing four distinct parameters. These parameters will serve as valuable indicators to ascertain the trajectory of our market and will facilitate us in making judicious and rational decisions.
1) The PE Check.
The PE ratio is a widely used measure to assess stock valuations, and similarly, the Nifty indices also have their own PE ratio, representing the combined PE ratio of the top 50 stocks in India.
Last 2 Years PE Ratio Analysis
As shown below, Over the past two years, the Nifty 50’s PE ratio has shown some interesting trends. It reached a peak of approximately 27.5 in October 2021 but has since declined and is currently trading at a premium of ~23. This suggests that the market is not overvalued but rather fairly valued at the moment.
Long-Term & Medium-Term
Furthermore, we conducted a comparative analysis of the Nifty PE levels with both long-term and medium-term averages, and the results are encouraging. Despite the substantial market rally, our current position appears to be relatively favorable.
Courtesy: Fin lives. in
The valuations are not as stretched as they were during the peak in October 2021, indicating a more balanced and reasonable market state.
But…!
Will the past performance determine the future?
NO!
This past performance of India is a historical narrative and does not necessarily predict our future performance.
Well, we have another metric to study how the future price to earnings will be and that is called the Forward PE.
2) The Forward PE Check
The forward PE ratio uses the forecasted earnings per share of the company over the next 12 months for calculating the price-earnings ratio.
How to calculate the Forward PE Ratio?
It is calculated by dividing the price per share by forecasted earnings per share over the next 12 months.
As we do it for the Nifty 50 index, we put together all the EPS of the top 50 companies into this calculation and arrive at the forward PE.
How does this performance compare to 2021?
Nifty’s one-year forward Price-to-Earnings (PE) ratio is currently at 18.7 times, exceeding the 10-year average of 17.4 times, considering a projected 20 percent earnings growth in FY24.
Nevertheless, it remains significantly lower than the peak of 23 times observed in October 2021.
PE Ratio and Returns
Based on research conducted by Ace Equities published in Economic Times, it has been observed that whenever the PE ratio falls below 20x, the 1-year forward returns have been higher.
This was evident when there were extreme movements in the index
- January 2003, – PE 15x the forward return was ~88%.
- 2008-09 crash- PE was at an extremely low level and 1-year forward return was over 80%.
- Covid crash of 2020-Nifty PE fell below 20x. The 1-year forward return was around 70%.
- On the contrary, PE surged over 35x in 2021 and, followed by a drop in Nifty,
So, in short, whenever the PE was less than 20 the subsequent year gave a return of almost 20%. When the PE is much less than 15 the projected growth is still higher as depicted below.
Returning to our PE ratio, which currently stands at a premium of approximately 23, the outlook appears positive at this level when considered in conjunction with other factors, has the potential to be quite lucrative.
3) The Buffet Indicator Check.
This is another important factor that is checked for the market valuation.
What is a Buffet Indicator?
The Buffet Indicator consists of 3 factors namely,
- The total market cap of the listed companies in India
- The total GDP of India
- Total Assets of the Central Bank
Variations
There are 2 variations in the Buffet Indicator
Ratio = Total Market Cap / GDP
and
Ratio = Total Market Cap / (GDP + Total Assets of Central Bank)
Analysing The Two Variations
Though there is a debate as to which one gives a better view of the state of the economy, we will examine both of these approaches to assess our current scenario.
Scenario 1:
We divide the Market capitalization by the total GDP and arrive at the ratio of 97.24 under the original ratio as defined by Warren Buffet
Scenario 2:
We include the total assets of the central bank in our calculation and combine the same with the GDP and then calculate this ratio. By virtue of this, the ratio comes down to 87.54 %
Further, based on these historical valuations, the market valuation is divided into five zones:
| Ratio = Total Market Cap / GDP | Valuation |
| Ratio ≤ 63% | Significantly Undervalued |
| 63% < Ratio ≤ 80% | Modestly Undervalued |
| 80% < Ratio ≤ 98% | Fair Valued |
| 98% < Ratio ≤ 116% | Modestly Overvalued |
| Ratio > 116% | Significantly Overvalued |
| Where are we today (2023-07-29)? | Ratio = 97.24%, Fairly valued |
Based on these modified historical valuations too, the market valuation is split as follows:
| Ratio = Total Market Cap / (GDP + Total Assets of Central Bank) | Valuation |
| Ratio ≤ 56% | Significantly Undervalued |
| 56% < Ratio ≤ 72% | Modestly Undervalued |
| 72% < Ratio ≤ 88% | Fair Valued |
| 88% < Ratio ≤ 104% | Modestly Overvalued |
| Ratio > 104% | Significantly Overvalued |
| Where are we today (2023-07-29)? | Ratio = 87.54%, Fairly valued |
So, in both cases, we are well under control and are primed to move up.
What can we conclude from these 2 scenarios?
Though there are limitations around the inclusion of only the listed companies and the applicability of this indicator to developing nations, this indicator can also be considered to be one of the factors in determining the valuation of the market.
Consequently, according to this analysis, we can conclude that we are fairly valued in both methodologies.
4. The FII Impact
What is FII?
FII is fondly referred to as the market movers, especially in a developing country like India.
How does FII affect the market?
- They infuse capital into the market and can change the course of the market within months.
- FIIs are single-handedly capable of driving individual stocks and benchmark indices.
- They are investors with deep pockets of money looking for lucrative investment options.
- The amount of money they can invest is impossible to replace by domestic investors or any retailers.
How FII’s have Driven the Market
There are many instances where the FIIs have been acting as the catalyst in the market movement.
Milestones Of FII
The FII pulled out almost Rs.65000 Cr during the Covid slump in March 2020 and we all know what happened after that. They have also led the recovery post covid.
During the period from Oct 2021 to July 2022, FII was on a continuous selling spree.
They have pulled out a whopping 390K Cr from the Indian stock market and what has been the impact of this brutal sell-off, a fall for Nifty from the all-time high of 18600 until 15000.
Role Of FII in the Indian Market
This confirms that FIIs play a pivotal role in propelling the Indian markets forward. This sell-off may be attributed to Macroeconomic factors, soaring inflation, and crude oil prices as well as the rupee depreciation.
| Date | Net Purchase |
| Jul-22 | -6567.71 |
| Jun-22 | -58112.37 |
| May-22 | -54292.47 |
| Apr-22 | -40652.71 |
| Mar-22 | -43281.31 |
| Feb-22 | -45720.07 |
| Jan-22 | -41346.35 |
| Dec-21 | -35493.59 |
| Nov-21 | -39901.92 |
| Oct-21 | -25572.19 |
5. Where are we now?
What happened post-July 2022?
The markets bottomed out and the FIIs made their first big purchase on Aug 22. This led to the market reversal, and it started an upward trajectory and hasn’t ceased yet.
The most important point to note is that,
‘the FII’s have been consistently net buyers since March, and this has led to the Nifty reaching all-time highs’.
Look at how evident the role played by FIIs is. There seems to be a 100% correlation between FII buying and markets.
| Date | Net Purchase |
| Jul-23 | 14,623.18 |
| Jun-23 | 27,250.01 |
| May-23 | 27,856.48 |
| Apr-23 | 5,711.80 |
| Mar-23 | 1,997.70 |
| Feb-23 | -11,090.64 |
| Jan-23 | -41,464.73 |
| Dec-22 | -14,231.09 |
| Nov-22 | 22,546.34 |
| Oct-22 | -489.06 |
| Sep-22 | -18,308.30 |
| Aug-22 | 22,025.62 |
| Jul-22 | -6,567.71 |
So, what is the underlying message here?
Markets hitting new highs and FII’s are net buyers for 5 continuous months and ominous signs for the Indian economy. Would they be buying if the markets are overvalued?
The answer seems to be a resounding ‘NO.’
This seems to be a concrete reason and propels the idea of Indian markets being fairly valued.
6. What is the BEER ratio?
This is another parameter that is used to determine the direction of the market. BEER ratio stands for “Bond Equity Earnings Yield Ratio”.
How the BEER ratio is calculated? The ratio is determined by dividing the 10-year yield of government bonds by the current earnings yield of Nifty. The denominator here, the earnings yield is also the inverse of the PE ratio.
- A BEER ratio of 1 is considered to be a fair value and the market is said to be fairly valued.
- A value greater than 1 is said to be overvalued and less than 1 indicates an undervalued market.
What is the use of the BEER ratio?
Generally, the BEER ratio is used in asset allocation to decide whether to invest in Equity or debt based on the outcome of the calculation. When considering asset allocation, a value greater than 1 indicates a preference for investing in bonds/debt funds, while a value of 1 indicates the investment is directed towards equity.
BEER Ratio Of INDIA
- The India 10 Years Government Bond has a 7.161% yield
- India’s equity market yield is around 4.36%
“So India’s BEER Ratio amounts to 7.161/4.36=1.5”
This typically indicates an overvalued market. However, to gain a deeper understanding, it is crucial to analyze the historical values of the BEER ratio.
BEER ratio – Values From The Past
Based on data from 2020, the long-term average of the BEER ratio for India was approximately 1.6 over two decades. This suggests that a value of 1.5 may be considered a fair valuation, given the historical context.
7) Inflation Check:
“Inflation plays a critical role in influencing our purchasing power”.
Put simply, it is a metric that leads to the gradual increase in prices of goods and services over time, impacting consumers’ personal finances, spending habits, and buying decisions.
As inflation rises, buyers experience the effects, which can be felt in their ability to afford goods and services in the market and vice versa.
Inflation Data vs Market Data
Though the correlation between the inflation data and the market data is not a straightforward one, we can derive some conclusions by just studying the inflation rates over the past few months and deciding for ourselves.
Reduced inflation means increased spending power at our disposal.
(* The Government of India did not release the CPI inflation rate for April and May 2020 due to the nationwide lockdown induced by the Covid-19 pandemic.)
Stock Market Now!
In India, inflation has experienced a downward trend in recent months, alleviating some of the pressure on the Reserve Bank of India (RBI) to increase interest rates.
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- This favorable development has contributed to bolstering the stock market, as investors have grown more confident in the prevailing interest rate conditions.
-
- The markets have reached an all-time high, and inflation is stabilizing, while the other essential parameters align to indicate favorable prospects for the long term.
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- Fundamental indicators such as the PE ratio, Buffet indicator, FII inflow, inflation checks, and BEER ratio collectively point toward a market that is not overvalued now.
Given these factors, the conditions seem conducive to sustained growth and investment in the long run.
To further strengthen our conviction let us now check from a technical perspective as well.
Technical Check:
RSI Check:
What is RSI?
The Relative Strength Index (RSI) was introduced in 1978 by technical analyst J. Welles Wilder Jr. in his book New Concepts in Technical Trading Systems.
The relative strength index (RSI) is a momentum indicator utilized to assess the speed of recent price fluctuations to gauge whether a stock is likely to experience a surge or a decline in value.
How to predict the growth or decline of a stock using RSI?
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- When the RSI goes below the horizontal 30 reference level, it indicates a bullish signal and is considered to be oversold, implying potential price growth.
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- Conversely, when the RSI goes above the horizontal 70 reference level, it indicates a bearish sign, suggesting an overbought position which may lead to a potential price decline.
What can we derive from the above illustration?
The provided chart depicts the weekly timeframe setup on TradingView, featuring the 14-period Relative Strength Index (RSI) as the selected indicator, which calculates price changes over the past 14 periods.
Based on this setup, we observe that the RSI indicated overbought conditions in both February and October 2021, preceding subsequent market declines.
What is the current scenario of RSI in 2023?
In the current scenario, the RSI for this week has already begun moving toward the median line, signifying that the market’s valuation is not as elevated as it was in February or October 2021.
When combined with the fundamental analysis we previously discussed, we can deduce that Nifty’s valuation is diminishing and is currently in a healthier state compared to its condition during the year 2021.
What’s Our Action Plan?
The first rule of compounding is to never interrupt it unnecessarily
-Charlie Munger
Now that we have learned that our markets are not as expensive as we had thought earlier what should our course of action be?
When we posted this question earlier in the introduction, we did not have an idea as to how the markets are prevailing, but that’s not the case now.
The answer is….
Do Not Stop! Persist…
“keep investing in your SIP, regardless of whether the markets are doing well or not”.
You must have seen the below image circulating on social media as why not to stop your SIP. This is true for reasons that SIP is convenient and gives people peace of mind in investing, thereby committing more time to his/her family and other priorities.
The money you put in during the initial 6 years can make up to 58% of your total investment amount by the end of your investment tenure.
If you had held these investments citing market conditions or other factors, we may end up with a lesser corpus or get lesser than the expected CAGR.
9. Conclusion
Here’s an interesting fact: if you stay invested for the long term, your daily gains might even match the value of one entire month’s SIP
This remarkable growth is due to the magic of compounding, which can only be realized when you remain invested over an extended period.
“Time in the market is more important than timing the market”.
So, embrace the power of long-term investments to witness the incredible benefits of compounding.
Are you interested in investments and spend your time relentlessly searching for a financial plan on social media sites like Quora, Facebook, Twitter, etc?
A professional Financial Planner is an expert in clearing your doubts!
Happy Investing!
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