Are Indian markets overvalued based on historical stats? That’s the question I’ll try to answer using historical data. While past data can be used as a map to understand what could possibly occur in the future, we must be wary of the idea that the same data can actually make us overconfident, compared to people who consider it risky to drown in such data.
I have collated the below vantage points, based on multiple articles/books I’ve read over the years. Hence, I thought let’s try to attack the problem from multiple angles instead of being a man with a hammer =D
Total Market cap of BSE companies
Let’s start with the total market cap of BSE companies (data available on BSE’s website). If we were to consider returns between peak market cap in the previous market cycle and today, the returns have been 16.7% CAGR, which is on the higher side. Conversely, from the previous top to the current top, the CAGR works out to 10.9% which isn’t a great return, considering risk-free interest rates during the same period.
Nifty P/E ratio
Nifty P/E, a widely tracked data point (or at least it used to be), is up from a low off 11 in 2009 to 39 in Jan 2021.
Let’s look at the “E” in the P/E ratio.
Nifty’s earnings per share have tanked by 20% from their peak of 452 in Jan 2020 to 364 today. If we were to assume Nifty’s earnings will be back to pre-covid levels, Nifty50 would still trade at 32 times earnings (14530 divided by 452).
32 P/E for the Nifty is still high by historical standards. Why then, is the market discounting Nifty’s earnings to the moon? I have 4 possible theories.
- Margins of Nifty companies are subdued (which is possibly why Nifty’s P/BV is low although Nifty P/E is high) and the market is expecting margins to bounce back at some point, leading to faster than expected EPS growth, from current levels.
- The market is predicting a healthy future state of the economy and not the other way around.
- The US Fed is printing $1.2 Billion (₹ 8700 Crores) everyday and all of that money is chasing assets like Bitcoin, Emerging market equities like the Nifty50 & Technology stocks in the US and other countries. The prices of these assets are probably being driven up by the TINA factor (There Is No Alternative – Read on Valuepickr)
- We are in a bubble and people inside the bubble don’t realise they are inside it.
Nifty’s Price to Book Value
Starting from the aftermath of the Global Financial Crisis in 2010, Nifty’s Price to Book has been in the range of 2.6 to it’s current 4.0, indicating we are in a bull market and not necessarily in a bubble market. Effectively, a low P/BV means, the assets of Nifty companies have grown, but are yet to produce the earnings they are supposed to produce (perhaps due to subdued margins or lower than usual asset turns) and Mr. Market is smart in discounting this factor.
Low interest rates
What do low interest rates mean for equity investors? In a recent interview, Warren Buffet said “think of it, the ten-year (Bond) at 1.4% that means you’re paying 70 times earnings for something that can’t increase its earnings for ten years.“
This means, investors in the US can either:
- Invest 100 bucks in a US treasury bond and get 1.4 bucks per annum as interest, with zero capital appreciation in the price of the treasury bond. This also results in permanent loss of capital, in terms of reduced buying power, thanks to the demon called inflation.
- Take some risk with the same 100 bucks and buy equities at P/Es much lower than the 70 P/E that the US Treasury Bond is currently available at. Better yet, they get to expect some growth in the earnings of businesses that you are buying.
What would you rather do? I think it’s fairly clear, most enterprising people would choose option 2.
In the Indian context, current Gsec yield is 5.8% – This means you can either buy a Gsec, guaranteed by the Govt. of India, at 17 P/E and are assured of no growth for 10 years or you can buy a basket of stocks at sub 20 P/Es and can hope for at least some growth over the next decade.
Market cap to GDP
The market cap-to-GDP ratio has been volatile as it moved from 85% in June 2018 to 58% in April 2020 and now stands at 98% FY21 GDP.
There were instances in the past, when this ratio hovered around 130%+ levels.
Critics of the Mcap to GDP ratio say, it doesn’t apply to India because the market cap does not capture MSMEs which contribute a significant chunk to India’s economy. Two, a good number of large and highly successful businesses prefer to remain private in India for reasons such as lower compliance requirements and easy availability of private capital.
When people no longer have colleagues/bosses peeping into what is on their monitors, they behave differently. The lock-down induced work from home culture brought a new generation of first time traders/investors to the market in 2020 and the same is reflected in the upward trajectory seen since April 2020. India has added 80 lac new demat accounts between the lockdown and today!
Mutual Fund SIP inflows
Mutual Fund SIP inflows between June 2018 and Jan 2021 have grown at 5.8% CAGR. Think about the feedback loop created by these inflows. Higher inflows lead to higher stock prices which in turn leads to even higher inflows.
Let’s look at the MF SIP data in another way. Pre-Covid peak monthly SIPs were in Feb 2020 (8641 Crs). If we were to assume this peak SIP amount from Jan-Mar 2021, here’s what the annual SIP data would look like. Based on this assumption, the below chart tells us, SIP inflows, which is one of the indicators of investors’ faith in the future of our country’s businesses isn’t even back to Pre-Covid levels.
Large cap vs Mid cap vs Small cap
The above 3 charts illustrate that although Nifty50 has been going up, the Nifty Midcap 100 index has been flat while the Nifty Small cap 100 index is still down by 23% from it’s previous highs, achieved in Jan 2018.
For the sake of an example, at the start of this month, we recommended a small cap auto ancillary company to our clients which has gone up by significantly (thanks to all time high sales posted by the co. recently) within the last month and is still available in lower teen multiples of it’s last 4 quarter’s earnings. This means, there are still opportunities out there, in the small cap space, waiting to be tapped.
The mother of all – Liquidity & The Federal Reserve Board
As Ravi Dharamshi, of ValueQuest, recently said about the effect of all the new dollar bills being printed, and assuming history will either repeat or rhyme, yet again, what will be the consequences of a ballooning US Federal balance sheet, over the next few years?
- Nifty P/E could be an incorrect indicator of market valuation, particularly so, during extreme events such as Covid19
- The market’s Price to book is still not outside the “normal” range.
- Opportunity costs matter – Low interest rates equal higher PEs for equities.
- Market cap to GDP is on the higher side, but not necessarily obscene. And this is despite a subdued economy.
- First time investors/traders got introduced to the markets due to lockdown and subsequent work from home culture.
- Mutual Fund SIPs back to Pre-Covid levels.
- There’s still some value left in the small cap space and in certain mid-caps.
- The markets are probably discounting higher future market caps, thanks to an exploding US Fed balance sheet.
- The difficult part of a bubble is not noticing it, but timing it.
- We are in a bull market, but not necessarily in a bubble. If you have conviction in the long term future of businesses that you’re invested in, stay put.
Timing the crash
For those of you smarties, who’d like to time the crash, here’s what Cory Wang of Bernstein Research, noted recently after analyzing documents dated right before the dotcom bubble burst in 2000 – the hard part of a bubble is not noticing it. The hard part is timing it. You could be wrong for a while, before you may or may not be eventually right. And you could turn out to be right, for the wrong reasons.