Nifty PE crosses 24|A statistically informed entry-exit model!

It’s different this time are 4 most dangerous words in investing. So i wouldn’t say it’s different this time. But it is also true that not everything is the same.

  1. During the past market highs, our GDP growth was also at cyclical high, this time GDP is slowing down. It is more likely to pick up from here than slow down.
  2. Corporate earnings growth was strong during previous peaks due to strong GDP growth. A combination of high earnings growth coupled with high PE ratio is not sustainable. In each case either earnings growth slowed down or PE ratio dropped or both causing a bear market. This time earnings growth is subdued. If at all, it will pick up from here.
  3. Interest rates are low which causes PE ratios to be high.
  4. Volatility is low (VIX dropped below 10 earlier this year) which reduces risk of investing in stocks making them attractive.
  5. Inflow into MF equity scheme is due to above 2 factors which is unlikely to reverse suddenly.
  6. Other asset classes (Gold, RE) aren’t doing so well or yielding very low (FDs) so there is tina factor (There Is No Alternative).
  7. Global markets are strong. Center bankers are not withdrawing the stimulus.
  8. Nifty 50 has added more high PE stocks (Bajaj Finance, Eicher Motors) recently replacing low PE stocks like Bank of Baroda, PNB etc.
  9. Finally, in previous peaks, market had produced above average trailing returns, this time trailing returns are just average (even below-average depending on what period you consider). PE ratios are high because earnings growth is missing. Demon, GST, low inflation, changes to NPA rules etc are few factors behind that. But these are all short-term-pain-long-term-gain type factors.

This is the fist time in decades we have many essential ingredients of a bull market (low interest rates, low inflation, no coalition government in Delhi, low capacity utilization, govt committed to fiscal discipline, reforms, strong currency, low oil prices, low current account deficit, low volatility, sensible monetary policy etc) in place. Last time I remember some of these factors were present was 2003 in addition to a bear market bottom. We saw one of the strongest bull markets in next 5 years. We might be in the middle of one but certainly not at the top.

Even if PE ratio is high, essential ingredients of a bear market (strong trailing returns, high inflation, rising interest rates, runaway fiscal deficits, uncontrollable current account deficit, political instability, weak currency, GDP slowdown, bad companies raising huge money from IPOs, indiscriminate buying etc) are missing. Market needs a strong catalyst to change direction.

A high PE means that future returns aren’t going to come from PE expansion but earnings growth so I am focusing on companies that will grow earnings and not banking on multiple expansion.

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My two cents: Inspite of all the positives you have mentioned, Indian market may face a significant correction if global markets face a severe financial crisis. FIIs still hold about 20% of the entire Indian market cap, and sharp out flows can cause sudden correction leading to panic among domestic investors.

So we should also include global factors into this interesting discussion.

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Currently, the fundamentals are not good. They are shaping up and are expected to improve in the quarters to come. But, currently they are not good. However, the investor sentiment is at its absolute peak. There is greed in the air. IPOs are going full house, the worst of the worst are jumping 25% on just the mention of a positive news. This is greed, and is aptly represented by the PE of 26.80

PE ratio is a very good measure of fear and greed. On the other hand, when fundamentals become good, PE can still reach levels below 15, as the investor sentiment could be of fear combined with good corporate earnings. It has happened in the past, that market fell while fundamentals were good.

A consistently profitable investor would be one who would buy in times of fear, and sell in times of greed… and a PE is a good measure of both.

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Just happened to be reading Peter Lynch’s “One up on Wall Street”. This section is pertinent to this discussion. What I find more interesting is how what is considered normal P/E has moved with the times.

Sometime in January, I think it was Marc Faber on CNBC who theorized that the market may move to a P/E of 30 and that it would be considered acceptable like how 25 is acceptable now. Coming to think of it, we have been progressively pricing in future earnings much ahead in a lot of aspects of life. I hear people take 30 year loans these days on houses? Isn’t that sort of the same where both the lender and the borrower are pricing in earning capacity for 30 years?

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I agree with you on this point Amit @jamit05, something I have highlighted in on my previous comment.

I think nobody here is contradicting to the India growth story here, which is pretty understandable as well.

Our population is growing at a rate of about roughly 2 crore every year and it is only natural that in the coming years consumption will rapidly increase and businesses in pretty much every sector will boom and that will reflected by rise in the stock market. Also expansion of the middle class is a massive positive. So the future is bright indeed for our country’s economy I believe.

But I don’t think the current ‘investor’ sentiment that we are witnessing in the stock market is a reflection of that optimism.

We do know that the recent upsurge in the market for the last couple of years or so is on a major part because of the huge influx of common man’s money through the mutual fund route and while I find it to be a real pleasure to see that the long held notion among the common Indian household that ‘stock market to jua he’ is slowly changing for the good and our market is slowly becoming less dependent on FII, but we should also not forget how the same common man who is feeling very optimistic today seeing his investment are green, can turn frustrated really quick when for some reason the market slows down (by nature) and the numbers get stagnant and on the 3-month, 6-month and 1-year average it starts showing red.

The reason why I put the word investor in quotes in one of the paragraphs above, is that the common man whose money is pushing the market today is not really an investor at core. I have a lot of friends who are ‘investing’ in the market through the MF route, but I have only 1 of them who has seen the 2008 market crash, and I believe it’s the same for a lot of us here.

A major part of them are yet to even see their first bear market, let alone a economic meltdown. So we don’t know how they will react when things go bad, but I think it is likely that it won’t be good.

Obviously it is my own view and I maybe completely wrong, I am no expert after all.

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Yogesh sir, great fan of your analysis, but don’t you think we are doing an intellectual treachery here by not discussing the negatives like anemic job growth for last five years, distress among the SME business community, outperformance of financial assets with respect to real assets (Ex. many SME owners are becoming full time share traders to earn a more decent living) and a government where economy is more run by PMO bureaucrats than by economists. Moreover there is an elusive earning recovery which everyone is saying just around the corner for last twelve quarters.

I believe it’s better to be cautious at this point and I personally don’t believe (I know I may be wrong) that fund managers of MFs are better allocators of capital than individual investors, they have the same herd mentality. Moreover, MFs have far higher limitation to invest in comparison to individual investors

After stalking the valuepickr posts for last three years, could not resist to delve in now.:grin::grin:

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Very interesting discussion

My 2 cents

Market corrects by 5-30%
But undervalued or good stocks goes up by 2-100x

  1. timing market is not possible
    Can’t buy at lows
    And can’t sell at highs

But it’s a good strategy for people who can’t find the undervalued /fair value good growth stocks

I am currently 110% invested

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This market is like a wagon run by horses full of hope and liquidity. You can never time when these horses will get tired as enough feed is being given to them at present by govt, domestic investors and positive global sentiment on equities.
Fact as an investor is you have to take the tough choices
1.slowly throw your stuff out of this mad wagon and get out but the risk is you could probably miss the most exciting part of the ride.
2.Hold on tight for the bumpy ride and also be ready to jump out when you could spot the steep. Risk is you could be lazy, complacent and get really hurt…

At the time of a big market crash like 2008 (I am not trying to predict one in near future, no one ever knows when it will happen, except for permabears who predict it everyday and one day in thousands they are right :smile: :smile:), we have seen even bellwether stocks like HDFC twins have lost 60% of value in one year. There have been multiple days when it lost around 10% in a day. When panic grips the market and stocks continue to move towards weaker hands, no good stock is immune.

Disclosure : My portfolio is currently 50% equity, down from 80% one month earlier. So its safe to assume my views are biased.

I am also sort of conservative like you, however my holding is little less than 50%. However, I often contemplate with myself- What if the market runs up another 10-30% from here? Will I be tempted to enter in between or not? Also, if and when the BIG FALL comes will I be ready to deploy the cash- not easy to catch a falling knife. Also, after a major fall there is possibility that the markets remain subdued for 1-3 years (who knows)

Lots of ifs and buts, doesn’t it make sense to be invested all through out (percentage may vary). Cause I have been also contemplating to reduce my holdings in single digit, but seems extremely difficult.

Agree Hdfc lost 60% but all regained and then started componunding again

I find it very hard to time the market
Some lucky ones might time it
But for me it’s always opposite
If I sell then from next day the stock starts running like crazy :blush:
And I can then never enter that stock

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Please let us know a day before you sell, we will start buying :smile:

p.s: sorry, could not resist.

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I am not sure of the point you are making here. Even if you bought HDFC Bank at the 2008 top, your stock is still up more than 5 times. If you bought at the bottom, its up more than 10 times. More likely your average is somewhere in between so its up 7-8 times. Stock selection is more important than timing.

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I think a mistake most people make is to judge the decision on the basis of its outcome. For example, if I sold a stock and it went up, I may think my decision was wrong, while if went down after I sold, the decision to sell was right. Or if I bought a stock and then it went up, the decision was right while if it went down after I bought, the decision was wrong. However, stock investing is not a perfect science. There are several variables that are neither known in advance nor predictable which affect the outcome of the decision. Hence a decision cannot be judged by the outcome alone.

What matters is the process by which the decision was reached. One needs to get the process right, and stick to it.

Does this mean that eventual success or failure depends on luck? My answer is both yes and no. For individual decisions, yes – luck does play a part. However, over a series of decisions taken for a long period of time, luck will eventually even out and the outcome will be determined by the strength of the process you started with.

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“A mistake is not something to be determined after the fact, but in light of the information available until that point.” - Taleb in “Fooled by Randomness

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Sorry, VIX is a contrarian indicator. Its not advised to buy stocks when its low or sell when its high. Low = Complacency, High = Fear. If the market is crashing to low PEs & VIX is spiking, I would sell my house to buy stocks. Check INDIAVIX for the following periods: Oct-2011, Aug-2013, Aug-2015.

I thought that’s the right environment for long-term investing…when nobody else wants to buy them.

It sounds like the current high PE and low earnings growth environment is great for long-term investment! I am not so sure.

This is not a buyer’s market. Whether you keep or sell your current holdings is your choice, but its definitely not the right time to make fresh additions. Definitely don’t swing for the fences.

Even the greatest batsmen would be advised to play defensively against Mohammad Amir. Hit 1s and 2s (buy small). Keep your wickets (cash); they will come in handy when Amir’s spell (high PE environment) is over.

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This book I have read a dozen times :slight_smile:

Peter Lynch has clearly said on this page that he wishes some student of the PE had advised him, it is simple for us to understand how much value it has when he agrees with it. But today it seems everyone has better strategies than Lynch and other very experienced investors. An overheated market is an overheated market and it is as simple as that :slight_smile:

Hi @v31

Well there are some wonderful questions there. I can share how I think of them. The most important thing to me is to have these answers (and some more) ready in advance so when the moment arrives we are then aware of exactly what steps we have to take, then there is no confusion or uncertainty on am I doing what I believe is right. It is a strategy thought out in advance, simply to be implemented.

What if the market runs up another 10-30% from here? - It does not matter. We neither want the top nor the bottom. We want value in a growth stock. For example today, there are no value buys in growth stocks; at least I cannot find any. Deep value stocks do not pay off too much. Growth at a fair price is the best place to invest. The issue right now is growth is available, but at a fair price it is not available; what else is the problem with a bull market, nothing.

Will I be tempted to enter in between or not? - Temptation is one of the evils right? :slight_smile: In the stock market most things we don’t have any control over, temptation is something we can control. So we should build resistance to temptation.

Also, if and when the BIG FALL comes will I be ready to deploy the cash- not easy to catch a falling knife - Well the stock market knife is a very simple knife. When a particular stock starts falling like crazy it is most of the times due to deteriorating fundamentals or some particular news on the company. If we see it is deteriorating fundamentals we must exit or not buy, if the news is just short term, then one could attempt to catch a falling knife as people will forget it soon. Example, Maggi Ban.
The second falling knife is when the knife is falling on everything indiscriminately. That time, we know it is a time to buy as it is not falling on a company it is falling on the entire stock market so good growth companies suddenly become available at a fair price. Example: De-monetizaton.

Also, after a major fall there is possibility that the markets remain subdued for 1-3 years (who knows) - That is a dream for any value investor. That the markets remain subdued while I keep ploughing in my fresh available cash flows that come in monthly or quarterly or whatever to buy more and more of a good thing. If I get 3 years to keep plugging into my good investments it is only better for me. Then time is our friend :slight_smile:

Those are the kind of rules I have for myself anyways, hope they help in some small way.

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One thing that bothers me about making fresh investment in this market, everyone I talk to use a term : Temporary Depressed Earnings. This is the second most widely used term in this market (first being Moat). What if this is not the depressed earnings but the new normal? This has happened with Japan and more recently in China too.Yesterday talked to a friend who is at a senior post at SBI Corporate and privately he was not so enthusiastic about the recapitalization as lots of evergreening of bad loans is still going on.

For the last twenty years we can see that India’s growth is synced to global economic growth. Now when the global growth is at a ten year high (Source), India’s growth is still not coming back. It’s as if our growth has diverged from the global economy. Is it structural or just a blip?

Even though well managed growing companies tend to perform really well even in bad macro conditions, they hardly run full throttle. And the more important question is if India is performing badly in such a benevolent global condition, what will happen if a black swan event like China Debt Bubble collapse or something like that happens?

P.S.: We investors should remember that most spectacular rise in our portfolios happens when market is near the peak. If one uses this post as logic to liquidate his holdings, there is a very high probability that he is going to curse me for rest of his life.

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Above statement is Gold.

When we observe parabolic rise in asset prices know that there is a pin waiting to prick the bubble.

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@valuestudent - From a behavioural economics standpoint, I think the difference is that some people are satisficers while some are maximisers. The ones that are ready to book profits and get off without regret if the market goes up 10-30% are satisficers. Maximisers will continue to hunt for bargains even in a overheated market because its in their nature to do so. Either will have their own view of what is right thing to do (Right based on inputs and disposition and not outcomes).

One path may emerge out of many as the future history and the rest become alternate histories (possible histories which didn’t turn out to be). Preparing for only one, no matter how likely it has been, based on past outcomes, is not the best approach IMHO.

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